How can Bitcoin Shake Off Bitfinex Hack?

Following the hack that successfully stole $64 million worth of Bitcoin yesterday from Bitfinex, there are still no answers to the questions on everyone’s minds.

Who was responsible? At this point, it seems there are two possible answers; a collusive effort between BitGo and Bitfinex, the holders of the keys to the multi-signature wallets that have missing funds or a malicious hacker. When will we get an update from Bitfinex on the status of fiat currency holdings? And finally, how will this impact bitcoin in general over the long term?

While bitcoin was designed to be decentralized, Bitfinex is an example of a centralized exchange. This latest hack highlights the risks associated with centralized exchanges, where losing customer’s money due to security breaches has been a recurring issue. For example, the infamous Mt. Gox scandal and BitStamp provide two examples of the unreliability of centralized exchanges. Users on Reddit are now calling on others to withdraw bitcoin from any websites, switching to ‘cold storage’.

Other cryptocurrencies are starting to carve up a larger slice of the industry, with Ethereum Classic recently gaining traction as the third largest cryptocurrency and Ethereum being one of the main beneficiaries of the Bitfinex hack. Bitcoin’s waning dominance is illustrated by the market share of altcoins relative to bitcoin and all other cryptocurrencies increasing from 13.4 percent in August 2015 to 19.7 percent at present.

One alternative to centralized exchanges that could see increased interest is BitShares, which has the novel feature of a decentralized exchange allowing trading with bitcoin against the US Dollar, Euros and Gold. Will we see cryptocurrency traders and holders shift toward decentralized exchanges to securely buy and sell bitcoin?

Individuals that abuse the bitcoin network for their own gain will act as a drag on the development and freedom to innovate in the sector. However, experts in the field have proposed some solutions that could reverse negative sentiment regarding Bitcoin.

Action, Reaction…

So what does a possible solution to the frequent attacks on exchanges that will secure customers funds look like?

One solution that has been proposed is to enact a soft-fork allowing Bitfinex to double spend and miners block the hacker from moving any funds. However, while such a move would effectively bribe miners to reorganize the blockchain, so could the thief and in fact could

give miners larger bribes as the thief does not take on any of the costs associated with reorganizing the blockchain.

Emin Gün Sirer, a prominent hacking expert, argues that this approach is misguided; irreversibility is crucial for dealing with people you do not trust. If you are transacting with people you do not trust on Paypal or Ebay, for example, chargebacks means that you could be fleeced for your money. Conversely, once you receive or send a bitcoin payment it cannot be reversed and it is recorded on the blockchain forever, meaning these malicious transaction reversals cannot be initiated.

Instead of the soft-fork solution, Sirer proposes a scheme whereby the irreversibility is not sacrificed but instead allows users to retrieve their funds in the case of a hack.

Sirer describes it as a vault, a type of cold storage wallet where to pay for things you would have to move funds out of the vault to another wallet. The unique aspect of this ‘vault’ with two keys instead of one. One of these keys would be used to unlock the vault and allow you to move your funds to spend whereas the other would be used in the case of a hack to retrieve stolen funds within 24 hours. The paper outlining this solution can be found here.

This solution would not permit reversing real transactions and only allows people to take back their own money from someone who is trying to steal it. But as of yet there has been neglect of this idea, pushed to the side by the block size debate. While we do not know yet whether Bitfinex or a thief was responsible, the vault solution would protect bitcoin holders whether there is an insider attack or hackers attacking an exchange.

Emphasis on the vault mechanism would be a step in the right direction at this juncture leaving the block size debate on hold for now. While the scalability issue of bitcoin has taken dominance, the security issue looks to be more important for bringing new users into the Bitcoin ecosystem. The general public will not overcome inertia to traditional money and banks unless they know their money is safe

The debate over security must take center stage to solidify Bitcoin’s position as the top cryptocurrency.