The recently announced hack of South Korean crypto exchange Coinrail brought the impact of hacking back into the spotlight alongside its effect on the nascent crypto economy. Unlike global fiat currencies which have some resistance against shock events, the crypto market is still too young to resist such a sharp incident.
As such, hacks tend to directly impact cryptocurrencies because of their ramifications on the broader market. The Coinrail incident, for instance, was closely followed by a 7.00% dip in bitcoin prices, with other cryptocurrencies suffering similar losses. All told, the hack of a little-known exchange was responsible for a loss of almost $30 billion in value.
The key factor to consider is that this is not an isolated incident, but rather a problem that appears engrained with cryptocurrencies’ architecture. Because of their digital nature, there are a few reasons hacks have such a strong correlation with losses in the major coins.
A Lack of Regulation Amplifies Shocks
One of the biggest attractions—and the biggest risks—is the lack of government regulation apparent in cryptocurrency markets. Although exchanges have somewhat centralized the coin and token market, digital currencies operate completely independent of any central authority. As such, they are not beholden to any restrictions, but they also lack many of the fail-safes central banks and governments have to mitigate the impact of financial shocks.
The absence means that a hack, no matter how small, may result in the loss of millions of dollars in value that may never be recovered. When Mt. Gox was hacked, nearly 650,000 coins were lost, and thousands of customers were left without a penny in their wallets. Bitcoin reacted with one of its biggest crashes, with nearly 23% of the capitalization wiped out in the immediate aftermath, and almost half of its value erased before eventually bottoming. While regulators are not always a positive force—they can create unnecessary layers of intermediaries, establish counterproductive policies, and more—they do provide some mechanisms for currencies to withstand shocks.
Hacks Can Erase Significant Value, and Cause Panics
The common thread in most of the well-publicized hacks is the massive number of coins that simply vanish, many times without a way to be recovered. From a purely economic standpoint, this would lead to higher valuations as coins become scarcer. However, this isn’t always the case for a few reasons. The first is that while the coins may be closed off to the users from whom they were stolen and even to exchanges, they are still in a wallet, and thus the number of coins doesn’t actually change.
The second is more psychological, but no less important. Massive hacks are panic-inducing events which directly impact sentiment. For cryptocurrencies, which largely depend on sentiment for their valuations, a dramatic change in perception can be potentially fatal. As substantial sums are drained from exchanges, users may rush to cash in their currencies or simply withdraw from the market, leading to selloffs and other price dips as sentiment cools. During the CoinCheck hack, Bitcoin lost more than $500 in value in under 12 hours, while most other major cryptocurrencies followed suit, experiencing double digit losses.
Hacks Can Result in Coins Flooding The Market
For hackers, holding a considerable sum of cryptocurrencies is never the end goal. For one, cryptocurrencies’ public keys can be used to trace specific coins to the wallets or exchanges they’re being held in. This means that the longer a wallet contains a coin, the more likely it is to be tracked to that wallet. Second, exchanges and cryptocurrency development teams can quickly move to block the coins that were stolen from circulation, which effectively nullifies their value.
To get around this, hackers use a variety of tools to launder their cryptocurrencies. This includes ‘tumbling’ them, which bunches together legitimate coins with stolen ones and transfers them between wallets to mask their movements. Others may simply attempt to exchange them for a different cryptocurrency and subsequently sell them. The impact of this is not often discussed, but it can be harmful to the entire ecosystem. By flooding the market with thousands or even millions of coins at once, hackers can significantly devalue coins and catalyze steep selloffs. EOS was recently suspected of doing as much (without the hacking) when it sold thousands of ETH over a short period.
Hacks are unfortunately a reality in the crypto market, and they can have a significant impact on prices. However, as the market continues to expand and stabilize, the impact of these attacks may start to dissipate as exchanges, users, and the overall industry learns how to cope better with the shocks hacks cause while systematically working to reinforce security protocols.