QuadrigaCX, Canadian crypto exchange, is another in a seemingly endless list of crypto brokers who have screwed up badly (read about LocalBitcoin’s security breach for another recent example). The exchange’s problems are twofold. First, QuadrigaCX lost access to funds in cold storage. Second, QuadrigaCX is having liquidity issues. Both of these issues are problematic but the first is much more embarrassing.
What does it mean to lose cold storage access? In the world of crypto exchanges, this means “we lost our users’ money”. Crypto exchanges routinely keep large stocks of cryptocurrency in storage not connected to the internet. This prevents anyone else from being able to access these coins. It’s the same way a Bitcoin paper wallet, or a hardware wallet like the Ledger Nano S, works.
Cold storage is great as long as the owner can access the funds. This requires the owner to keep track of a secret key. The secret or “private” key is a long alphanumeric code that serves as the ID of ownership for various quantities of cryptocurrency. Specific Bitcoins go with specific keys, and no one without the correct key can use specific Bitcoin.
An exchange losing private keys to cold stored coins is very much a “you only had one job!” unforced error. Any exchange that loses access to cold storage is obviously poorly managed, to say the least, and QuadrigaCX shut its service down for a time after this revelation.
Knowing this, it should come as no surprise that QuadrigaCX was also suffering from low liquidity. Liquidity indicates a cryptocurrency (or any other asset) that can be easily bought or sold because there are plenty of customers and plenty of asset supply on both sides.
When a cryptocurrency exchange starts to lose customers, or a specific digital asset stops being traded, liquidity suffers. There are either too few customers or too little supply to fill orders, or both. In the case of QuadrigaCX, it’s likely that both problems were a factor.
Not all of this is QuadrigaCX’s fault. Cryptocurrency customers are not very active right now, and retail investors are especially quiet. This makes it very difficult for cryptocurrency exchanges, who survive on transaction fees, to make money. However, this doesn’t make it any less unacceptable for a fintech company like QuadrigaCX to lose access to its own funds.
This event simply underscores the reality that this market is learning to accept: the cryptocurrency industry is not as robust as conventional asset markets. More and more exchanges will have catastrophes like this and exit the space. Will effective players rise up and carry the industry into a new, more mature era? We’ll have to wait and see.
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