Bitcoin Exchanges

 

By Othman Darwish

Nowadays Bitcoin has proven a great success as a virtual currency. With its innovated payment network protocols, as open and trustless environment, that is protected by cryptography, users of Bitcoin enjoy transacting and executing their payments in highly secure, fast and with less fees compared to traditional payment systems. The decentralize nature of the Bitcoin payment network, where there is no need for intermediaries or third parties, plays an important role in its success, in fact this shapes the  innovation that the Bitcoin payment network is all about, and makes it competing alternative with the traditional currency. Yet, when it comes to Bitcoin Exchanges markets, where the user could buy or sell Bitcoins with other currencies like USD, EURO or AltCoin, the exchange has a single point of failure since it acts as intermediary between buyer and seller, and thus the trustless decentralized core feature of Bitcoin payment network is vanished. The trust of those Exchanges is one of the main reasons that lead to small adoption of the Bitcoins as an alternative currency, this is in addition to fluctuation and differences in prices between those Exchanges.     

In his study Dr. Tyler Moore investigated the risk posed by Bitcoin Exchanges, these exchanges have popped up over the past few years; Moore found that half of all these exchanges have been subsequently closed, and many of those closed exchanges did not refund their customers who had bitcoins accounts (addresses and private keys) stored in these exchanges. Exchanges could close for any reason just like any other businesses, for example they may not attract enough customers, however in Bitcoin exchanges, they are frequently closed because they are hacked by criminal who want to steal the bitcoins held at the exchanges. This problem happens with some frequency; Moore found that exchanges with low transactions volume are more likely to subsequently closed and have greater risks than more popular Exchanges. The second result of the study shows that again the transactions volume matters, but it went to opposite direction; the higher transactions  volume, the more likely those exchanges would be breached and hacked. Finally, the study concluded that from security perspectives, the biggest threat within the Bitcoin ecosystem takes place outside the protocols specification, and those exchanges do pose substantial risk .

Fortunately ,Bitcoins  network protocols could solve this problem, when it is adopted/mandated by all Exchanges, Bitcoin network protocols provide complex transaction type, which requires multiple signatures to be executed form  different parties before the bitcoins transfered from one address to another, those transactions are usually known as M-of-N transactions. Stander transactions of the Bitcoin network  require only a single signature of the bitcoins owner who own the private key that is associated with the address (public key) of those bitcoins. In the case of  M-of-N transactions, there are multiple signatures addresses that are linked with multiple private keys, the M-of-N address has N private keys and requires M of signatures (parties) in order to unlock the transaction and makes the transfer. In the current Exchanges model, there are three main parties involved in executing the trade; the buyer, the seller, and the Exchange itself. By applying 2-3 signatures transaction when executing the trade, the buyer will hold a private key, the seller will hold another private key, and the Exchange will hold the third private key, during the execution of the payment, if the buyer and seller agreed  on and the payment goes smoothly, both the buyer and seller sign the transaction, if they disagreed, the third private key held in the Exchange will provide escrow like and arbitrate on the disagreement and decide whether the buyer or seller has the right to own the coins. From security perspective, if the Exchange hacked or compromised, the hacker can do nothing by the Exchange private key, since he is in need for the buyer or seller private key in order to unlock the transactions and steal the coins, and in case of  dispute and disagreement between the buyer/seller, the Exchange cannot move those coins to his own, all what he can do is to move it to either the buyer or seller. This model is currently adopted by some Exchanges such as MultiSigna. With multi signature transactions, the risk of Exchange exposure will be minimized, yet the central and trust nature still need to be established with those Exchanges  to resolve disputes between  trading  parties.

References

   

· Gerrard Hartley (2015), MultiSigna: The Bitcoin Market Exclusively Using Multi-Signature Wallets,cryptocoinsnews

· Tyler Moore and Nicolas Christin (2013), Beware the Middleman: Empirical Analysis of Bitcoin-Exchange Risk, Computer Science & Engineering, Southern Methodist University, USA