May 4, 2019
Exchanges: From Casinos to the Drivers of Blockchain Innovation — Part 1
[UDC Story — Insights from UDC 2018]
As Bitcoin prices were nearing KRW 22 million (approx. USD 2,000) on January 11, 2018, things abruptly took a downward turn. In less than 2 hours, the price plummeted to the KRW 14 million range. The collapse was triggered by comments from Park Sang-ki, South Korea’s Minister of Justice. Earlier that day during the traditional New Year’s press briefing, he stated, “Cryptocurrency trading is shaping up to be no different from speculation or gambling. All related agencies (financial authorities, etc.) agree that cryptocurrency exchanges should be shut down.” Within the crypto community, this day is known as “Sang-ki’s Uprising”.
The entire cryptocurrency market was in turmoil, and the Blue House (Korea’s White House) stepped in to calm the flames. They stressed that the statement was the minister’s personal opinion and not the government’s official position. Too little, too late, especially since the market already suspected that the administration viewed cryptocurrency trading as just another shady gambling operation. It looked as if the government, needing to nip the issue in the bud before it became politically damaging, but not wanting any of the backlash, sent out the minister to take one for the team.
Just a week later, another proxy publicly defended the government’s anti-crypto stance. On the 18th, JTBC, a prominent cable network, hosted a televised debate titled ‘Newsroom/Emergency Debate — Virtual Currencies: A New World or A Mirage.’ Rhyu Simin, a writer and former Minister of Health and Welfare during the Roh administration, went on the program and made this comment:
“To use an analogy, blockchain technology is “architecture,” and Bitcoin is the “building.” The building was originally supposed to be a community center, but once completed, it turned out to be a gambling house. So, we’re trying to regulate this gambling house, but they’re saying we’re cracking down on the “architecture.” The fact that these exchanges exist is proof that Bitcoin’s promise of decentralization has failed.”
The statement mirrors the government’s view that blockchain technology and cryptocurrencies can be separated, and while blockchain technology should be fostered, cryptocurrency investing must be eradicated. Exchanges are the cause of all problems, the “axis of evil” that needs to be wiped out.
Exchanges = Casinos?
To cryptocurrency investors, there’s a very thin line between love and hate when it comes to exchanges. Exchanges provided cryptocurrencies with liquidity, established market prices, and helped grow the size of the pie.
On the other hand, exchanges also emerged as the epicenter of speculation. Fraud involving exchanges became rampant as the investors’ desires intersected. With no proper regulatory framework, unethical actions such as insider trading went unpunished. Shabby security left customer assets exposed to hackers, and any negative press involving exchanges meant the entire crypto market had to suffer.
Mt. Gox, the world’s first exchange, is the ultimate example of how exchanges can be double-edged swords. Via Mt. Gox, Bitcoin went from a plaything for a small number of hardcore developers to “digital gold”. There was a time when 80% of the world’s Bitcoin transactions went through Mt. Gox. It played a major role in raising the price of Bitcoin past USD 1,000, which had initially been priced based on production costs such as electricity and rent (space for mining equipment).
Of course, Mt. Gox was also responsible for bringing about the first major market crisis. In February 2014, Mt. Gox CEO Mark Karpeles filed for bankruptcy in Japan, claiming that 850,000 Bitcoin were stolen by hackers. That was around 7% of all Bitcoin issued at that time. Converted to current market prices (USD 6,500 per Bitcoin), it equals USD 5.5 billion (approx. KRW 6.2 trillion). Despite Karpeles’ claims, Japanese law enforcement indicted him for fraud. News of the world’s largest exchange going bankrupt lead to Bitcoin prices nosediving, ultimately dropping to the USD 200 mark in 2015. The so-called dark ages continued until 2016, when the Chinese began purchasing Bitcoin en mass as a means to hide their assets offshore.
For Korea, an exchange called Yapizon was the first to court controversy. Hackers stole 37% of their total assets, all of it in Bitcoin, in April 2017, which amounted to around KRW 5.5 billion at the time. Yapizon responded by first deducting 37% from all customer assets, then claiming that they would make it up through transaction fee profits. The question was, of course, who would want to make trades on an exchange that was just recently hacked?
So, they decided to change their name to Ubit and try again. Unfortunately, they got hacked again just 8 months later in December 2018. This time, they announced that they would file for bankruptcy, and there were plenty of murmurs of it being an inside job as the company had gotten cyber insurance just 18 days prior to the incident. Although they claimed they would seize operations, they are still in business after changing their name yet again, this time to CoinBin. According to media reports, one of the hacking victims took over the exchange, assuming all of its assets and debts.
Yapizon was just the beginning. Soon after, Korean exchanges such as CoinRail and Bithumb also became hacking victims. Cash-strapped CoinRail is fighting bankruptcy and Bithumb had to compensate customers using their 2017 profits.
Frequent server outages caused by massive user traffic also contributed to the negative perception of exchanges. Bithumb was once again front and center. On November 12, 2017, as Bitcoin Cash prices began to spike, Bithumb’s transaction volume exploded. Unable to handle to traffic, the exchange was down for more than 90 minutes. The funny thing was, Bitcoin Cash prices, which had surpassed KRW 2.8 million, began dropping rapidly once Bithumb’s service went down. At that time, half of the world’s Bitcoin Cash transactions went through Bithumb, and since half of the world’s transactions were not in play, investors on other exchanges assumed it was a bad sign and began flooding the market with sell orders simultaneously. When Bithumb resumed service at around 5:30 pm, the price of Bitcoin Cash had fallen to KRW 1.68 million.
Investors who couldn’t sell during the high point were rather suspicious of how Bithumb dealt with the situation. Many accused the exchange of purposefully shutting down their service to sell off their own Bitcoin Cash. Investors impacted by Bithumb’s service failure even filed a class action lawsuit. Legal experts believe it won’t be easy to prove unrealized profits or Bithumb’s nefarious intentions, but incident certainly did a lot to paint the picture that cryptocurrency exchanges were run by a bunch of shady people.
To make things worse, investigation by the prosecutor’s office in early 2018 discovered that executives and employees of various exchanges were involved in unsavory activities, including kickbacks for listing coins and misuse of investor’s funds. Reaping illegal profits by running automated trading programs and insider trading on soon-to-be-listed coins were some of the other accusations faced by exchanges
Recently, exchanges have received criticism for manipulating the price of certain coins with low market capitalization after disabling the deposit and withdrawal functions under the pretense of security or system upgrades.
How exchanges help grow the blockchain ecosystem
South Korea’s government has maintained their anti-crypto stance since they tossed out the idea of shutting down exchanges in early 2018. Cryptocurrency exchanges are no longer recognized as venture companies, as the government ratified legislation to remove the ‘buying, selling, and brokering of encrypted assets’ category from their venture company verification list on September 27, 2018.
Other businesses placed in this no man’s land along with crypto exchanges include night clubs, bars, casinos and other late night establishments, which is a clear indication of the government’s unflattering opinion of crypto-adjacent businesses.
Restricting cryptocurrency exchanges by grouping it with casinos yet still wanting the blockchain industry to grow is baffling to say the least. The negative image it perpetuates will directly affect funding and recruitment for countless blockchain startups and will no doubt end up stunting the growth of the entire industry.
This won’t be the first time the government has hastily unsettled a rising industry. Despite showing rapid growth and being responsible for most of the country’s overseas content export, Korea’s video game industry faced a critical challenge when the ‘shutdown policy’ was put in effect. The entire industry opposed the policy due to its unprecedented attempt to label all video games as “harmful”. Ultimately, the competitiveness of the individual game companies suffered as they struggled to attract top-level developers, allowing Chinese game developers to make up significant ground and expand into the global market.
*This post is a translated excerpt from Proof of Report UDC 2018 written by Ran Ko, CCO of Join:D, a blockchain media affiliated with JoongAng Daily.
