What can go wrong

The horror stories

If you are getting involved in crypto, there are many good stories but there are also the times when things go terribly wrong. Fortunately, you can learn from the mistakes of others and if you take steps to secure your assets properly you have a good chance of avoiding the same fate.

The problem issue fall broadly into four categories:

• Failing to securely store your crypto.

• Exchanges being hacked.

• Coins losing their value

• Management failures

Failing to securely store your crypto

This is the story of lost Bitcoin. In the early days of Bitcoin, it was easy to mine with household computers and because it was not initially worth much and had no real use case at that stage, people often made no real effort to look after it and store it correctly. They would come to regret their lax attitude when Bitcoin started to increase in value. For some people, by then it was too late.

You should feel sorry for James Howells. James, an IT engineer who lives in South Wales in the UK had mined about 8000 Bitcoin and stored them on a hard drive. He accidentally threw away the hard drive in 2013. At Bitcoin’s all time high price of $68,789.63 USD, the value of his lost Bitcoin was valued at $550 Million USD. James knows the hard drive is at his local rubbish dump but the Local Council will not let him search for it despite James offering them a share of the prize if he finds it. It seems those Bitcoins are lost forever.

Stefan Thomas has a small hard drive known as an”IronKey”. It contains approximately 7,000 Bitcoin. At Bitcoin’s all time high price of $68,789.63 USD, the value of Stefan’s Bitcoin was valued at $481 Million USD This would usually be a happy story but Stefan has forgotten the password to access the device. He has had 8 attempts using his most common passwords but none have worked. The big problem is that the device only allows ten attempts before it encrypts its contents permanently so Stefan has 2 attempts left. It is looking like this story will not end well.

It is estimated that approximately 4 million Bitcoins have been irreversibly lost due to forgotten passwords, lost devices or the failure to leave proper instructions to beneficiaries in the case of death.

The moral of these stories is to look after your assets so you don’t accidentally lose access to them.

Exchanges being hacked

At least James Howells tragedy is limited to one man. Other horror stories have affected many more. Currently, it has never been easier to buy Bitcoin and cryptos. There are many exchanges that allow you to do so in a number of easy steps. But it has not always been this way.

In the early days of Bitcoin there was an exchange based in Tokyo, Japan with the name “Mt Gox”. At it’s height it handled 70% of all Bitcoin transactions. It operated between 2010 and 2014. In early 2014 Mt Gox was hacked and somewhere between 650,000 to 850,000 Bitcoin were stolen, although some 200,000 were later recovered. This resulted in Mt Gox closing down and declaring bankruptcy. Many users lost their investments. Litigation has been ongoing for several years and it is possible that some of the companies assets may eventually be distributed to their rightful owners in the near future.

Since 2012 it has been estimated that there have been at least 47 exchanges that have lost funds through a cyber security breach. The resulting loss is estimated at $2.72 Billion USD.

The moral of these stories is to self custody your own assets and never leave security to someone else.

Coins losing their value

The crypto market is volatile. Prices can go up and down and that is all part of the market. Bitcoin reached its all time high on 10 November 2021. At this time it was valued at $68,789 USD. By mid December 2021 it dropped to $46,164. If you bought it at the top you would have felt very demoralised. For this reason, it is better to take a long term view and remember that any losses are paper losses only until you sell. The same applies for profits. Your timing of entry and exit from the market can significantly impact your success or failure.

Unlike Bitcoin, stable coins are not expected to fluctuate in value. Their name suggests their price should be stable and linked to a certain asset. In 2019 a Korean company, Terraform labs, created an algorithmic stable coin known as terraUSD (UST) and its companion token LUNA. Both coins worked in unison so that when one went up the other went down. It was designed to stabilise the value of UST at $1USD with very little fluctuation. The synergy was maintained by an algorithm. While this may have worked in theory, it failed in practice. The reasons why it failed are technical and beyond the current discussion but in May 2022, UST lost its peg to the USD and investors fled, crashing the price of UST and LUNA. Anyone holding either coin lost their money with the total losses estimated to be $50 Billion USD. This also had knock on effects for other crypto businesses which were estimated at $300 Billion. The effect of Terra’s collapse is still being felt across the crypto industry today.

Management failures

We were going to use a number of less kind descriptions for this section but we need to be careful what we say. Some of the examples that fall into this category are still being investigated and are possibly the subject of criminal investigations. We wouldn’t want to pre-empt the findings of a court but failure of management is certainly apt.

Celsius Network was a company founded in 2017 with the catchphrase “unbank yourself”. They aimed to replace banks by paying customers an interest rate on crypto deposited to their platform. They also made loans to other users by requiring crypto deposits for security. By May 2022 they had approximately $30 Billion in assets under management and had made loans to customers of $8 Billion.

By mid 2022, questions were being raised about the firms liquidity, particularly in light of the flow on effect from the Terra collapse in May 2022. The CEO, Alex Mashinsky, continued to reassure customers that everything was fine. However, on 13 June 2022 Celsius paused all customer withdrawals "in order to stabilise liquidity and operations". One month later, on 13 July 2022, Celsius filed for chapter 11 bankruptcy citing a $1.2 Billion deficit in the company’s balance sheet. As a result, customers who had deposited funds to earn interest had their accounts frozen. Customers who took out loans were unable to pay back the loans and have their security returned.

While there is a prospect that customers may get back at least some of their crypto in time, the whole sorry saga is still being played out in the courts.

FTX was a cryptocurrency exchange founded in 2019 by Sam-Bankman Fried and was based in the Bahamas. In July 2021 it had over 1 Million users and was the third largest crypto exchange by volume. The situation is complex and involves a related company, Alameda Research. Put simply, a general loss of investor trust in the exchanges own token (FTT) led to a rush to sell or withdraw the tokens. A liquidity crisis followed resulting in FTX not having enough funds to meet their users demands for withdrawals. On 9 November 2022, FTX advised it would cease processing client requests for withdrawals. On the 11 November 2022 FTX, Alameda Research and 100 associated affiliates filed for bankruptcy. Between $1 billion and $2 billion in customer funds reportedly could not be accounted for as of 12 November 2022. FTX's balance sheet shortly before the bankruptcy showed $9 billion in liabilities against $900 million in liquid assets and $5 billion in "less liquid" assets, and $3.2 billion in illiquid private equity investments. Investors who had their crypto on the exchange may never see it again. The only upside to this tragic series of events is that it heightened awareness of the importance of self custody of users assets. Many investors purchased hardware devices and took their crypto off exchanges. Many other exchanges saw a significant increase in withdrawals but were able to manage the demand and survive.