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New Investing Ideas Around Bitcoin Security

Bitcoin investors still have one big problem. When they try to explain bitcoin to friends and family, they get the question, “Isn’t bitcoin the money that people use to buy drugs online?”

Even today, when a single bitcoin bought one year ago would have produced a 900% return, many people still have the idea that bitcoin is not an investment opportunity, but money for criminal activity. The truth, as Jamie Smith recently said on the Unchained podcast, is that the only criminals who use bitcoin are the stupid ones. Bitcoin is not anonymous, as it creates a permanent record wherever it goes.

Still, bitcoin and altcoins do offer unique problems when it comes to security, and the companies solving these problems offer interesting investing opportunities. At the recent meetup for Boston Crypto Traders, Investors and Entrepreneurs, two speakers gave their perspective on “The Dark Side of Crypto.”

 

Investing Idea: Blockchain Auditing Firms

Eduard Kotysh, CEO of Solidified, highlighted the rapid rise of bitcoin over the past several years, and noted that hackers “follow the money.” Since the maturity and security of blockchain companies is often lower than that of large financial institutions, hackers are attracted to this emerging space.

Kotysh classified blockchain security risks into three categories:

  • Exchanges and wallets. For example, the CoinDash ICO was interrupted when hackers broke into the CoinDash website and changed the “transfer address” to one they controlled. A similar hack was carried out on ClassicEtherWallet, where hackers used social engineering (i.e., really good phone skills) to convince the hosting company to point the domain name to another website they controlled. These hacks were not technically complex, but a matter of redirecting the existing systems to ones they controlled.
  • Forks and upgrades. When one altcoin “spins off” from another, it can cause confusion on the blockchain. As an example, when bitcoin cash split off from bitcoin, investors held equal amounts of both. It is advisable, Kotish says, to avoid buying or selling near the fork date, so that all transactions can be properly reconciled on both ledgers.
  • Smart contracts. Here Kotish gave the example of Parity Wallet, where hackers stole millions from user wallets by finding an unreported bug. Parity has since implemented a bug bounty program, paying volunteer developers to find any potential bugs in their wallet code. This kind of “open source auditing” is necessary for blockchain projects because, as Parity put it, “the greatest disinfectant is direct sunlight.”

As blockchain projects grow increasingly complex, rigorous auditing is a requirement. That’s the opportunity for investors: look for companies like Solidified that provide auditing of blockchain code and security. They’ll be increasingly in demand as the blockchain economy grows.

 

Investing Idea: Blockchain Surveillance Companies

Offering a counterpoint was David Fragale, an MIT Sloan Fellow in Innovation who has advised the U.S. government on how “bad actors” such as terrorists and organized crime syndicates might use cryptocurrencies in the future.

Fragale gave an overview of the dark web ecosystem, which we’ll call the “reekosystem”:

  • Dark Markets: New online markets to buy and sell illicit goods will spring up just as quickly as law enforcement shuts them down (think Silk Road).
  • Bitcoin Laundering Sites: Also called “mixers,” “tumblers,” or “cleaners,” these sites run bitcoin through dozens of shell accounts to make it harder to trace.
  • Bitcoin ATMs: Increasingly, physical bitcoin ATMs are being used to convert bitcoin into cash and vice versa, which is another way of erasing the digital trail that bitcoin leaves behind.

While there are some anecdotal reports that terrorists may be using bitcoin, Fragale’s research suggested it’s not their funding method of choice. Zcash, he pointed out, may end up becoming the favored currency for criminals, due to its built-in privacy.

Investors would do well to look into blockchain surveillance technologies. For example, companies like Chainalysis and Elliptic provide “blockchain intelligence,” allowing easier tracking of bad actors as they leave a digital trail. As governments and law enforcement want to know who’s moving money through these dark corners of the web, blockchain surveillance companies will become increasingly valuable in providing that information. Not many police departments have in-house cryptographers.

 

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