Cryptocurrencies: A Perfect Storm

A perfect storm is forming on the horizon. Can you see the flashes of light getting closer? A cold front of accumulating risk is creeping toward the cryptocurrency market, bringing with it a category 5 cyclone that will utterly destroy every investor, and probably innocent bystanders too.

The risks include grand theft on a massive scale, the likes of which the world has never seen, but the problems go deeper than that.

Cryptocurrencies were initially invented to circumvent the central banking system, allowing parties to transfer money peer-to-peer by relying on computational power rather than trusting a small group of extremely wealthy and historically corrupt bankers.

Traditional fiat currencies are subject to value manipulation, but it turns out that cryptocurrencies are even more vulnerable, sometimes disappearing into thin air — and often reappearing into someone else’s digital wallet.

Cyberheists. The news recently broke that $400 million was stolen from a well-known Japanese exchange called Coinbase. “This is the biggest theft in the history of the world,” said the president of the NEM Foundation. This incident brings to mind the Mt. Gox heist, the then-biggest Bitcoin theft in history, also occurring on a Japanese exchange, where hackers initially stole $450 million but got away with about $290 million.

Making things worse, the transfer of cryptocurrency money is untrackable, by design. “Nobody can be investigated or prosecuted of theft if evidence is completely lacking,” says Randall Isenberg, attorney and founder of The Law Offices of Randall B. Isenberg. Even with these untrackable thefts of historic proportions, cryptocurrency stocks are still rising. Why would anyone trust the operators of these exchanges, the very people who are best positioned to exploit weaknesses and pull off heists such as these? Some people just trust the technology and the people behind it to deliver on its promises, but others simply have dollar signs (or coin glyphs) in their eyes.

The Cryptocurrency Bubble. Investors are trusting the cryptocurrency promise right now because they’re currently making piles of profits by doing so. This is the classic formula for inflating a market bubble: speculation, misunderstanding and huge returns. Billionaire financier George Soros, speaking recently at the World Economic Forum in Davos, Switzerland, says cryptocurrencies are in a bubble, that “it’s a speculation based on misunderstanding.” Also noting on the bubble, one central banker said, “All the market indicators right now look very similar to what we saw before the Lehman crisis, but the lesson has somehow been forgotten.”

The Perils of Tight Coupling. Tight coupling is the technical term for systems that are rigidly connected together, logically or physically, making them fragile and prone to catastrophic failure when one part fails. As we recently witnessed, the CPU vulnerabilities called Meltdown and Spectre were discovered to affect just about every modern computer, leaving few alternatives for safe harbor because they’re all built on the same architectural principles.

Since these sorts of “side channel” attacks are difficult or impossible to detect, nobody even knows if their system has been compromised, leaving a very big open question about the security of cryptocurrencies in general and exchanges in particular.

Besides the common processor dependencies, cryptocurrencies share common dependencies on algorithmic principles that are simply assumed to operate flawlessly — assumptions that will last until they’re demonstrated to be false and the whole system crashes.

The Bitcoin Technocracy. Developer centralization represents a tight coupling of engineers working on cryptocurrency technologies. Bitcoin is the blockchain reference implementation, for example, and its development is wholly controlled by one mysterious and unaccountable software developer, and he delegates work to his own cadre of coders.

The Imminent Cryptography Disruption. Like the name “cryptocurrency” suggests, the monetary value of cryptocurrencies is established and controlled by leveraging the same cryptological methods that secure private digital information like passwords. The key component of these techniques involves challenging computers to crunch hard math problems such as discovering very large prime numbers, problems that would take current computer technology years, if not centuries, to solve.

The keyword here is “current,” meaning that as computational power increases exponentially, these cryptological methods will be rendered obsolete. Experts estimate that quantum computers will overtake current computers in this area within a few years, even as soon as 2020. At that point, a point known as “quantum supremacy,” the very foundation of cryptocurrencies will be shaken.

It’s ironic to call these digital units of money “coins,” a term that denotes real and enduring money. Just imagine bank robbers trying to haul away $400 million in pennies — they would need a fleet of Mack trucks — and then trying to spend all those coins by exchanging them for candy in gumball machines. The scale and intangibility of digital currencies is nothing like hard cash. Like a vapor, they could be here one moment and vanish the next.