Everyone knows that when you give your assets to someone else, they always keep them safe. If this is true for individuals, it is certainly true for businesses.
Custodians always tell the truth and manage funds properly. They won't have any interest in taking the assets as an exchange operator would. Auditors tell the truth and can't be misled. That's because organizations that are regulated are incapable of lying and don't make mistakes.
First, some background. Here is a summary of how custodians make us more secure:
Previously, we might give Alice our crypto assets to hold. There were risks:
- Alice might take the assets and disappear.
- Alice might spend the assets and pretend that she still has them (fractional model).
- Alice might store the assets insecurely and they'll get stolen.
- Alice might give the assets to someone else by mistake or by force.
- Alice might lose access to the assets.
But "no worries", Alice has a custodian named Bob. Bob is dressed in a nice suit. He knows some politicians. And he drives a Porsche. "So you have nothing to worry about!". And look at all the benefits we get:
- Alice can't take the assets and disappear (unless she asks Bob or never gives them to Bob).
- Alice can't spend the assets and pretend that she still has them. (Unless she didn't give them to Bob or asks him for them.)
- Alice can't store the assets insecurely so they get stolen. (After all - she doesn't have any control over the withdrawal process from any of Bob's systems, right?)
- Alice can't give the assets to someone else by mistake or by force. (Bob will stop her, right Bob?)
- Alice can't lose access to the funds. (She'll always be present, sane, and remember all secrets, right?)
See - all problems are solved! All we have to worry about now is:
- Bob might take the assets and disappear.
- Bob might spend the assets and pretend that he still has them (fractional model).
- Bob might store the assets insecurely and they'll get stolen.
- Bob might give the assets to someone else by mistake or by force.
- Bob might lose access to the assets.
It's pretty simple. Before we had to trust Alice. Now we only have to trust Alice, Bob, and all the ways in which they communicate. Just think of how much more secure we are!
"On top of that", Bob assures us, "we're using a special wallet structure". Bob shows Alice a diagram. "We've broken the balance up and store it in lots of smaller wallets. That way", he assures her, "a thief can't take it all at once". And he points to a historic case where a large sum was taken "because it was stored in a single wallet... how stupid".
"Very early on, we used to have all the crypto in one wallet", he said, "and then one Christmas a hacker came and took it all. We call him the Grinch. Now we individually wrap each crypto and stick it under a binary search tree. The Grinch has never been back since."
"As well", Bob continues, "even if someone were to get in, we've got insurance. It covers all thefts and even coercion, collusion, and misplaced keys - only subject to the policy terms and conditions." And with that, he pulls out a phone-book sized contract and slams it on the desk with a thud. "Yep", he continues, "we're paying top dollar for one of the best policies in the country!"
"Can I read it?' Alice asks. "Sure," Bob says, "just as soon as our legal team is done with it. They're almost through the first chapter." He pauses, then continues. "And can you believe that sales guy Mike? He has the same year Porsche as me. I mean, what are the odds?"
"Do you use multi-sig?", Alice asks. "Absolutely!" Bob replies. "All our engineers are fully trained in multi-sig. Whenever we want to set up a new wallet, we generate 2 separate keys in an air-gapped process and store them in this proprietary system here. Look, it even requires the biometric signature from one of our team members to initiate any withdrawal." He demonstrates by pressing his thumb into the display. "We use a third-party cloud validation API to match the thumbprint and authorize each withdrawal. The keys are also backed up daily to an off-site third-party."
"Wow that's really impressive," Alice says, "but what if we need access for a withdrawal outside of office hours?" "Well that's no issue", Bob says, "just send us an email, call, or text message and we always have someone on staff to help out. Just another part of our strong commitment to all our customers!"
"What about Proof of Reserve?", Alice asks. "Of course", Bob replies, "though rather than publish any blockchain addresses or signed transaction, for privacy we just do a SHA256 refactoring of the inverse hash modulus for each UTXO nonce and combine the smart contract coefficient consensus in our hyperledger lightning node. But it's really simple to use." He pushes a button and a large green checkmark appears on a screen. "See - the algorithm ran through and reserves are proven."
"Wow", Alice says, "you really know your stuff! And that is easy to use! What about fiat balances?" "Yeah, we have an auditor too", Bob replies, "Been using him for a long time so we have quite a strong relationship going! We have special books we give him every year and he's very efficient! Checks the fiat, crypto, and everything all at once!"
"We used to have a nice offline multi-sig setup we've been using without issue for the past 5 years, but I think we'll move all our funds over to your facility," Alice says. "Awesome", Bob replies, "Thanks so much! This is perfect timing too - my Porsche got a dent on it this morning. We have the paperwork right over here." "Great!", Alice replies.
And with that, Alice gets out her pen and Bob gets the contract. "Don't worry", he says, "you can take your crypto-assets back anytime you like - just subject to our cancellation policy. Our annual management fees are also super low and we don't adjust them often".
How many holes have to exist for your funds to get stolen? Just one.
Why are we taking a powerful offline multi-sig setup, widely used globally in hundreds of different/lacking regulatory environments with 0 breaches to date, and circumventing it by a demonstrably weak third party layer? And paying a great expense to do so?
If you go through the list of breaches in the past 2 years to highly credible organizations
, you go through the list of major corporate frauds (only the ones we know about)
, you go through the list of all the times platforms have lost funds
, you go through the list of times and ways that people have lost their crypto from identity theft, hot wallet exploits, extortion, etc... and then you go through this custodian with a fine-tooth comb and truly believe they have value to add far beyond what you could, sticking your funds in a wallet (or set of wallets) they control exclusively is the absolute worst possible way to take advantage of that security.
The best way to add security for crypto-assets is to make a stronger multi-sig. With one custodian, what you are doing is giving them your cryptocurrency and hoping they're honest, competent, and flawlessly secure. It's no different than storing it on a really secure exchange. Maybe the insurance will cover you. Didn't work for Bitpay in 2015. Didn't work for Yapizon in 2017. Insurance has never paid a claim in the entire history of cryptocurrency. But maybe you'll get lucky. Maybe your exact scenario will buck the trend and be what they're willing to cover. After the large deductible and hopefully without a long and expensive court battle.
And you want to advertise this increase in risk, the lapse of judgement, an accident waiting to happen, as though it's some kind of benefit to customers ("Free institutional-grade storage for your digital assets.")? And then some people are writing to the OSC that custodians should be mandatory for all funds on every exchange platform? That this somehow will make Canadians as a whole more secure or better protected compared with standard air-gapped multi-sig? On what planet?
Most of the problems in Canada stemmed from one thing - a lack of transparency. If Canadians had known what a joke Quadriga was - it wouldn't have grown to lose $400m from hard-working Canadians from coast to coast to coast. And Gerald Cotten would be in jail, not wherever he is now (at best, rotting peacefully). EZ-BTC and mister Dave Smilie would have been a tiny little scam to his friends, not a multi-million dollar fraud. Einstein would have got their act together or been shut down BEFORE losing millions and millions more in people's funds generously donated to criminals. MapleChange wouldn't have even been a thing. And maybe we'd know a little more about CoinTradeNewNote - like how much was lost in there. Almost all of the major losses with cryptocurrency exchanges involve deception with unbacked funds.
So it's great to see transparency reports from BitBuy and ShakePay where someone independently verified the backing. The only thing we don't have is:
- ANY CERTAINTY BALANCES WEREN'T EXCLUDED. Quadriga's largest account was $70m. 80% of funds are in 20% of accounts (Pareto principle). All it takes is excluding a few really large accounts - and nobody's the wiser. A fractional platform can easily pass any audit this way.
- ANY VISIBILITY WHATSOEVER INTO THE CUSTODIANS. BitBuy put out their report before moving all the funds to their custodian and ShakePay apparently can't even tell us who the custodian is. That's pretty important considering that basically all of the funds are now stored there.
- ANY IDEA ABOUT THE OTHER EXCHANGES. In order for this to be effective, it has to be the norm. It needs to be "unusual" not to know. If obscurity is the norm, then it's super easy for people like Gerald Cotten and Dave Smilie to blend right in.
It's not complicated to validate cryptocurrency assets. They need to exist, they need to be spendable, and they need to cover the total balances. There are plenty of credible people and firms across the country that have the capacity to reasonably perform this validation. Having more frequent checks by different, independent, parties who publish transparent reports is far more valuable than an annual check by a single "more credible/official" party who does the exact same basic checks and may or may not publish anything. Here's an example set of requirements that could be mandated:
- First report within 1 month of launching, another within 3 months, and further reports at minimum every 6 months thereafter.
- No auditor can be repeated within a 12 month period.
- All reports must be public, identifying the auditor and the full methodology used.
- All auditors must be independent of the firm being audited with no conflict of interest.
- Reports must include the percentage of each asset backed, and how it's backed.
- The auditor publishes a hash list, which lists a hash of each customer's information and balances that were included. Hash is one-way encryption so privacy is fully preserved. Every customer can use this to have 100% confidence they were included.
- If we want more extensive requirements on audits, these should scale upward based on the total assets at risk on the platform, and whether the platform has loaned their assets out.
There are ways to structure audits such that neither crypto assets nor customer information are ever put at risk, and both can still be properly validated and publicly verifiable. There are also ways to structure audits such that they are completely reasonable for small platforms and don't inhibit innovation in any way. By making the process as reasonable as possible, we can completely eliminate any reason/excuse that an honest platform would have for not being audited. That is arguable far more important than any incremental improvement we might get from mandating "the best of the best" accountants. Right now we have nothing mandated and tons of Canadians using offshore exchanges with no oversight whatsoever.
Transparency does not prove crypto assets are safe. CoinTradeNewNote, Flexcoin ($600k), and Canadian Bitcoins ($100k) are examples where crypto-assets were breached from platforms in Canada. All of them were online wallets and used no multi-sig as far as any records show. This is consistent with what we see globally - air-gapped multi-sig wallets have an impeccable record, while other schemes tend to suffer breach after breach. We don't actually know how much CoinTrader lost because there was no visibility. Rather than publishing details of what happened, the co-founder of CoinTrader silently moved on to found another platform - the "most trusted way to buy and sell crypto" - a site that has no information whatsoever (that I could find) on the storage practices and a FAQ advising that “[t]rading cryptocurrency is completely safe” and that having your own wallet is “entirely up to you! You can certainly keep cryptocurrency, or fiat, or both, on the app.” Doesn't sound like much was learned here, which is really sad to see.
It's not that complicated or unreasonable to set up a proper hardware wallet. Multi-sig can be learned in a single course. Something the equivalent complexity of a driver's license test could prevent all the cold storage exploits we've seen to date - even globally. Platform operators have a key advantage in detecting and preventing fraud - they know their customers far better than any custodian ever would. The best job that custodians can do is to find high integrity individuals and train them to form even better wallet signatories. Rather than mandating that all platforms expose themselves to arbitrary third party risks, regulations should center around ensuring that all signatories are background-checked, properly trained, and using proper procedures. We also need to make sure that signatories are empowered with rights and responsibilities to reject and report fraud. They need to know that they can safely challenge and delay a transaction - even if it turns out they made a mistake. We need to have an environment where mistakes are brought to the surface and dealt with. Not one where firms and people feel the need to hide what happened. In addition to a knowledge-based test, an auditor can privately interview each signatory to make sure they're not in coercive situations, and we should make sure they can freely and anonymously report any issues without threat of retaliation.
A proper multi-sig has each signature held by a separate person and is governed by policies and mutual decisions instead of a hierarchy. It includes at least one redundant signature. For best results, 3of4, 3of5, 3of6, 4of5, 4of6, 4of7, 5of6, or 5of7.
History has demonstrated over and over again the risk of hot wallets even to highly credible organizations. Nonetheless, many platforms have hot wallets for convenience. While such losses are generally compensated by platforms without issue (for example Poloniex, Bitstamp, Bitfinex, Gatecoin, Coincheck, Bithumb, Zaif, CoinBene, Binance, Bitrue, Bitpoint, Upbit, VinDAX, and now KuCoin), the public tends to focus more on cases that didn't end well. Regardless of what systems are employed, there is always some level of risk. For that reason, most members of the public would prefer to see third party insurance.
Rather than trying to convince third party profit-seekers to provide comprehensive insurance and then relying on an expensive and slow legal system to enforce against whatever legal loopholes they manage to find each and every time something goes wrong, insurance could be run through multiple exchange operators and regulators, with the shared interest of having a reputable industry, keeping costs down, and taking care of Canadians. For example, a 4 of 7 multi-sig insurance fund held between 5 independent exchange operators and 2 regulatory bodies. All Canadian exchanges could pay premiums at a set rate based on their needed coverage, with a higher price paid for hot wallet coverage (anything not an air-gapped multi-sig cold wallet). Such a model would be much cheaper to manage, offer better coverage, and be much more reliable to payout when needed. The kind of coverage you could have under this model is unheard of. You could even create something like the CDIC to protect Canadians who get their trading accounts hacked if they can sufficiently prove the loss is legitimate. In cases of fraud, gross negligence, or insolvency, the fund can be used to pay affected users directly (utilizing the last transparent balance report in the worst case), something which private insurance would never touch. While it's recommended to have official policies for coverage, a model where members vote would fully cover edge cases. (Could be similar to the Supreme Court where justices vote based on case law.)
Such a model could fully protect all Canadians across all platforms. You can have a fiat coverage governed by legal agreements, and crypto-asset coverage governed by both multi-sig and legal agreements. It could be practical, affordable, and inclusive.
Now, we are at a crossroads. We can happily give up our freedom, our innovation, and our money. We can pay hefty expenses to auditors, lawyers, and regulators year after year (and make no mistake - this cost will grow to many millions or even billions as the industry grows - and it will be borne by all Canadians on every platform because platforms are not going to eat up these costs at a loss). We can make it nearly impossible for any new platform to enter the marketplace, forcing Canadians to use the same stagnant platforms year after year. We can centralize and consolidate the entire industry into 2 or 3 big players and have everyone else fail (possibly to heavy losses of users of those platforms). And when a flawed security model doesn't work and gets breached, we can make it even more complicated with even more people in suits making big money doing the job that blockchain was supposed to do in the first place. We can build a system which is so intertwined and dependent on big government, traditional finance, and central bankers that it's future depends entirely on that of the fiat system, of fractional banking, and of government bail-outs. If we choose this path, as history has shown us over and over again, we can not go back, save for revolution. Our children and grandchildren will still be paying the consequences of what we decided today.
Or, we can find solutions that work. We can maintain an open and innovative environment while making the adjustments we need to make to fully protect Canadian investors and cryptocurrency users, giving easy and affordable access to cryptocurrency for all Canadians on the platform of their choice, and creating an environment in which entrepreneurs and problem solvers can bring those solutions forward easily. None of the above precludes innovation in any way, or adds any unreasonable cost - and these three policies would demonstrably eliminate or resolve all 109 historic cases as studied here
- that's every single case researched so far going back to 2011. It includes every loss that was studied so far not just in Canada but globally as well.
Unfortunately, finding answers is the least challenging part. Far more challenging is to get platform operators and regulators to agree on anything. My last post
got no response whatsoever, and while the OSC has told me they're happy for industry feedback, I believe my opinion alone is fairly meaningless. This takes the whole community working together to solve. So please let me know your thoughts. Please take the time to upvote and share this with people. Please - let's get this solved and not leave it up to other people to do.
Facts/background/sources (skip if you like):
- The inspiration for the paragraph about splitting wallets was an actual quote from a Canadian company providing custodial services in response to the OSC consultation paper: "We believe that it will be in the in best interests of investors to prohibit pooled crypto assets or ‘floats’. Most Platforms pool assets, citing reasons of practicality and expense. The recent hack of the world’s largest Platform – Binance – demonstrates the vulnerability of participants’ assets when such concessions are made. In this instance, the Platform’s entire hot wallet of Bitcoins, worth over $40 million, was stolen, facilitated in part by the pooling of client crypto assets." "the maintenance of participants (and Platform) crypto assets across multiple wallets distributes the related risk and responsibility of security - reducing the amount of insurance coverage required and making insurance coverage more readily obtainable". For the record, their reply also said nothing whatsoever about multi-sig or offline storage.
- In addition to the fact that the $40m hack represented only one "hot wallet" of Binance, and they actually had the vast majority of assets in other wallets (including mostly cold wallets), multiple real cases have clearly demonstrated that risk is still present with multiple wallets. Bitfinex, VinDAX, Bithumb, Altsbit, BitPoint, Cryptopia, and just recently KuCoin all had multiple wallets breached all at the same time, and may represent a significantly larger impact on customers than the Binance breach which was fully covered by Binance. To represent that simply having multiple separate wallets under the same security scheme is a comprehensive way to reduce risk is just not true.
- Private insurance has historically never covered a single loss in the cryptocurrency space (at least, not one that I was able to find), and there are notable cases where massive losses were not covered by insurance. Bitpay in 2015 and Yapizon in 2017 both had insurance policies that didn't pay out during the breach, even after a lengthly court process. The same insurance that ShakePay is presently using (and announced to much fanfare) was describe by their CEO himself as covering “physical theft of the media where the private keys are held,” which is something that has never historically happened. As was said with regard to the same policy in 2018 - “I don’t find it surprising that Lloyd’s is in this space,” said Johnson, adding that to his mind the challenge for everybody is figuring out how to structure these policies so that they are actually protective. “You can create an insurance policy that protects no one – you know there are so many caveats to the policy that it’s not super protective.”
- The most profitable policy for a private insurance company is one with the most expensive premiums that they never have to pay a claim on. They have no inherent incentive to take care of people who lost funds. It's "cheaper" to take the reputational hit and fight the claim in court. The more money at stake, the more the insurance provider is incentivized to avoid payout. They're not going to insure the assets unless they have reasonable certainty to make a profit by doing so, and they're not going to pay out a massive sum unless it's legally forced. Private insurance is always structured to be maximally profitable to the insurance provider.
- The circumvention of multi-sig was a key factor in the massive Bitfinex hack of over $60m of bitcoin, which today still sits being slowly used and is worth over $3b. While Bitfinex used a qualified custodian Bitgo, which was and still is active and one of the industry leaders of custodians, and they set up 2 of 3 multi-sig wallets, the entire system was routed through Bitfinex, such that Bitfinex customers could initiate the withdrawals in a "hot" fashion. This feature was also a hit with the hacker. The multi-sig was fully circumvented.
- Bitpay in 2015 was another example of a breach that stole 5,000 bitcoins. This happened not through the exploit of any system in Bitpay, but because the CEO of a company they worked with got their computer hacked and the hackers were able to request multiple bitcoin purchases, which Bitpay honoured because they came from the customer's computer legitimately. Impersonation is a very common tactic used by fraudsters, and methods get more extreme all the time.
- A notable case in Canada was the Canadian Bitcoins exploit. Funds were stored on a server in a Rogers Data Center, and the attendee was successfully convinced to reboot the server "in safe mode" with a simple phone call, thus bypassing the extensive security and enabling the theft.
- Over $200m has been stolen impersonating users of cryptocurrency platforms by one group alone. Here's a list of 10 social engineering attacks against corporate companies. Here's an even larger case. While verification methods are improving, so are methods of identity theft and social engineering. We now have sim swapping and deep fake videos to contend with. Hackers have massive database sets of personal information they can utilize. As the sums at stake increase, so to will the level of effort criminals are willing to undertake. Obscurity for an insecure system will only postpone an attack until the "jackpot" is large enough.
- The very nature of custodians circumvents multi-sig. This is because custodians are not just having to secure the assets against some sort of physical breach but against any form of social engineering, modification of orders, fraudulent withdrawal attempts, etc... If the security practices of signatories in a multi-sig arrangement are such that the breach risk of one signatory is 1 in 100, the requirement of 3 independent signatures makes the risk of theft 1 in 1,000,000. Since hackers tend to exploit the weakest link, a comparable custodian has to make the entry and exit points of their platform 10,000 times more secure than one of those signatories to provide equivalent protection. And if the signatories beef up their security by only 10x, the risk is now 1 in 1,000,000,000. The custodian has to be 1,000,000 times more secure. The larger and more complex a system is, the more potential vulnerabilities exist in it, and the fewer people can understand how the system works when performing upgrades. Even if a system is completely secure today, one has to also consider how that system might evolve over time or work with different members.
- By contrast, offline multi-signature solutions have an extremely solid record, and in the entire history of cryptocurrency exchange incidents which I've studied (listed here), there has only been one incident (796 exchange in 2015) involving an offline multi-signature wallet. It happened because the customer's bitcoin address was modified by hackers, and the amount that was stolen ($230k) was immediately covered by the exchange operators. Basically, the platform operators were tricked into sending a legitimate withdrawal request to the wrong address because hackers exploited their platform to change that address. Such an issue would not be prevented in any way by the use of a custodian, as that custodian has no oversight whatsoever to the exchange platform. It's practical for all exchange operators to test large withdrawal transactions as a general policy, regardless of what model is used, and general best practice is to diagnose and fix such an exploit as soon as it occurs.
- False promises on the backing of funds played a huge role in the downfall of Quadriga, and it's been exposed over and over again (MyCoin, PlusToken, Bitsane, Bitmarket, EZBTC, IDAX). Even today, customers have extremely limited certainty on whether their funds in exchanges are actually being backed or how they're being backed. While this issue is not unique to cryptocurrency exchanges, the complexity of the technology and the lack of any regulation or standards makes problems more widespread, and there is no "central bank" to come to the rescue as in the 2008 financial crisis or during the great depression when "9,000 banks failed".
- In addition to fraudulent operations, the industry is full of cases where operators have suffered breaches and not reported them. Most recently, Einstein was the largest case in Canada, where ongoing breaches and fraud were perpetrated against the platform for multiple years and nobody found out until the platform collapsed completely. While fraud and breaches suck to deal with, they suck even more when not dealt with. Lack of visibility played a role in the largest downfalls of Mt. Gox, Cryptsy, and Bitgrail. In some cases, platforms are alleged to have suffered a hack and keep operating without admitting it at all, such as CoinBene.
- It surprises some to learn that a cryptographic solution has already existed since 2013, and gained widespread support in 2014 after Mt. Gox. Proof of Reserves is a full cryptographic proof that allows any customer using an exchange to have complete certainty that their crypto-assets are fully backed by the platform in real-time. This is accomplished by proving that assets exist on the blockchain, are spendable, and fully cover customer deposits. It does not prove safety of assets or backing of fiat assets.
- If we didn't care about privacy at all, a platform could publish their wallet addresses, sign a partial transaction, and put the full list of customer information and balances out publicly. Customers can each check that they are on the list, that the balances are accurate, that the total adds up, and that it's backed and spendable on the blockchain. Platforms who exclude any customer take a risk because that customer can easily check and see they were excluded. So together with all customers checking, this forms a full proof of backing of all crypto assets.
- However, obviously customers care about their private information being published. Therefore, a hash of the information can be provided instead. Hash is one-way encryption. The hash allows the customer to validate inclusion (by hashing their own known information), while anyone looking at the list of hashes cannot determine the private information of any other user. All other parts of the scheme remain fully intact. A model like this is in use on the exchange CoinFloor in the UK.
- A Merkle tree can provide even greater privacy. Instead of a list of balances, the balances are arranged into a binary tree. A customer starts from their node, and works their way to the top of the tree. For example, they know they have 5 BTC, they plus 1 other customer hold 7 BTC, they plus 2-3 other customers hold 17 BTC, etc... until they reach the root where all the BTC are represented. Thus, there is no way to find the balances of other individual customers aside from one unidentified customer in this case.
- Proposals such as this had the backing of leaders in the community including Nic Carter, Greg Maxwell, and Zak Wilcox. Substantial and significant effort started back in 2013, with massive popularity in 2014. But what became of that effort? Very little. Exchange operators continue to refuse to give visibility. Despite the fact this information can often be obtained through trivial blockchain analysis, no Canadian platform has ever provided any wallet addresses publicly. As described by the CEO of Newton "For us to implement some kind of realtime Proof of Reserves solution, which I'm not opposed to, it would have to ... Preserve our users' privacy, as well as our own. Some kind of zero-knowledge proof". Kraken describes here in more detail why they haven't implemented such a scheme. According to professor Eli Ben-Sasson, when he spoke with exchanges, none were interested in implementing Proof of Reserves.
- And yet, Kraken's places their reasoning on a page called "Proof of Reserves". More recently, both BitBuy and ShakePay have released reports titled "Proof of Reserves and Security Audit". Both reports contain disclaimers against being audits. Both reports trust the customer list provided by the platform, leaving the open possibility that multiple large accounts could have been excluded from the process. Proof of Reserves is a blockchain validation where customers see the wallets on the blockchain. The report from Kraken is 5 years old, but they leave it described as though it was just done a few weeks ago. And look at what they expect customers to do for validation. When firms represent something being "Proof of Reserve" when it's not, this is like a farmer growing fruit with pesticides and selling it in a farmers market as organic produce - except that these are people's hard-earned life savings at risk here. Platforms are misrepresenting the level of visibility in place and deceiving the public by their misuse of this term. They haven't proven anything.
- Fraud isn't a problem that is unique to cryptocurrency. Fraud happens all the time. Enron, WorldCom, Nortel, Bear Stearns, Wells Fargo, Moser Baer, Wirecard, Bre-X, and Nicola are just some of the cases where frauds became large enough to become a big deal (and there are so many countless others). These all happened on 100% reversible assets despite regulations being in place. In many of these cases, the problems happened due to the over-complexity of the financial instruments. For example, Enron had "complex financial statements [which] were confusing to shareholders and analysts", creating "off-balance-sheet vehicles, complex financing structures, and deals so bewildering that few people could understand them". In cryptocurrency, we are often combining complex financial products with complex technologies and verification processes. We are naïve if we think problems like this won't happen. It is awkward and uncomfortable for many people to admit that they don't know how something works. If we want "money of the people" to work, the solutions have to be simple enough that "the people" can understand them, not so confusing that financial professionals and technology experts struggle to use or understand them.
- For those who question the extent to which an organization can fool their way into a security consultancy role, HB Gary should be a great example to look at. Prior to trying to out anonymous, HB Gary was being actively hired by multiple US government agencies and others in the private sector (with glowing testimonials). The published articles and hosted professional security conferences. One should also look at this list of data breaches from the past 2 years. Many of them are large corporations, government entities, and technology companies. These are the ones we know about. Undoubtedly, there are many more that we do not know about. If HB Gary hadn't been "outted" by anonymous, would we have known they were insecure? If the same breach had happened outside of the public spotlight, would it even have been reported? Or would HB Gary have just deleted the Twitter posts, brought their site back up, done a couple patches, and kept on operating as though nothing had happened?
- In the case of Quadriga, the facts are clear. Despite past experience with platforms such as MapleChange in Canada and others around the world, no guidance or even the most basic of a framework was put in place by regulators. By not clarifying any sort of legal framework, regulators enabled a situation where a platform could be run by former criminal Mike Dhanini/Omar Patryn, and where funds could be held fully unchecked by one person. At the same time, the lack of regulation deterred legitimate entities from running competing platforms and Quadriga was granted a money services business license for multiple years of operation, which gave the firm the appearance of legitimacy. Regulators did little to protect Canadians despite Quadriga failing to file taxes from 2016 onward. The entire administrative team had resigned and this was public knowledge. Many people had suspicions of what was going on, including Ryan Mueller, who forwarded complaints to the authorities. These were ignored, giving Gerald Cotten the opportunity to escape without justice.
- There are multiple issues with the SOC II model including the prohibitive cost (you have to find a third party accounting firm and the prices are not even listed publicly on any sites), the requirement of operating for a year (impossible for new platforms), and lack of any public visibility (SOC II are private reports that aren't shared outside the people in suits).
- Securities frameworks are expensive. Sarbanes-Oxley is estimated to cost $5.1 million USD/yr for the average Fortune 500 company in the United States. Since "Fortune 500" represents the top 500 companies, that means well over $2.55 billion USD (~$3.4 billion CAD) is going to people in suits. Isn't the problem of trust and verification the exact problem that the blockchain is supposed to solve?
- To use Quadriga as justification for why custodians or SOC II or other advanced schemes are needed for platforms is rather silly, when any framework or visibility at all, or even the most basic of storage policies, would have prevented the whole thing. It's just an embarrassment.
- We are now seeing regulators take strong action. CoinSquare in Canada with multi-million dollar fines. BitMex from the US, criminal charges and arrests. OkEx, with full disregard of withdrawals and no communication. Who's next?
- We have a unique window today where we can solve these problems, and not permanently destroy innovation with unreasonable expectations, but we need to act quickly. This is a unique historic time that will never come again.
In case you haven't noticed the consultation paper
, staff notice
, and report on Quadriga
, regulators are now clamping down on Canadian cryptocurrency exchanges. The OSC and other regulatory bodies are still interested in industry feedback. They have not put forward any official regulation yet. Below are some ideas/insights and a proposed framework.
- This framework was developed through a study of 96 past exchange hack/scam/fraud events. It prevents all historic cases where funds were lost in cryptocurrency exchanges.
- Typical securities frameworks will cost Canadians millions of dollars (ie Sarbanes-Oxley estimated at $5m USD/yr per firm). Implementation costs of this proposal are significantly cheaper.
- Canadians can maintain a diverse set of exchanges, multiple viable business models are still fully supported, and innovation is encouraged while keeping Canadians safe.
Many of you have limited time to read the full proposal, so here are the highlights:
Effective standards to prevent both internal and external theft. Exchange operators are trained and certified, and have a legal responsibility to users.
Regular Transparent Audits
Provides visibility to Canadians that their funds are fully backed on the exchange, while protecting privacy and sensitive platform information.
Establishment of basic insurance standards/strategy, to expand over time. Removing risk to exchange users of any hot wallet theft.
Background and Justifications
Cold Storage Custody/Management
After reviewing close to 100 cases, all thefts tend to break down into more or less the same set of problems:
• Funds stored online or in a smart contract,
• Access controlled by one person or one system,
• 51% attacks (rare),
• Funds sent to the wrong address (also rare), or
• Some combination of the above.
For the first two cases, practical solutions exist and are widely implemented on exchanges already. Offline multi-signature solutions are already industry standard. No cases studied found an external theft or exit scam involving an offline multi-signature wallet implementation. Security can be further improved through minimum numbers of signatories, background checks, providing autonomy and legal protections to each signatory, establishing best practices, and a training/certification program.
The last two transaction risks occur more rarely, and have never resulted in a loss affecting the actual users of the exchange. In all cases to date where operators made the mistake, they've been fully covered by the exchange platforms.
• 51% attacks generally only occur on blockchains with less security. The most prominent cases have been Bitcoin Gold and Ethereum Classic. The simple solution is to enforce deposit limits and block delays such that a 51% attack is not cost-effective.
• The risk of transactions to incorrect addresses can be eliminated by a simple test transaction policy on large transactions. By sending a small amount of funds prior to any large withdrawals/transfers as a standard practice, the accuracy of the wallet address can be validated.
The proposal covers all loss cases and goes beyond, while avoiding significant additional costs, risks, and limitations which may be associated with other frameworks like SOC II.
On The Subject of Third Party Custodians
Many Canadian platforms are currently experimenting with third party custody. From the standpoint of the exchange operator, they can liberate themselves from some responsibility of custody, passing that off to someone else. For regulators, it puts crypto in similar categorization to oil, gold, and other commodities, with some common standards. Platform users would likely feel greater confidence if the custodian was a brand they recognized. If the custodian was knowledgeable and had a decent team that employed multi-sig, they could keep assets safe from internal theft. With the right protections in place, this could be a great solution for many exchanges, particularly those that lack the relevant experience or human resources for their own custody systems.
However, this system is vulnerable to anyone able to impersonate the exchange operators. You may have a situation where different employees who don't know each other that well are interacting between different companies (both the custodian and all their customers which presumably isn't just one exchange). A case study of what can go wrong in this type of environment might be Bitpay, where the CEO was tricked out of 5000 bitcoins
over 3 separate payments by a series of emails sent legitimately from a breached computer of another company CEO. It's also still vulnerable to the platform being compromised, as in the really large $70M Bitfinex hack
, where the third party Bitgo held one key in a multi-sig wallet. The hacker simply authorized the withdrawal using the same credentials as Bitfinex (requesting Bitgo to sign multiple withdrawal transactions). This succeeded even with the use of multi-sig and two heavily security-focused companies, due to the lack of human oversight (basically, hot wallet). Of course, you can learn from these cases and improve the security, but so can hackers improve their deception and at the end of the day, both of these would have been stopped by the much simpler solution of a qualified team who knew each other and employed multi-sig with properly protected keys. It's pretty hard to beat a human being who knows the business and the typical customer behaviour (or even knows their customers personally) at spotting fraud, and the proposed multi-sig means any hacker has to get through the scrutiny of 3 (or more) separate people, all of whom would have proper training including historical case studies.
There are strong arguments both for and against using use of third party custodians. The proposal sets mandatory minimum custody standards would apply regardless if the cold wallet signatories are exchange operators, independent custodians, or a mix of both.
On The Subject Of Insurance
ShakePay has taken the first steps
into this new realm (congratulations). There is no question that crypto users could be better protected by the right insurance policies, and it certainly feels better to transact with insured platforms. The steps required to obtain insurance generally place attention in valuable security areas, and in this case included a review from CipherTrace. One of the key solutions in traditional finance comes from insurance from entities such as the CDIC.
However, historically, there wasn't found any actual insurance payout to any cryptocurrency exchange, and there are notable cases where insurance has not paid. With Bitpay, for example
, the insurance agent refused
because the issue happened to the third party CEO's computer instead of anything to do with Bitpay itself. With the Youbit exchange
in South Korea, their insurance claim was denied
, and the exchange ultimately ended up instead going bankrupt with all user's funds lost. To quote Matt Johnson in the original Lloyd's article
: “You can create an insurance policy that protects no one – you know there are so many caveats to the policy that it’s not super protective.”
ShakePay's insurance was only reported to cover
their cold storage, and “physical theft of the media where the private keys are held”. Physical theft has never, in the history of cryptocurrency exchange cases reviewed, been reported as the cause of loss. From the limited information of the article, ShakePay made it clear their funds are in the hands of a single US custodian, and at least part of their security strategy is to "decline to confirm the custodian’s name on the record". While this prevents scrutiny of the custodian, it's pretty silly to speculate that a reasonably competent hacking group couldn't determine who the custodian is. A far more common infiltration strategy historically would be social engineering, which has succeeded repeatedly. A hacker could trick their way into ShakePay's systems and request a fraudulent withdrawal, impersonate ShakePay and request the custodian to move funds, or socially engineer their way into the custodian to initiate the withdrawal of multiple accounts (a payout much larger than ShakePay) exploiting the standard procedures (for example, fraudulently initiating or override the wallet addresses of a real transfer). In each case, nothing was physically stolen and the loss is therefore not covered by insurance.
In order for any insurance to be effective, clear policies have to be established about what needs to be covered. Anything short of that gives Canadians false confidence that they are protected when they aren't in any meaningful way. At this time, the third party insurance market does not appear to provide adequate options or coverage, and effort is necessary to standardize custody standards, which is a likely first step in ultimately setting up an insurance framework.
A better solution compared to third party insurance providers might be for Canadian exchange operators to create their own collective insurance fund, or a specific federal organization similar to the CDIC. Such an organization would have a greater interest or obligation in paying out actual cases, and that would be it's purpose rather than maximizing it's own profit. This would be similar to the SAFU which Binance has launched, except it would cover multiple exchanges. There is little question whether the SAFU would pay out given a breach of Binance, and a similar argument could be made for a insurance fund managed by a collective of exchange operators or a government organization. While a third party insurance provider has the strong market incentive to provide the absolute minimum coverage and no market incentive to payout, an entity managed by exchange operators would have incentive to protect the reputation of exchange operators/the industry, and the government should have the interest of protecting Canadians.
On The Subject of Fractional Reserve
There is a long history of fractional reserve failures, from the first banks in ancient times, through the great depression (where hundreds of fractional reserve banks failed), right through to the 2008 banking collapse referenced in the first bitcoin block. The fractional reserve system allows banks to multiply the money supply far beyond the actual cash (or other assets) in existence, backed only by a system of debt obligations of others. Safely supporting a fractional reserve system is a topic of far greater complexity than can be addressed by a simple policy, and when it comes to cryptocurrency, there is presently no entity reasonably able to bail anyone out in the event of failure. Therefore, this framework is addressed around entities that aim to maintain 100% backing of funds.
There may be some firms that desire but have failed to maintain 100% backing. In this case, there are multiple solutions, including outside investment, merging with other exchanges, or enforcing a gradual restoration plan. All of these solutions are typically far better than shutting down the exchange, and there are multiple cases where they've been used successfully in the past.
Proof of Reserves/Transparency/Accountability
Canadians need to have visibility into the backing on an ongoing basis.
The best solution for crypto-assets is a Proof of Reserve. Such ideas go back all the way to 2013, before even Mt. Gox. However, no Canadian exchange has yet implemented such a system, and only a few international exchanges (CoinFloor in the UK being an example) have. Many firms like Kraken, BitBuy, and now ShakePay use the Proof of Reserve term to refer to lesser proofs which do not actually cryptographically prove the full backing of all user assets on the blockchain. In order for a Proof of Reserve to be effective, it must actually be a complete proof, and it needs to be understood by the public that is expected to use it. Many firms have expressed reservations about the level of transparency required in a complete Proof of Reserve (for example Kraken here
). While a complete Proof of Reserves should be encouraged, and there are some solutions in the works (ie TxQuick), this is unlikely to be suitable universally for all exchange operators and users.
Given the limitations, and that firms also manage fiat assets, a more traditional audit process makes more sense. Some Canadian exchanges (CoinSquare, CoinBerry) have already subjected themselves to annual audits. However, these results are not presently shared publicly, and there is no guarantee over the process including all user assets or the integrity and independence of the auditor. The auditor has been typically not known, and in some cases, the identity of the auditor is protected by a NDA. Only in one case (BitBuy) was an actual report generated and publicly shared
. There has been no attempt made to validate that user accounts provided during these audits have been complete or accurate. A fraudulent fractional exchange, or one which had suffered a breach they were unwilling to publicly accept (see CoinBene
), could easily maintain a second set of books for auditors or simply exclude key accounts to pass an individual audit.
The proposed solution would see a reporting standard which includes at a minimum - percentage of backing for each asset relative to account balances and the nature of how those assets are stored, with ownership proven by the auditor. The auditor would also publicly provide a "hash list", which they independently generate from the accounts provided by the exchange. Every exchange user can then check their information against this public "hash list". A hash is a one-way form of encryption, which fully protects the private information, yet allows anyone who knows that information already to validate that it was included. Less experienced users can take advantage of public tools to calculate the hash from their information (provided by the exchange), and thus have certainty that the auditor received their full balance information. Easy instructions can be provided.
Auditors should be impartial, their identities and process public, and they should be rotated so that the same auditor is never used twice in a row. Balancing the cost of auditing against the needs for regular updates, a 6 month cycle likely makes the most sense.
Hot Wallet Management
The best solution for hot wallets is not to use them. CoinBerry reportedly uses multi-sig
on all withdrawals, and Bitmex is an international example known for their structure devoid of hot wallets.
However, many platforms and customers desire fast withdrawal processes, and human validation has a cost of time and delay in this process.
A model of self-insurance or separate funds for hot wallets may be used in these cases. Under this model, a platform still has 100% of their client balance in cold storage and holds additional funds in hot wallets for quick withdrawal. Thus, the risk of those hot wallets is 100% on exchange operators and not affecting the exchange users. Since most platforms typically only have 1%-5% in hot wallets at any given time, it shouldn't be unreasonable to build/maintain these additional reserves over time using exchange fees or additional investment. Larger withdrawals would still be handled at regular intervals from the cold storage.
Hot wallet risks have historically posed a large risk and there is no established standard to guarantee secure hot wallets. When the government of South Korea dispatched security inspections to multiple exchanges, the results were still that 3 of them got hacked after the inspections
. If standards develop such that an organization in the market is willing to insure the hot wallets, this could provide an acceptable alternative. Another option may be for multiple exchange operators to pool funds aside for a hot wallet insurance fund. Comprehensive coverage standards must be established and maintained for all hot wallet balances to make sure Canadians are adequately protected.
Current Draft Proposal
(1) Proper multi-signature cold wallet storage.
(a) Each private key is the personal and legal responsibility of one person - the “signatory”. Signatories have special rights and responsibilities to protect user assets. Signatories are trained and certified through a course covering (1) past hacking and fraud cases, (2) proper and secure key generation, and (3) proper safekeeping of private keys. All private keys must be generated and stored 100% offline by the signatory. If even one private keys is ever breached or suspected to be breached, the wallet must be regenerated and all funds relocated to a new wallet.
(b) All signatories must be separate background-checked individuals free of past criminal conviction. Canadians should have a right to know who holds their funds. All signing of transactions must take place with all signatories on Canadian soil or on the soil of a country with a solid legal system which agrees to uphold and support these rules (from an established white-list of countries which expands over time).
(c) 3-5 independent signatures are required for any withdrawal. There must be 1-3 spare signatories, and a maximum of 7 total signatories. The following are all valid combinations: 3of4, 3of5, 3of6, 4of5, 4of6, 4of7, 5of6, or 5of7.
(d) A security audit should be conducted to validate the cold wallet is set up correctly and provide any additional pertinent information. The primary purpose is to ensure that all signatories are acting independently and using best practices for private key storage. A report summarizing all steps taken and who did the audit will be made public. Canadians must be able to validate the right measures are in place to protect their funds.
(e) There is a simple approval process if signatories wish to visit any country outside Canada, with a potential whitelist of exempt countries. At most 2 signatories can be outside of aligned jurisdiction at any given time. All exchanges would be required to keep a compliant cold wallet for Canadian funds and have a Canadian office if they wish to serve Canadian customers.
(2) Regular and transparent solvency audits.
(a) An audit must be conducted at founding, after 3 months of operation, and at least once every 6 months to compare customer balances against all stored cryptocurrency and fiat balances. The auditor must be known, independent, and never the same twice in a row.
(b) An audit report will be published featuring the steps conducted in a readable format. This should be made available to all Canadians on the exchange website and on a government website. The report must include what percentage of each customer asset is backed on the exchange, and how those funds are stored.
(c) The auditor will independently produce a hash of each customer's identifying information and balance as they perform the audit. This will be made publicly available on the exchange and government website, along with simplified instructions that each customer can use to verify that their balance was included in the audit process.
(d) The audit needs to include a proof of ownership for any cryptocurrency wallets included. A satoshi test (spending a small amount) or partially signed transaction both qualify.
(e) Any platform without 100% reserves should be assessed on a regular basis by a government or industry watchdog. This entity should work to prevent any further drop, support any private investor to come in, or facilitate a merger so that 100% backing can be obtained as soon as possible.
(3) Protections for hot wallets and transactions.
(a) A standardized list of approved coins and procedures will be established to constitute valid cold storage wallets. Where a multi-sig process is not natively available, efforts will be undertaken to establish a suitable and stable smart contract standard. This list will be expanded and improved over time. Coins and procedures not on the list are considered hot wallets.
(b) Hot wallets can be backed by additional funds in cold storage or an acceptable third-party insurance provider with a comprehensive coverage policy.
(c) Exchanges are required to cover the full balance of all user funds as denominated in the same currency, or double the balance as denominated in bitcoin or CAD using an established trading rate. If the balance is ever insufficient due to market movements, the firm must rectify this within 24 hours by moving assets to cold storage or increasing insurance coverage.
(d) Any large transactions (above a set threshold) from cold storage to any new wallet addresses (not previously transacted with) must be tested with a smaller transaction first. Deposits of cryptocurrency must be limited to prevent economic 51% attacks. Any issues are to be covered by the exchange.
(e) Exchange platforms must provide suitable authentication for users, including making available approved forms of two-factor authentication. SMS-based authentication is not to be supported. Withdrawals must be blocked for 48 hours in the event of any account password change. Disputes on the negligence of exchanges should be governed by case law.
Continued review of existing OSC feedback is still underway. More feedback and opinions on the framework and ideas as presented here are extremely valuable. The above is a draft and not finalized.
The process of further developing and bringing a suitable framework to protect Canadians will require the support of exchange operators, legal experts, and many others in the community. The costs of not doing such are tremendous. A large and convoluted framework, one based on flawed ideas or implementation, or one which fails to properly safeguard Canadians is not just extremely expensive and risky for all Canadians, severely limiting to the credibility and reputation of the industry, but an existential risk to many exchanges.
The responsibility falls to all of us to provide our insight and make our opinions heard on this critical matter. Please take the time to give your thoughts.
Alan Booth is the CEO of one of Cryptopia, an exchange regarded as having one of the widest selection of tokens. Founded in 2014, Cryptopia is one of a handful of blockchain-focused companies in New Zealand.
The Cryptopia team is often tasked with researching hundreds of projects to determine their efficacy before any other major exchange has touched them. The exchange lists many projects in their early stages and post-ICO.
As an entrepreneur and business consultant for over 50 years, Alan Booth’s story is fairly atypical of that of many entrepreneurs in the cryptocurrency world. His perspective on the cryptocurrency is grounded in decades of business development experience, and he views the cryptocurrency exchange realm as one of the most exciting opportunities yet.
In the following interview, we dive into everything from cryptocurrency psychology, the coin listing process, and blockchain entrepreneurship. How did you get introduced into the crypto world?
That’s interesting. I was consulting for Cryptopia or consulting to assist them in their development path for several months when it became obvious that they needed some senior leadership to move them from where they are, which was basically a reactive technical focus to a more business global focus on how we develop their business model. We are very conscious of the fact that you need a higher level of thinking. You need a global perspective, particularly from New Zealand because there’s not a lot of us down here.
That probably predicates why we’re a global business grown out of such a small population. We’d known each other for a while, certainly six months or so, and when the opportunity came up, why wouldn’t I move from a very safe, comfortable, fun job that I had previously, which was the chief executive of an international flying school. Nothing really scary goes on there.
I am at the latter end of my working life, somewhat semi-retired and all my colleagues went, “You’re going to do what? Are you kidding?” Of course, the blood pressure went up and I said, “yeah, I’m going to have a go at this.”
So, it’s really about the opportunity when you’ve learned so much over 40 or 50 years of developing business models and floating companies and taking them to the world, which is primarily what I’ve done. To find something that’s new and a full of excitement and fear and trepidation and where is all this going? Then it’s an opportunity you can’t afford to pass up. So, it’s just the daredevil saying let’s go. The risk and the general fervor for the industry have gotten a lot of people very excited. What are the top concerns for exchanges moving forward from your perspective?
They are many fold and they are variable based on feedback from the community and somewhat driven by legislation, driven by corporate requirements. The FinTech world, we’ve got to look at that as well as the coin world. If we want to grow and deliver a product that the average consumer can consume, then we have to deliver all the things that they would typically expect. So, if you went into a retail store to buy a heater, you expect to have a warranty.
You expect to be safe, you expect to be treated well with clarity. And typically, the coin industry to date has not been very good at that because it’s been evolving and mostly evolving from a technical perspective with probably less weight put on the public consumption of the coin. It’s being technically driven as a technical product when you look at it. When you go to the exchange, some of them take a fair bit of thinking about before you can operate.
So, for us, the first thing is trust. If people can’t trust your brand, and that means every part of it, you’re not going to succeed
. So, we are very proactive here in New Zealand, talking to legislators, government agencies in and out of New Zealand. KYC, AML, CML, all of that stuff. We are drafting our own internal rules and then most cases they exceed the requirements of our banking partners. So, they look at us and they go, wow, you’re way ahead of where we thought it would be. So, developing a trust relationship with our consumers and business partners is vital. The next thing is developing a stable and functional platform.
I don’t just mean the coin exchange itself, but all of the underlying technology. Will we be up? Do we have latency? Are we speedy? Have we purchased the right partnership relationships for our equipment and how do we continue to be able to scale at will and not risk failing to deliver a result? That means helping people get an exchange done, their coins on and off. I suspect it’s the same as every other exchange.
Only thing is, down here, we have really focused on three things to move us very quickly forward. One is the public-facing components. That’s the help desk if you get stuck. We want to be able to respond very quickly. And like the other exchanges, we headed enormous influx in the early part of the year and that was debilitating. Nobody was ready for it. We employed teams of people to come in and train as support operators. We’ve since then spent a huge amount of money on a new ticketing system, which actually went live yesterday.
So, this morning when I come in, there’s smiley faces trying to get their head around it going, wow, this is amazing. So, we triage all the tickets on the inbound route now and puts it in a good space for our response team to reply as quickly as possible, I want. At the moment, we’re not there. Instead of being 40 or 50 hours and all these horrible delays, I want people to have a response from us immediately and I mean within seconds saying we’ve got your ticket. I can’t answer it right now, but we’re on you. Then, within hours, get back to those customers and fix their problem. They don’t deserve to wait 24 hours or 48 hours.
People are anxious. Ticketing, we’ve done something about it. Highly trained staff, we’re employing all the time. We’ve developed foreign offices to beat the time zone thing. We now have a support office in the UK that we have had for some time, actually. The next thing is just the stabilizing of our software and hardware.
When you start these things, the enthusiasm and the inexperience of the development team may not know what’s here to them and now we’ve bought in bigger, stronger, international teams. So, that’s great what you’ve got, but let’s do this. So, that’s the phase we’re on now. We’re spending all of our money. In fact, every penny that we generate in this business goes straight back into furthering and developing the products. Nobody’s racing home in Lamborghinis or flying their jets around. They’re just piling into it.
So, that’s how I am in terms of producing a high-quality product. It’s not a decision we just made. It’s always been there, but we are now articulating it internally, that we want to be in the top five of crypto exchanges and digital asset exchanges of some form within the next two years. In the top five, bar none, in every respect. Would you say the number one component of being thought of as one of the top five would be trading volume? Is that the primary metric?
I absolutely agree with you, but you can’t have trading volume unless you provide the other things first, like security, safety, a good trading platform.
If you want trading volume, I have to have a reason for you to trust me, which has to be if I have a failure, will my ticket, be answered? If you do those things, you will get trading volume. I don’t believe you look at it the other way and say, hey, let’s create trading volume because if that comes at you hard and sharp, how are you going to cope with it when something breaks?
It’s technology, things will break. It’s how you address things that go wrong that made you successful, not what you put in place to drive that business in. That will happen if you’re good. The word gets out saying this is a great exchange. They fixed my tickets, they’re fast, they’re responsive, it’s safe. That will create trading volume.
Trading volume for us is income and of course, we want it. We have actually slowed down on coin listings. We’ve slowed down on taking new customers and we’ve slowed down on developing relationships with partners simply to get our platform in better shape so that we can become the most reliable, trusted partner you can have. That will create trading volume, no doubt about it. Although trading volume does bring in a sizable amount of revenue, there comes a point where it just becomes a vanity metric where people are using an exchange simply because there just aren’t any better alternatives out there.. So, if there is an exchange that can offer all the features that you’re talking about and a premium level of service, then the trading volume will trickle down. There’s no real loyalty for exchanges other than preferences.
Absolutely. We wouldn’t ask for that. Why would you say to somebody, hey, you got to be loyal to us? That’s just silly. You will be loyal to us if I offer you a great experience. That means volume of coins, a huge range to trade through. Ease of trading. One click, two clicks. How about some trading tools just like you see in a modern foreign exchange opportunity? Some arbitrage tools, some tools for measurement, some nice desktop tools.
We want to introduce other things. It just means that you’ve got control over your own reporting and your own desktop environment. It can become a very powerful tool to use as long as we listen to the customers and say, hey guys, we can develop that. Give us a couple of months, let’s put it in front of you. What is the coin listing process for you guys? What’s the process for someone who wants to get their coin listed on Cryptopia?
We’re just reviewing that and we’re being very focused on changing the way we list coins and who we list. We’re very conscious to gain trust. We are actually your first port of call for particularly those people who don’t know much about coin, so they have to trust their exchange partner. Therefore, we have to make sure that if we list a coin, it’s a viable trusted, honest coin that’s going to give value.
Not just to us as an exchange but it’s not a scam coin. It’s not something just to raise money, pump and dump thing. We have coin listing teams who are very tough. I have introduced people as the CEO to my coin listing team and I can’t get it through them. I’ve said, but these are great guys and I have a great story and I met them in Vancouver and boy, they’ve convinced me.
My coin listing technical team does all the due diligence. Everything from GitHub, Facebook pages, normal stuff like that. If it doesn’t look like a viable product to us on many levels, then it doesn’t get listed. That’s the end of it.
If [the coin] gets past that, we do further due diligence. We’ll actually interview the company. We’ll ask why do you want to list? Why do you want to list with Cryptopia? What’s your plan for the coin? What do you want us to tell customers because they’re going to be relying on us?
So, we’d like to do more than just have a coin called 21 Million sitting on the exchange. How about if we had a link to that with some of the criteria we use to judge whether that was a good opportunity. Whether it was a good coin. We might have a 10-point plan and we might say, hey, this coin passed at 9.7. This coin is in, but it only got in at 2.4. Whereas the negative coins, the coins that have gotten negative plans, negative equity in our mindset, they just don’t get on the exchange.
We have a very large number of coins at the moment. We want to remain in that space, be the leader. That means that clearly, we’re not going to get it right all the time because we make mistakes and actually, so do the some of the honest and reliable coin generators. Their plans might not just happen, so they get the benefit of the doubt for a while.
As long as we see that they’re not doing something deliberately to disrupt the market or just to take money, then we’ll support them until they get their business model right. But we’re very focused on a coin listing to us is actually a business partnership. We’re not just going to throw coins up there. I think 2018 is the year of reckoning, wherein 2017, pretty much anything got listed anywhere. It didn’t really matter how functional the coin was or whether it was legitimate or not. So, it’s really cool to see the trend in exchanges making a stance against that because if the ax falls, it doesn’t fall on the anonymous coin team that could be in Switzerland and Ethiopia. It’s falling on the CEOs and the exchange teams that are allowing access.
People come to us and they say, hey, I haven’t got my money. You’re the exchange. I go, well actually, the coin that we listed, I’m afraid the wallet’s faulty or they didn’t do this, or they ran away. People don’t care. They’re relying on us. That’s why Cryptopia has to be a business partner with each and every user, not just a provider of some coin listings. That would be unethical. Absolutely, and it’s good to hear. Speaking of regulations, how do you think that’s going to evolve for exchanges, especially being out of New Zealand?
I welcome a regulatory intervention for many reasons. The primary one is that as soon as the regulators start imposing their will and taking notice, it means that it’s a genuine opportunity. They don’t waste their time on something that’s not going to affect global economies or our economy. For example, the New Zealand regulators, we’re working and we’re working with them because they recognize that somebody has got to work with them to tell them what’s going on.
The other side of the fence, that’s us. We have to work with them to say, you can’t do that because it won’t work in this environment. So, working with regulators is critical, in my opinion, and we’re doing that very well.
Regulation has to come.
It was just announced in New Zealand a few days ago that we’re going to start, this is unrelated to coins, collecting GST, which is our equivalent of your local taxes, on online purchases. So, typically anything up to $400 that you buy online from Amazon, for example, in New Zealand, you wouldn’t pay tax on and they’re changing that. They’re taking the same view with coins. So, the government is saying, how do we tax revenue? When do we tax revenue? What should it look like? How do we make it fair for you, the exchange and how do we make it fair and manageable by the consumers who may have to declare a capital gain if they’re going, for instance, as an equity or a property as pure speculative fun like betting? And if that’s the case, when should we do this? Should we backdate all that stuff?
Every country is going through this and some have jumped in and made decisions that they’ve had to backpedal on. They were a little bit hasty. In New Zealand, in particular, we have a great relationship with the regulators and all the powers that be, right down to the banks, and are all looking at the space saying, you know what? We don’t quite know what to do, but let’s start doing something and I welcome it.
And the more understanding and control we have on these things at this early stage these next few years, the neater and cleaner will be over the next few years. Just as banking has become very stabilized through regulations, so will this crypto business, whatever it ends up looking like. New Zealand has its advantages because a smaller population could make building direct relationships with regulating authorities easier. Tim Draper, for example, is investing in Papua New Guinea to try and make this whole digital citizenship country. The Binance guys just moved over to Malta. The global landscape just opened up, and governments will have to start offering distinct advantages to attract companies that could hypothetically set up virtually anywhere.
That’s great because that’s exactly what online trading is about. It’s online and it’s global. We have to join the global party, but we better start from a position of understanding and strength in our own environment. Make sure we have our own stuff together before we start yelling about what someone else should do. Yeah, absolutely. Shifting gears a little bit, what do you think about decentralized exchanges and how they’re going to affect the whole exchange thing?
The quick and easy answer to that is it will definitely affect the global exchange market. It will definitely affect FinTech because if people who are regular investors and that’s people with mom and pops with a few dollars, right up to institutional investors, if they can see a way of generating revenue and it’s safe, they’re going to move there. They’re not going to discard their other investment opportunities and they’re not going to discard regular exchange-traded equities or working on the stock exchange. But there’s a space here that we haven’t quite worked out who that’s going to work for or how, but the more we regulate, the more we make the tools visible.
The stronger we look to the market and the more professional we look. That doesn’t necessarily mean just wearing a suit into a meeting, but the more gravitas we have behind those discussions demonstrating that we’ve done on the work and that we’ve got smart people here and the technology’s good. We’re ready to come and meet and talk equitably to investors and traditional investment houses. Then there will be a way that they join up. There’s no doubt about it. I mean, it can’t be helped. How about the lightning network and atomic swaps where you could pretty much exchange peer to peer. You could trade Litecoin for Ethereum directly in one single transaction without an exchange. Centralized exchanges have their benefits, like for example, there’s someone you can knock on their door and say where’d my money go? I need customer support. So, there are advantages there, but then the advantages of a decentralized exchange are just the efficiency. I’m wondering how is that viewed for the centralized exchange world?
I don’t want people to take away my income opportunity. We’re building a business. We would argue, and I think it could be demonstrated to date until the blockchain comes up with some technical solutions. We’re building a trust environment and we are taking on, at considerable cost, the responsibility for providing the trust. First, it’s a coin that we like and here are the reasons. We’ve done the due diligence on your behalf. We allow the transactions to take place and here’s how we regulate, manage and deliver that transaction and manage the wallet relationships.
Cryptopia’s Coin Information display
That’s a role we take on. So, if you trade with a centralized exchange, you’ve got a whole lot of advantages that you don’t have by trading peer to peer. It’s fairly obvious what a peer to peer relationship looks like. If that’s on a personal level, that risk is much greater. If it’s on a more corporate structured level, I don’t know what that looks like yet, but I think we’ve got a long way to go before we could move from centralized exchanges to peer to peer simply because there’s going to have to be some regulation around it. How would the regulators engage in that space? Who are they engaging with? Every single person who wants to trade?
At the moment, they can deal with an exchange that has potentially 2,000,000 to 10,000,000 customers. That’s not easy for a regulator or a tax authority. So, there’s the regular regulatory component. That’s got to be there. Then there’s the trust management and then there are just a few more technical issues that I think have yet to evolve. It all comes down to running a business. It takes money and capital to get all these users you want to get. If the technology works, that’s great, but onboarding users take resources. How do these projects plan on doing that? It’s just a missing component of every single white paper that tries to go after that who isn’t trying to build a centralized business to oversee it.
I think philanthropy is wonderful and when people are talking about decentralization. It’s a great idea and it’s philanthropic and it would be wonderful if the world could work like that. But there’s never been a business model that has worked without generating revenue. There isn’t one. Everyone’s tried, but you can’t name one that doesn’t have to generate revenue at some point or another.
Even if that revenue is simply generated to make the action happen, the hardware, the software, the bandwidth, someone’s got to pay. So, if you’re decentralizing, how do you get paid? How do you police it? How do you manage it? Why not stick to a model that works? And it’s not just about centralized coin exchanges. It’s not just about front-end institutions. This is a model that’s worked since the first inhabitants of Earth swapped a bean for a stick or can I give you my dinosaur to cook while I bring you a giraffe? I don’t know, but you can’t have a society without an exchange happening of some value in exchange.
Even if I go to a coffee bar with you, here’s the simplest thing. I would say, hey, I’ll meet you for coffee, on me I might pay for the coffee, but guess what? We’ve sat down and exchanged information. I’ve gotten something out of it. How do you do stuff without exchanging value? It’s push and pull between advancing technology and proving the model works but then what’s the incentive to run it and popularize it because you’ve got that whole chicken and egg problem. We need a bunch of users for this to work efficiently, but we’re not going to make any money doing it. Hopefully, we’ll see how things play out in the next couple of months or years or decades.
I’m down for decades and a lot of failures. We’ll be there watching them saying we’ll help you if we can and hey, go and play guys, but come back here when it doesn’t work because we are going to be here. What are your thoughts on Bitcoin dominance in general compared to all the other coins out in 2018? So, what does a cryptocurrency landscape look like if Bitcoin happens to fall down to, let’s say, 15\% or 10\% of the market?
Does Bitcoin really dominate or is it just big? If you look at the exchanges and watch the traffic, can you see as much traffic taking place and as much interest in the CoinCash or 21 Million or Kenya or any of these things? They’re all there and people are trading them for various reasons. Mom and pops are going to be doing this to buy a new car.
Someone else purely looking as a store of wealth and other people are looking to dominate a market. So, I’m not sure that you could say Bitcoin dominates. It might be the largest store of wealth at the moment. Does it dominate people’s thinking? I’m not sure about that. If you’re a coin developer, it’s your coin that’s dominant in your mind and you’ll go after a particular vertical, even a geographic market. So, you have the potential to develop your store or your story within that business scope.
Why does Bitcoin dominate? Simply because it was seen as an opportunity? Is it dominated because the people who trade in Bitcoin put so much faith in it being a store of wealth or an opportunity for capital gain? But a lot of those people have run away. That’s why it’s not $20,000 at the moment. It’s just trading between 8,000 and 10,000 in there. So, it stabilized. So, what if it fell over? Some people will lose money.
It’s not going to change the blockchain, it’s not going to change our thinking about cryptocurrencies. It’s not going to change Cryptopia’s approach to the market. It might dominate in volume. I’m not sure it’s the dominant force supporting cryptocurrencies. I see what you’re saying. It might just be a dominance of user acquisition because there’s a larger chance they heard of Bitcoin instead of Ethereum if they have heard of cryptocurrency at all. So, it’s like the gateway crypto.
Take care that people aren’t saying Bitcoin just like a Hoover, the vacuum cleaner. Every vacuum cleaner for 20 years was called a Hoover. That was the dominant brand. Hey, I’m going to Hoover the floor. What they meant was I’m going to get my vacuum cleaner of which there are 80,000 different makes out there now and they’re going to vacuum the floor, but they just called it a Hoover. So, I trade in Bitcoin.
I’ll bet you someone who says, yeah, I trade Bitcoin, he’s only saying bitcoin because he knows or she knows that people understand that you’re referring to a cryptocurrency. If you say to someone I trade in Clearpoll or CoinMedic3, they have no clue what you’re talking about. They go what is that? Oh, it’s Bitcoin. Oh, I get it. If you went home to your mom and dad and they asked what are you doing? You’d say, oh yeah, I’m trading cryptocurrency. They’d go, oh? What’s what? You’d go, Bitcoin. They go, oh, that thing. Bitcoin Cash is competing to be known as the Bitcoin for a reason. In the next four or five years, there are millions of people that haven’t even heard of crypto that would probably receive a lot of benefits from being onboarded into the cryptocurrency world. I’m not really sure how what they get onboarded to first matters immediately, but I know it plays a substantial role for a lot of people.
It’s an initiator. It’s a keyword that attracts them to the space that we’re in. It’s simply because it’s got brand dominance in the public persona. If you say a Bitcoin, most people know you’re talking about that strange online thing that no one understands and there are a few other coins, but we don’t know what their name is. As soon as they hit an exchange, if they really want to try it, they’re going to look at the next one down and say oh, I didn’t know that existed. They’ll make their way right to the bottom of the 2,000 list.
So, I really don’t think we should worry too much about dominance or anything that’s measured in that way in the space because the variables that change our value perception on any of these products is a mystery to everyone. A rumor can cause change overnight and things like that have happened. Guess what? They also happen in traditional exchanges.
Go to the London stock exchange and you’ll see a piece in the paper tomorrow that prices rocketed or have fallen over the next day because the public is there. The public is there late, remember. If you see it in the news, it has already happened. That’s the same thing for this. So, what are your favorite projects out right now?
It has to be blockchain focused. I mean, coins seem to be a tool that are being used to raise capital, raise awareness, create hysteria over or some fun. Some of them, and I believe it’s very few of them, I wouldn’t like to statistically put a number on that, but I think it’s very, very few have actually got a basis of a typical good investment. Is company strong behind it? Do they have good ethics? Why are they doing this? What’s it for? Or is it just to raise money?
When they’ve got money they can go, oh, look how much money we’ve got. Let’s do something. That’s not the way to grow a business. Somebody has to have a good story that’s technically supported. It has to have social value these days. And that means is it good for mankind? Is it going to save the planet? Will it do something? Create manufacturing? Whatever it is.
Hey, I’m not a philanthropist. I’m not saying you’ve got to do something to save the planet. But the youth of today are much more conscious about anything we/they do is about social conscience and social values and responsibility. So, for me, any of those projects, whether they be blockchain based or coin based that do something more than just making money for a bunch of guys, so they can go buy a Lamborghini, gets more of a look and support from us than the others.
There are ways of going and creating wealth for yourself than preying on opportunities that exist simply because exchanges listed them. So, we’re very careful about that. So, I wouldn’t like to say at this stage, we have anyone in particular. We do have some businesses we’re looking at, but they all are very well rounded in terms of their sales pitch. It’s ethical, it’s got a good background.
They have strong management, a history. They’re well-funded already. They’re not just grabbing money to then decide what they’ll do with it. Well said. The one point you made about how these projects need to be ethical and how that impacts those business models because again, you tap into to the same vein of projects that are looking to substantially change industries that had been stifled by inefficiencies or corruption.
It stretches a long way. If you find a solution that bugs business and usually if it bugs a business, it bugs and effects people, consumers, in some way. That might just be, where it’s blockchain related, securities and tracking things to make this whole trust environment that we live in. The point is we say we can trust but we can’t trust.
Everything we do is about trust. We get lawyers to look after our trust issues and we shake hands and we still wonder whether it’s a deal. So, solving trust issues globally is probably one of the biggest benefits to mankind because once we solve the trust issue, you can then be positive or confident that something that you want to happen and agreed to happen is actually going to happen. If it doesn’t happen, it’s not just about the broken trust. It’s then about the finances involved before you got there.
That’s all gone. The future has all gone around that business model. So, trust management in blockchain and around coins and around exchanges, decentralized exchanges, is probably the biggest thing we have to deal with. Which takes me back to my core development program right now, which is developing a trustworthy exchange. Make it clear, unambiguous. Make it reliable, deliver what we said we were going to do. What does a day in the life of Alan Booth look like? What do you do for fun when you’re not doing exchange type things? If there’s even time for fun.
If you’re running an exchange, it’s 26 hours a day to run an exchange. If you can squeeze another hour in, you might find some fun. This is probably my last employment opportunity. I’m in my 60’s. I’ve spent 50 years being an entrepreneur and an arm waver. Wave your arms and see who’s taking notice and make something happen.
So, fun for me is actually the exploitation of a business opportunity. I go to bed hoping that I wake up in the night with an idea to scribble on the pad. I come to work a very early. I’m up at 5 am. I get here at 7 am if I can with the work already done. I don’t want to arrive at work and look at emails. If you’re looking at email and other stuff, it’s other people’s requests on your time. I’m going to arrive here being creative.
I want to arrive every day going, I’ve got nothing to do except be creative and compel all of my employees and partners to support that creativity and bring their own creativity to it. So, you couldn’t have more fun than that, could you? What else is there? Just to make stuff and see people get excited and give them the opportunity.
But when I’m outside of this, hey, I liked to fly light aircrafts. I ride fast motorbikes. I do guy stuff, and when I’m not doing guy stuff, I’m at home helping my wife in the garden. Just an ordinary guy. Most of my daylight waking hours is about being that global entrepreneur with regard to this huge global opportunity which is let’s change the world.
It’s like moving from coal to steam, steam to mechanization, mechanization to electronics, and now we move into the digital age and we’re in it. What a fantastic place to be. So, how exactly do you do that? Do you just wake up earlier and just get everything done at 5:00 AM?
There’s never enough time in the day. What it is, it’s being super critical about what’s actually important. If you open your email when you get to work, I will guarantee that you will sit there procrastinating and jump between emails. Most people don’t work from the top to the bottom or the bottom to the top. You’re a little bit selective, so already you failed to do what people expect you to. Email and inbound inquiry are other people’s expectations of how to use your time.
They’re imposing their requirements on you. So, you’ve already allowed yourself to be managed by outside rules. You’ve got to arrive at your office with nothing that interferes with the creative process of why am I at this office? Why did I come here? I came here to understand what we’ve got. So, that’s a constant job. To work with the clever people that you have employed. I have a major role in employment and myself. Only employ smarter people than yourself, only.
Because if you’re employing people that aren’t smarter than you, you’re going to have to tell them what to do and you don’t have time for that.
Now, employing people smarter than yourself, for me, that sets the bar quite low, that’s easy, so I get really good pickings. But, generally speaking, you need to employ the best people and get them going and then you’ll be so busy running around trying to keep up with him, not them keeping up with you, that you actually have no time for all that outside noise. You’ve got to impose on the world what you want, not the world imposing on you what they want. Turn it around.
Every time I have a conversation with somebody, it’s about what I want, in the nicest possible way. We will listen to inbounds but we already have a path to follow. If you start following other people’s paths, you’re not going to get where you want to go.
Here’s the thing. I’ve been a business mentor for probably 20 years.
Mentoring basically new CEOs. New CEOs, it’s the loneliest job in the world because it might be your first CEO job, so you can’t talk down because those people below you expect you to be the boss, so you can’t ask them. You can’t talk up because you’re the CEO. It’s no good asking the board, they’re looking down at you. You can’t talk sideways because they’re your competitors. So, the first year or two as a new CEO is the loneliest place on the planet.
So, what you have to do is be entirely focused on what you need to get done and that is by changing what you used to do before you became a CEO or a boss. What you used to do is respond to every bit of noise that came at you and it filled your day up until you went nutty. Thank you!
Cryptopia CEO Alan Booth on the Cryptocurrency Exchange Realm
CoinCentral's owners, writers, and/or guest post authors may or may not have a vested interest in any of the above projects and businesses. None of the content on CoinCentral is investment advice nor is it a replacement for advice from a certified financial planner.
Alex is the Editor-in-Chief of CoinCentral. Alex also advises blockchain startups, enterprise organizations, and ICOs on content strategy, marketing, and business development. He also regrets not buying more Bitcoin back in 2012, just like you.
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