Facing Decentralized Finance and Crypto Security Dilemmas

In the race to transform the financial world, different types of security exposure and risks have emerged -- or at least old hacker habits have been used on new fintech.

The Department of Justice made arrests this month in a case about an alleged cryptocurrency laundering scheme tied to the 2016 Bitfinex hack where billions of dollars’ worth of Bitcoin got swiped. This follows January’s news that a third party stole some $80 million in cryptocurrency from decentralized lending and borrowing platform Qubit Finance. Further, there is some ongoing debate on whether quantum computers, which are still in their nascent stage, might one day be capable of cracking encryption meant to safeguard cryptocurrency and the blockchain.

Such matters may stir questions about the security of cryptocurrency, decentralized finance, and other aspects of fintech, but it does not necessarily signal a need to retreat from this frontier.

Though there is talk about the potential upheaval quantum computers might bring, Andras Cser, vice president and principal analyst with Forrester, says it is still speculation. “It’s too early to worry about this,” he says. “We’re still a few years away from viable quantum computers that can actually break the current algorithm encryption in public key cryptography algorithms.”

Cryptocurrencies for Ill-gotten Gains 

Fraudsters have capitalized on cryptocurrencies for ill-gotten gains including money laundering, Cser says, but solutions from such sources as CipherTrace are being developed to tackle such problems. “Open banking has garnered some additional interest in better customer authentication,” he says. Overall awareness and efforts to improve compliance tend to follow regulatory filings in this arena, he says, but there is more work to be done.

“Cryptocurrencies are super unstable today,” Cser says. “That’s a problem.” There is also no national government funding or support behind crypto, he says, citing that many national governments are not keen on promoting cryptocurrencies. “They all want to exert their political influence on other economies of the world,” Cser says. “A cryptocurrency has no government support -- no real economic outputs. Most of these cryptocurrencies are tied to very expensive, very environmentally damaging [crypto] mining activities.” That is in reference to the compute power being put to work for extended periods to mine cryptocurrencies. “It is really something that is detrimental to environmental responsibility.”

Financial institutions are also a bit averse to aspects of crypto. Their appetite for risks associated with the adoption of cryptocurrencies, decentralized finance, and other fintech solutions remains low, Cser says. “If you look at the totality of transactions happening, I think decentralized finance and cryptocurrency transactions represent a small chunk.”

He says it is unclear what will become of cryptocurrency in the long-term when it comes to payments. Naturally, regulators want to see the same level of ease-of-use and trackability in cryptocurrency as traditional alternatives, Cser says. If regulators can enforce trackability of crypto payments and cryptocurrency transactions, fraudsters may lose their taste for it as a vehicle for money laundering, ransomware payments, and other nefarious activities, he says.

Nascent Cryptocurrency Anti-money Laundering Tools

The pace of development in this space can outstrip the safety nets, which Cser says is frequently the case for emerging technology. There are cryptocurrency anti-money laundering solutions and resources to identify bad exchanges and unusual activity -- but they are just surfacing. “In general, these tools are very nascent,” he says.

A disparity exists between the safety resources regulators want in place now versus what is available to deploy. “That is another reason why these tools are inadequate,” Cser says. “Regulators are ahead in their requirements on what the tools can do and what a lot of financial institutions are capable of doing.” Most crypto exchanges have had to engage in customer due diligence exercises in response, he says.

Cser says the future may see a lot of innovation and acquisitions of smaller decentralized finance tech companies that offer fraud management and anti-money laundering resources. That might see this space become more mainstream and normalized into the flow of traditional finance. “If cryptocurrency stays, it will blend into one of the payment channels, such as the ACH (automatic clearing house) system. It’s just another transaction type.”

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