At The End Of Your Tether: Addressing, Responding To And Insuring Cryptocurrency Theft

Author:Mr Herbert Kozlov, J. Andrew Moss, Kari S. Larsen and Vincent James (Jim) Barbuto
Profession:Reed Smith

Tether Suffers $31 Million Loss of Tokens

On November 20-21, 2017, Tether, the company behind USDT – a digital token backed by fiat currencies like the dollar and euro – disclosed that a hack resulted in the loss of $30.95 million worth of tokens.1 Tether posted an announcement to its website November 19 reporting that a "malicious action by an external hacker" resulted in the coins being "removed from the Tether Treasury wallet" and "sent to an unauthorized Bitcoin address."2 Tether is now working to "blacklist" or otherwise inhibit hackers from using the stolen coins.

The Tether hack illuminates the privacy, reputational, financial and recovery risks associated with issuing, owning and storing digital currencies. These risks and events are likely to repeat themselves as more initial coin offerings ("ICO") come to the market, and the prices of digital currencies continue to soar.

According to Tether, USDT tokens are pegged to fiat currency to decrease the volatility experienced by non-fiat backed cryptocurrencies, such as Bitcoin, and to facilitate trading of USDT tokens on crypto-exchanges.3 Although it is a less commonly used coin, the Tether hack rippled throughout the cryptocurrency market. News of the Tether theft contributed to a 5.4 percent decline in Bitcoin's value the week the incident was announced (it eventually recovered).4

Background: Recent Breaches/Cryptocurrency Thefts and the Consequences

Tether is only the most recent of a number of security incidents that have befallen cryptocurrency providers and partners since the introduction of Bitcoin in 2009. Although the Bitcoin blockchain (the underlying distributed ledger of the digital currency) itself is often touted as unhacked (as of yet), a litany of digital wallets (resources for users to store cryptocurrencies), cryptocurrency exchanges, and ICOs have suffered losses to hackers, often without realistic recourse for issuers or users who have incurred significant losses.

Two of the largest cryptocurrency exchanges, Bitfinex and Coinbase, have both been targeted by hackers, as have the digital wallets of their customers. Last year, Bitfinex suffered the second-largest exchange platform breach, resulting in the loss of $72 million in users' Bitcoin from the exchange.5 The exchange later reimbursed affected customers.6 The U.S. Commodity Futures Trading Commission (CFTC) also fined the exchange "for offering illegal off-exchange financed retail commodity transactions,"7 by offering trades on margin and not "actually delivering" the cryptocurrencies within the required timeframe of 28 days.8 The CFTC considered the exchange's security and access controls in its analysis, and determined that by controlling the private keys that accessed customers' digital wallets, Bitfinex was interfering with the level of "possession and control" required to connote "actual delivery" under the Commodity Exchange Act.9 Tether and Bitfinex share an owner,10 and their relationship, coupled with continued security vulnerabilities, including a distributed denial-of-service (DDoS) attack on the exchange as recently as November 26,11  have fueled speculation and accusations surrounding the Tether hack.12 

Coinbase, a cryptocurrency exchange valued at more than $1 billion,13 has also experienced multiple wallet-based incidents whereby hackers exposed vulnerabilities to the Signaling System 7 (SS7) to manipulate customers' SMS-based, two-factor authentication wallet access systems and drain coins from their accounts, sometimes before their eyes.14 According to reports, "hackers have never breached Coinbase's own virtual fortress,"15 but the exchange's security has not prevented significant losses from customers' accounts.

The risks associated with cryptocurrency operations do not stop at the issuer's or exchange's doorstep; massive losses can occur from issues systemic to the on-ramps and off-ramps used to access, trade, and store digital currencies on a distributed network.16 

In July 2017, $30 million in Ether was stolen when hackers exploited vulnerabilities in a startup's digital wallet to obtain exclusive ownership of the wallet and move all of its funds.17  Attempts to fix the bug in November may have unintentionally frozen (effectively lost) an additional $150 million or more in an irreversible transaction, highlighting one way in which blockchain technology's immutability...

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