The Sad Story of QuadrigaCX: What it Means for Crypto
It has been all over the news recently and has shocked both crypto evangelists and newbies alike.
It is the seemingly unlikely story that a cryptocurrency exchange can lose access to C$190m ($143m) of its customer’s money.
How did we get here? Who is to blame? And what does this mean for the cryptocurrency industry going forward?
I will attempt to answer all of this in the post below.
What is QuadrigaCX?
For those people who have still not heard of QuadrigaCX, they were a large Canadian cryptocurrency exchange that was based in Vancouver. Prior to their collapse, they were one of the largest.
Although the exchange was not one of the most efficient or technologically advanced, it was trusted by over 100,000 Canadian crypto users as their fiat gateway of choice. They handled an impressive amount of volume for such a basic exchange.
The exchange did run into some trouble and there were a few warning signs that the operation was not being run with business best practices in mind.
Indeed, they even had C$25m frozen in their CIBC bank account in the middle of 2018. The CIBC was concerned that they were unable to identify whether the funds did, in fact, belong to Quadriga. While these funds were eventually unfrozen, the exchange faced a backlog of withdrawal requests.
These problems came to a head towards the end of the year as customers started complaining about not only Fiat withdrawal requests taking forever but also crypto withdrawals being held up.
There was something going on and that Crypto canary in the coal mine was long dead.
So What Happened?
The founder and CEO of QuadrigaCX was an individual by the name of Gerald Cotten. He was quite well known in the Canadian cryptocurrency scene and started QuadrigaCX back in 2013.
Gerald was quoted several times in the press as saying that the firm employed cold storage when it came to managing their vast supplies of cryptocurrency. For those who do not know, cold storage is keeping the coins in an offline and secure state such that it is out of the reach of hackers.
When most people heard this explanation of “Cold storage” they assumed that QuadrigaCX employed a multi-signature wallet scheme with at least a 2 of 3 key authentication. This would mean that Gerald held one of the keys and two other people at Quadriga held the remaining.
This would have the benefit that even if one of those keys was lost, the other two keys could be used to unlock the funds. It is a pretty standard operating procedure at any cryptocurrency business.
There is only one real problem with this…
Gerald Cotten ran a single key authentication scheme and he was the sole holder of this key. He was also the only person who knew the password or seed words to access these wallets.
Gerald also decided to take a trip to India in December of last year while long suffering with the Crohn’s disease. While on the trip, Gerald fell ill and was admitted to hospital. Unfortunately, he passed away from complications to the disease without anyone knowing how to access the cold wallets.
He, quite literally, took the money to his grave.
As one could expect, the news was shocking to most.
At first it hit the cryptocurrency news outlets that the company had filed for creditor protection and had gone offline. Then news got out that the CEO had died with the private keys. The reaction from some industry veterans like the Binance exchange CEO is quite telling.
That's sad. There are many solutions to split private keys or signing to achieve 3/5, 5/7 etc. Never neglect security.
Also, never have CEO carry private keys. Bad on many levels.
— CZ Binance (@cz_binance) February 2, 2019
How could an exchange of this size operate such an amateurish wallet management protocol? How can a CEO with over $130m in easy-to-steal cryptocurrency travel to India holding the primary key?
Indeed, there were a number of theories around whether he actually did die and whether Quadriga was facing issues prior to his death. There were also questions around the other founders at Quadriga and what part they played.
I won’t go into all of these theories for the moment, but there is one thing that is clear from this debacle: It has harmed crypto adoption.
The coverage exploded onto all of the major news outlets. Across the globe people were alerted to the fact that an unregulated cryptocurrency exchange does not really have government mandated cold storage protocols.
For those who were thinking of investing in cryptocurrency, they will most likely think twice. For those that were convinced that cryptocurrency was a “scam” now have further fodder to play with.
Not your keys, not your crypto?
While most crypto users know the dangers of leaving funds on the exchange, there were many who thought that QuadrigaCX could be trusted. There were some who merely looked at an opportunity to move funds and were caught in the mess.
As more and more victims start to come forward with the stories of their losses, it is sure to further impact on the mindset of those considering an investment.
What Will Happen?
Given that QuadrigaCX was unregulated, it is hard to see exactly how the Canadian government agencies will get involved.
The British Columbia Securities Commission (BCSC) says that it falls outside of their oversight because the firm did not sell registered securities. The Ontario Securities Commission says they are looking into it but there is no clarity on exactly what they could do to recover funds.
In terms of any potential for investigation by the Federal Police, the exchange says that they are not the subject of any inquiries by the RCMP.
Indeed, this legal vacuum has created a few issues for those who lost funds on the exchange. There are a number of civil claims that have opened up against QuadrigaCX but given the creditor protection granted to them, it will be an uphill battle.
Some of the most important things that may come out of this debacle is what it could do for long-term common-sense exchange regulation.
While regulation is often considered a dirty word to many of crypto’s most ardent supporters, it could have helped prevent the circumstances that led to this.
If there was more oversight into the actual operations at the exchange then it is unlikely that the CEO would have been so blasé when it comes to the management of the company. There would have been more transparency as to their funds and reserves.
There would have been penalties that came from non-compliance and there would have been clearly defined protocol to follow when the CEO died.
Moreover, if there was any sort of suspicious business going on at the exchange prior to its collapse, then a governmental regulator would have been able to spot it and take corrective action before users got harmed.
Most crypto maximalists like to think that they do not need the government to look after them in the wild west markets. However, if you were merely caught up in the QuadrigaCX mess by mere circumstance, your view would likely change pretty quickly.
Silver Lining to Crypto Clouds
While it does appear as if this is bad for the crypto industry in the short term, it could herald in some much-needed change to the industry in the long term.
Common sense regulations will likely clean up the sector, remove the numerous “questionable” exchanges and other opaque entities that operate in the space. These could also be coupled with other regulations that are being proposed in the STO space for example.
If the regulators are able to create a sense of control over a sometimes-lawless industry then it is likely to assuage lingering fears of potential users. There are millions of users who are sitting on the fence and are looking for confirmation to jump into the crypto waters.
This is actually something that has happened in Japan in the fallout from the Mt Gox. hack. The regulators there set out to make a number of laws around the registration of a crypto exchange. The result is a booming cryptocurrency industry.
As it relates to the current Quadriga users, one can only hope that they are able to recover some funds. The civil lawsuits could start pursuing the operators or they could attempt to recover funds from Gerald Cotton’s estate.
There are also quite a bit of funds that are tied up with a few payment processors. If the courts are able to prove that these funds are Quadriga’s, they can be recovered.
This story will no doubt go down in the annals of Bitcoin history similar to that of Mt Gox et al. And, something tells me that just like Gox, we have only heard the beginning of it…
Featured Image via Fotolia and QuadrigaCX