Navigating the Labyrinth: Advanced Topics in Cryptocurrency Security: Course 2.4

Introduction

Cryptocurrency is unlike any other currency or asset that’s come before. With a decentralized system, incredible perks, and an increasing adoption rate, it’s no wonder why so many turn to crypto. It’s a fantastic choice for investing and trading or using a regular payment method. Plus, each cryptocurrency provides unique benefits, and a welcoming community to join.

With all its advantages, though, also come risks. With expert knowledge of how these risks present themselves, you can more effectively protect your crypto from them.

In this lesson, we’ll explain the root causes of security threats and how they’ve evolved. You’ll also learn the advanced measures you can apply to safeguard against.

DeFi and its Security Landscape

Decentralized finance, or DeFi, is a new peer-to-peer (P2P) financial network. It’s popular with crypto users who prefer a fast, secure, accessible, and anonymous experience. The benefits of DeFi are many; this technology eliminates the need for intermediary parties who can tamper with or delay your transactions. This also means that users enjoy the benefit of complete autonomy. They are the only ones with access and control over their DeFi account and its funds.

Read the previous lesson: Advanced Cryptocurrency Security Threats: Course 2.3

DeFi vs. Banks

When you use DeFi, a smart contract takes the place of a bank or other overseeing party. This contract, once agreed on by both users, uses code to automatically carry out a seamless transaction - depositing crypto into their wallet or sending it out. 

Then, all these transactions are recorded on a public ledger; a database that only shows users’ public wallet keys. In doing so, users’ personal or identifying information is kept completely anonymous. The ledger describes blockchain technology, which is the foundation for crypto. 

The Benefits of DeFi security

Due to its nature, DeFi has less oversight from third parties. To ensure the safety of its users, DeFi platforms take their security protocols seriously. With DeFi, you use your digital wallet to keep, send, or accept your cryptocurrency. These wallets are protected with a private key; a string of long letters and numbers that acts as a key to unlock the wallet. 

On the other hand, your public key is similar to your bank account number. You can send this key to those you want to conduct transactions with. When doing transactions, a smart contract (which is made up of code) does the job of an intermediary.

Since your crypto is never touched by another party, it’s securely sent to and from other users. The smart contract is then processed on the blockchain, becoming an unchangeable part of the ledger. This keeps the DeFi transparent and honest, as users can view all transactions occurring on the blockchain.

How to keep your crypto safe with DeFi platforms

Let’s delve into an example of how you can keep your crypto safe, using a real-life case study. DeFi hacks are not a usual experience, but they’re also not uncommon - so you must be familiar with risks and best security approaches. 

One of the biggest DeFi hacks occurred in 2022, which resulted in over a $325 million loss. In this case, the cryptocurrencies Ethereum and Solana were connected by a ‘bridge’. This bridge was called the Wormhole, responsible for exchanging tokenized assets between the two parties. It was a type of cross-chain, meaning that it directly connected both parties, rather than a multi-chain. 

The hacker in the Wormhole incident manipulated a weakness in the bridge’s smart contract. They used the false contract to credit themselves ETH, minting and then sending back these tokens from Solana to Ethereum. In just three transactions, the hacker stole millions. 

To prevent this, use multi-chain bridges instead of singular cross-chain ones. A multi-chain instead allows for one-directional movement, so there’s no direct connection between the involved parties. The transactions would instead move through their own, distinct networks. Another vulnerability lay in the smart contract. The faulty function, which lay in the ‘verify signature’ line allowed the hacker to manipulate the contract. They bypassed the verification process by sending in their program.

Regulatory Landscape and Security

As crypto becomes a more popular payment method and asset amongst global users, scrutiny of its regulatory status has increased. Many regulatory bodies, such as the Securities and Exchange Commission (SEC) in the US, the Canadian Securities Administrators (CSA) the British Parliament, and more are working to employ regulations. 

These bodies are more encouraging or neutral in their crypto positions, with regulations that:

• protect users, 
• ensure proper taxation, 
• and allow for accessible crypto trading. 

Other countries, such as China and Korea, have less supportive regulations. The different regulations in each region of the world can have greatly varying effects on security standards and investor protections. When it comes to crypto, which values its independence from intermediaries, regulations walk a fine line between innovative and constricting.

This intersection causes unique consequences for crypto users and developers. For users, they might benefit from mitigated risk, stability, and higher protections in the case of fraud. For developers, these regulations may impose limitations on their business model and expansion to other regions. Let’s explore a case study example of how regulatory framework can influence security measures within a crypto space. 

In 2019, the France-based Financial Action Task Force (FATF) implemented the Travel Rule. Its guidelines outlined how virtual asset service providers, including cryptocurrency exchanges and DeFi platforms, must collect information on all origins and destinations of crypto transactions. 

As a result, these crypto platforms created and launched extensive anti-money laundering and Know Your Customer initiatives. These served to comply with the new Travel Rule, identifying crypto users’ information, monitoring activity, and notifying the FATF of suspicious actions. They also had to conduct regular due diligence checks to ensure their protocols were secure. 

Future of Cryptocurrency Security

Emerging technologies in the crypto sphere have great potential to enhance user security. These include zero-knowledge proofs, where the prover can prove to the verifier that a given statement is correct to complete a transaction. In doing so, both parties avoid having to provide each other with any other information beyond that one truthful statement. It uses a cryptographic method to verify that truth, which the prover can only do if they already know the underlying information.

Another example is multi-party computation. This technology allows multiple users with single pieces of private data to collaborate and conduct an action. With this system, a group can carry out a computation without ever having to reveal their private data to one another.

Ongoing research in the crypto space is also looking to find innovative solutions to common crypto security and building issues, such as private key management and scalable growth. In collaboration with regulatory bodies, these parties are working to create standardized regulatory frameworks that improve security while not limiting creativity and development.

Looking ahead, the future of cryptocurrency security poses both opportunities and challenges. How can the cryptocurrency community effectively balance security and privacy considerations in decentralized systems?

Conclusion

With the rise of decentralized finance (DeFi), users benefit from autonomy and security but also face evolving threats, as demonstrated by high-profile hacks like the Wormhole incident. Regulatory scrutiny also varies globally, impacting security standards and investor protections. Both crypto users and developers must take into account existing and possible future regulatory standards.

Crypto’s future also holds potential, in technologies like zero-knowledge proofs and multi-party computation. Likewise, for both users and developers, ongoing vigilance and education of potential security threats is imperative to navigate the evolving landscape of cryptocurrency security effectively.