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Mt. Gox, The Lessons And Legacy - Part 2

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coinbase-exchangeIn part 1 we looked at the bigger issue of responsibility for any loss of Bitcoins associated with the Mt. Gox situation. There is the more practical issue of exposing Bitcoins and fiat currencies to loss due to freezing, theft, or company failure as in the case of Mt. Gox. Any Bitcoin that is stored off the blockchain, in privately controlled accounts is exposing that Bitcoin to loss for any number of reasons. In many ways this is another factor in user responsibility.

If we look at a real world example, who would give a wallet or purse stuffed full  of thousands of Dollars to a complete stranger for "safe keeping", yet this is what everyone who kept Bitcoin at Mt. Gox did, and what everyone who keeps Bitcoin at Coinbase or any web based, off-blockchain wallet is doing.

Once Bitcoin is off the blockchain and no longer protected by your own private keys, it is immediately at risk of being lost, stolen of frozen permanently. This is particularly true of Bitcoin due to the very young and rapidly evolving nature of the ecosystem where security, government regulation or confiscations and company failures can easily occur - and very often do. No exchange or wallet service is safe as we have seen time and again, because these actions and situations that cause loss of Bitcoin can happen any time for any reason, and unlike Mt. Gox where it seemed inevitable, without warning.

For now exchanges are a necessary aspect of the Bitcoin ecosystem, but as ATM's become more widely deployed and peer to peer distributed exchanges become the norm, then centralised exchanges will become a thing of the past, especially because they will likely be regulated out of existence anyway.

Unlike exchanges, wallet are a choice. The choices being broadly local software wallets such as Armory and Multibit, smartphone based wallets such as Blockchain and Mycelium and web based wallets/exchanges such as Coinbase and Blockchain.

With software and smartphone based wallets, security is entirely the responsibility of the user in keeping wallet keys, pass phrases etc secure. With an on-blockchain wallet such as, although Bitcoins can never be frozen or confiscated, keys and pass phrases are still the responsibility of the user - if they are lost, all Bitcoins associated with them will be lost.

If though we look at off-blockchain services such as Coinbase and Mt. Gox, the situation is very different and far more dangerous. The responsibility for keeping Bitcoin safe is taken out of the hands of the owner, and entrusted with the service who keep the Bitcoin in a central Bitcoin wallet, wallets or other means of off-blockchain account which they control and have the keys too. The Bitcoin are also associated with the identity of the owner, often through photo-ID so no longer anonymous.  In this situation Bitcoin is highly exposed to external influences such as government freezing or seizing an entire account or the entire service, or the service itself failing as in the case of Mt. Gox.

So assuming for now centralised exchanges with off-blockchain accounts are needed, how should Bitcoin be secured?

It is always best to assume the worst and take the position that every time Bitcoin or fiat currency is sent to an exchange, during the time it is there it could well be lost forever - as could prove to be the case with Mt. Gox. So clearly the most sensible way of reducing exposure to these external factor is to never actually store Bitcoin there at all, as if it were a wallet, but simply exchange fiat for Bitcoin and immediately transfer the Bitcoin out to a secure wallet over which you have full control, preferably a software wallet such as Armory of smartphone based wallet such as Mycelium. is a secure on-blockchain based wallet as far as it goes, but if anything happened to the service and the private keys are not held, then Bitcoins will still be lost.

In conclusion, the lesson to be learned from Mt. Gox is to never trust an online exchange - however trustworthy they may seem - they are not immune from government interference or could get hacked - assume that Bitcoin will be lost if stored there, and therefore immediately transfer all Bitcoin out to a secure wallet to which you hold all the keys and the responsibility for the security of your own Bitcoin. 

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