How Popular Crypto Exchanges Addressed Hackers and Reimbursed Users Lessons and inspirations

Security breaches have become a painful reality in all areas. Crypto is no different. High-profile hacks involving major exchanges such as Mt. Gox and Bitfinex, emphasize the importance of robust security measures and effective compensation strategies.

In traditional finance, managing risk and compensating victims of fraud or mismanagement has long been a focus of regulatory and institutional circles. The crypto sector, although newer and less regulated, faces similar challenges in ensuring the security of users’ assets and the financial losses caused by cyber-attacks.

Here’s a comprehensive look at how some prominent exchanges have overcome breaches, the lessons they’ve learned, and how WazirX is using these experiences to enhance user protection and provide a resilient platform.

Mt. Gox Hack. long recovery

Incident

Mt. Gox, originally launched in 2010 by Jed McCaleb as a trading platform for collectible cards, has quickly grown into a leading crypto exchange under the ownership of Mark Karpeles. By 2013, Mount Gox processed roughly 70% of all Bitcoin transactions worldwide. However, in early 2014, the exchange suffered a catastrophic hack that led to the theft of approximately 850,000 BTC, which was valued at around $450 million at the time. This breach led to the bankruptcy of Mount Gox and caused considerable turmoil in the crypto market.

The incident highlighted vulnerabilities that affected all users, regardless of their crypto. Mount Gox entered bankruptcy proceedings, and after extensive legal proceedings, a civil rehabilitation plan was approved. The recovery process has taken a long time and is ongoing, showing the complexities of dealing with large crypto losses.

Compensation model

• Recovery processInstead of going the traditional bankruptcy route, Mount Gox opted for a civil recovery process. This legal framework aims to recover and return assets to creditors over a long period of time.
• Claims and registrationLenders had many repayment options, including:
  • Early lump sum repayment. lump sum cash payment.
  • Crypto Redemption. receiving part of the repayment in Bitcoin and/or Bitcoin Cash.
  • Bank transfers. traditional bank transfers.
  • Money transfers through fund transfer service providers. using various money transfer services.
• Repayment status: AAs of July 24, 2024, more than 17,000 creditors have begun receiving repayments. The revised plan, signed in September 2023, set a new deadline of October 2024 for full repayment. As reported by Forbes on July 5, 2024, Mount Gox began the repayment process with their “Recovery Plan”. The repayments are phased, with creditors expected to receive approximately 140,000 Bitcoin (worth $7.6 billion) and 143,000 Bitcoin Cash (BCH) tokens (worth $42.5 million).

Teachings

• Asset management and distribution following a large-scale breach is complex and may require extended timeframes.
• A well-defined legal framework can help navigate the recovery process effectively.
• Keeping affected parties informed during the recovery process helps maintain trust and manage expectations.

Challenges

• Long processThe process of restoring Mount Gox has been extremely long, spanning more than a decade. This extended period has caused considerable frustration among creditors and highlighted inefficiencies in managing large-scale financial recoveries.
• Legal and administrative complicationsThe civil rehabilitation process, although innovative, has proven to be complex and slow, reflecting the difficulties of solving legal frameworks and technical problems over a long period of time.
• Partial recoveryThe fact that not all creditors were immediately repaid in full led to continued discontent and uncertainty. The need for ongoing repayments and the uncertainty of full recovery have been ongoing concerns for affected users.

Bitfinex Hack. Innovative compensation with BFX Tokens

Incident

Founded in 2014, Bitfinex quickly became a prominent crypto exchange known for its extensive trading pairs and security measures. In August 2016, the exchange experienced a major hack where 120,000 BTC (about $72 million at the time) was stolen. This incident prompted Bitfinex to develop a new approach to user compensation.

They socialized the loss by initially spreading the loss across all users’ accounts, reducing balances by 36%, regardless of whether users held BTC or other crypto assets.

Compensation model

• Issuance of BFX TokensIn response to the hack, Bitfinex issued BFX tokens, each representing one dollar of a user’s loss. These tokens can be traded on the open market, used as collateral for margin trading, or held for future redemption. Users had the opportunity to:
  • SaveExchange BFX tokens for cash or crypto.
  • EquityConvert BFX tokens to shares of iFinex, the parent company of Bitfinex. Users who chose this route also received Recovery Right Tokens (RRT), allowing for additional compensation from future recoveries.
• Redemption and Equity ExchangeWithin eight months of the hack, Bitfinex successfully redeemed and destroyed all BFX tokens. Users had the flexibility to convert their tokens into either cash or equity. It is understood that if the stolen BTC is recovered, the recovered funds will be used to distribute to RRT holders, up to USD 1 per RRT.

Teachings

• Issuance of tokens or equity offerings can provide flexible compensation options and help innovatively address financial impacts.
• Effective compensation methods can help maintain operational continuity while addressing user losses.
• Offering different reimbursement options allows users to choose the method that best suits their needs and preferences.

Challenges

• Initial impact on usersThe decision to socialize the loss across all accounts, reducing balances by 36%, initially affected all users, not just those directly affected by the hack. This approach, while spreading the burden, caused dissatisfaction among users who did not experience direct losses.
• Complex repayment processThe use of BFX tokens and the subsequent option to exchange them for iFinex shares introduced complexity for users. Some users may find the process confusing or difficult to navigate, especially if they are unfamiliar with equity conversion options.
• Market volatilityThe value of BFX tokens and subsequent equity could be affected by market volatility, affecting the ultimate compensation value of users. This introduces some uncertainty into the overall reimbursement process.

WazirX. Drawing inspiration for user redemption and protection

At WazirX, we are well aware of the challenges and lessons learned from these notable hacks. Our approach to user protection and compensation is inspired by these models, experiences and prevailing circumstances;

Our approach

• Innovative compensation mechanismsWe explore flexible compensation models that offer fairness and efficiency to address user losses. Inspired by the BFX token model, we’re looking at options that give users choice and flexibility.
  • We are aware of the potential complications of implementing token-based or similar compensation models. Our goal is to simplify these processes to avoid confusion and provide a simple, user-friendly experience.
  • Ensuring users understand and can easily navigate reimbursement options is critical. We focus on clear communication and support to address user concerns about the process.
• Community support and timely resolutionWe understand the importance of community support and timely resolution to prevent lengthy delays and maintain user trust.
  • The experiences at Mount Gox highlight the pitfalls of long recovery processes. We aim to implement effective recovery procedures to avoid similar issues and provide clear resolution timelines.
  • We are committed to transparent communication throughout the recovery process. Keeping users informed of the steps being taken and any updates regarding their compensation is essential to maintaining trust and confidence in our platform.

We are focused on ensuring that our compensation and recovery mechanisms prioritize the needs and preferences of our users. By embracing feedback and adapting our strategies, we aim to increase user satisfaction and flexibility.

As the crypto space continues to evolve and face new challenges, Mt. Gox, Bitfinex, and many others provide valuable insights into effective user compensation and security practices. At WazirX, we are dedicated to applying these lessons to protect our users, ensure fair compensation, and maintain a trusted platform. Our goal is to maximize recovery and keep the exchange operational, preventing further losses and providing a safe environment for our users.

Disclaimer: Cryptocurrency is not legal tender and is currently unregulated. Please ensure that you carry out a sufficient risk assessment when trading cryptocurrencies as they are often subject to high price volatility. The information presented in this section does not represent any investment advice or the official position of WazirX. WazirX reserves the right, at its sole discretion, to modify or amend this blog post at any time and for any reason without prior notice.