While the future of blockchain-based investments looks promising, many potential investors are concerned by recent headlines that describe exchange or wallet hacks wherein tens of millions of dollars worth blockchain assets are stolen. However, it is necessary to note that the issue is not with blockchain networks themselves but rather the secondary applications on top of the system.
The good news is that certain steps can be taken to improve the safekeeping of blockchain assets. The benefits of this technology are enormous as it could provide increased efficiencies across various industries like healthcare, supply chain management, and financial services. But to reach that point, blockchain innovators and the broader financial community must cooperate to mitigate the risks—real and perceived—in three key areas: market manipulation, custody, and valuation.
Market manipulation: Owing to the comparatively thin trading volume on many blockchain asset exchanges, large volume transactions by institutional investors can cause dramatic valuation swings in any trading pairs. On a similar note, some investors may use arbitrage price variations across different pricing sources to manipulate prices. In order to counter this, blockchain-based markets must establish processes and circuit breakers that help protect against market manipulation by automated trading algorithms and mitigate the risk of flash crashes.
Custody: Today, stocks and bonds assets are settled and cleared by third-party clearing houses that sit between banks, broker-dealers, and individual investors. Blockchain, one type of a distributed ledger, avoids central clearing houses as independent computers can verify, record, and synchronize ownership of digital assets.
In the case of distributed ledgers, retail investors can self-custody using software wallets , hosted exchange accounts, or store their funds in cold storage. A custom multi-signature wallet is the initial step in complying with the security standards as the risk of theft of a single key is significantly reduced where multiple people are needed to confirm any value transfer. Custody can be secure in systems when assets can only be reached through cryptographic keys that are unlocked or signed by multiple parties, like the investors or their third-party financial institutions. Setting industry-wide custody standards encompassing the use of signatures and permissions-based controls have the potential to eliminate critical dangers in blockchain investing.
Valuation: When an investor trades a security on the New York Stock Exchange, there is usually an exhaustive order book with a competitive bid and ask prices. Consequently, when we place a market order, an investor will match his request within a penny or two of the rate at which the trade will be executed. With blockchain asset exchanges, each exchange calculates their bid and asks prices based on its propriety methodology. Blockchain asset exchanges need to develop industry-wide price transparency. Besides, exchanges should transparently disclose their valuation data to trace in the fixed-income markets.