Cryptocurrency exchanges are increasingly finding themselves targeted by hackers. In a proactive move, Huobi decided to create an Investor Protection Fund – using a buyback scheme – to be used in case of an adverse external emergency. Over the last months, a few exchanges lost control of users’ assets, such as CoinCheck which lost $500 million worth of NEM last January, and BitGrail’s $185 million NANO hack in February. The solution might lie in the expansion of decentralized exchanges (DEX). The problem is that not only does a DEX decrease the ease of use, speed, and liquidity that centralized exchanges provide, but they also can be targeted by hackers – such as what happened with EtherDelta.
Given the likelihood of such events occurring, some exchanges decided to increase security measures by improving their infrastructure, building up their cyber security divisions, using multi-signature cold storage wallets, or by providing bounties if flaws are found. The problem is that if a hack is large enough, such as the Mt. Gox incident, the exchange might not have enough liquidity to refund their customers, and might even go bankrupt.
In response to these increasing threats, Huobi, among the top 5 crypto exchanges by volume ($1.5 billion daily), has decided to launch an Investor Protection Fund (IPF). The fund aims at compensating users for their losses in case of an emergency. In essence, the exchange sets aside money which is used to refund customers if the exchange’s security is breached, or anything outside the control of the users happens on the exchange and assets are lost or compromised.
Investor/User Protection Fund (UPF) and Huobi Token (HT) buyback
Emergency funds are important as they enable an exchange to have funds available if they encounter an unexpected expense in the case of an emergency. For example in Huobi’s case, unexpected expenses might arise from a project’s exit scam such as what happened with Confido, a refund of investor’s assets if a flaw is exploited by hackers, or if official Huobi’s email addresses were compromised and used to phish private keys and other information. Also, as Huobi supports Tether (USDT), in the case of the loss in value of the coin, the Protection Fund would enable users to receive the correct amount of dollars/parity – in all cases, investors know that they are protected against external troubles.
The Investor Emergency Fund will be funded from the revenues generated by Huobi on a quarterly basis. Each quarter, Huobi will use 20% of its generated income to buy back Huobi Tokens (HT) from the open market, to be stored in the Investor Protection Fund. The fund, being a cold wallet, is secure and auditable – assuring investor’s that Huobi has the funds needed in case of an emergency. Huobi announced that the first buyback occurred on the 16th April and saw Huobi locking 38.6 million HT.
The value of the emergency fund is dependent on the success of Huobi itself, and of its native HT token, as the fund will be composed of them. Huobi Tokens has a total supply of 500 million (with 60% being in circulation). The token enables users to receive reduced trading fees, to enable teams to create security deposits in order to be listed on HADAX, and to vote for listings on the HADAX platform – a hybrid form of a decentralised exchange where professional traders choose the coins to be listed using HT – and the token will have other use cases as the platform continues to grow.
Repercussions for Huobi and its HT token
First and foremost, in the case of an adverse event, the fund would enable Huobi to handle the situation quietly and avoid a bank run or worse, bankruptcy, as customers would know that they will be refunded.
Additionally, we believe that reducing downside risks to investors will help grow Huobi’s users base – especially with users predominantly preferring to keep their assets on exchanges, even if it’s not always the best idea. This factor is critical as Huobi.pro allows for margin trading of BTC/USDT and several BTC pairs, where traders do not intend to hold their assets off the exchange, and protection is of prime importance to them.
Finally, given the increasing numbers of exchanges seeking governmental licenses, increased efforts will be asked from crypto exchanges – with proper capitalisation and protections for users being of primary importance. Having a funded mechanism to increase user security could enable Huobi to acquire licenses in new markets, enabling them to grow their user bases.
We see the creation of capitalisation funds in a positive light, especially with the rise of exchanges being targeted by hackers. Unlike in the banking system where transactions can be reversed, due to the nature of blockchain transactions these same measures are simply impossible in cryptocurrency markets – barring a hard fork to recover funds, which the Parity hack of 2017 showed as an ever-unlikelier option – making these financial backup measures increasingly important. The creation of the Investor Protection Fund sets a milestone within the cryptocurrency exchange space.
Finally, with the growing numbers of exchanges seeking governmental licenses, increased efforts will be asked from regulators to exchanges. Proper capitalisation, and auditable user protection mechanisms are likely to be some of the main factors regulators will analyze in order to grant them licenses, alongside AML and KYC procedures. With exchanges such as Binance seeking compliance, there is no doubt that exchanges are beginning a real push to seek heightened legitimacy from both institutional and retail investors, and the creation of the Investor Protection Fund will enable Huobi to foster its growth.
If you are interested in registering on Huobi.Pro, and gaining access to the HADAX platform as well, you can do so here.
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