Third Party Risk
- If you go to the Investopedia website you will find many good articles explaining 3rd party risk.
- Alternatively you could go to Taskmasters Leoglossary and find an impressively well worded definition there.
- But I am going to give you the plain English definition here. *If you as the first party, want to invest your money with Bob, who is the second party, but first, your money has to go to Charlie, a third party, who then gives it to Bob, there is a risk, that Charlie, the 3rd party, could steal your money or not give all of it to Bob the second party. Therefore Charlie is called the 3rd party risk.
- Ironically, Bitcoin’s creator and his/her associates designed Bitcoin to be Trustless which they defined as having no 3rd party risk. This was partially to avoid banks and government, and very importantly, as a security feature.
3rd Party Risk Cryptocurrency Exchanges: Mt. Gox
- Unfortunately, the peer to peer exchanges found in early Bitcoin history were inefficient markets and so 3rd party exchanges like Mt Gox were created.
- Unfortunately, this development reintroduced 3rd party risk into cryptocurrency.
- The first exchanges were internet webpages connected to the internet and malicious individuals could steal the exchange employees passwords and then steal the cryptocurrency investors stored there.
— Later in cryptocurrency history the founders of exchanges were anonymous and they stole the cryptocurrency stored on the exchange by investors. - Unfortunately early in cryptocurrency history someone stole thousands of Bitcoin from an exchange called Mt. Gox, in Japan.
- Mt Gox is the first and perhaps most famous cryptocurrency theft. The stolen Bitcoin, is now worth billions of dollars US. And the legal settlement is still stuck in the US Court System.
Japan laws
- The good news is that after the Mt Gox Exchange cryptocurrency theft, the country of Japan created laws protecting investors and regulating exchanges. Investors in Japanese exchanges are now some of the best protected cryptocurrency investors in the world.
- In fact after the FTX Exchange collapse, which affected investors in 15 countries, investors in FTX Japan were refunded 100% of their deposited cryptocurrencies in less than 30 days. While investors affected by the collapse of exchanges in other countries have not received their funds more than 1 to 2 years after those exchanges collapsed.
Bridges
In addition to 3rd party risk at cryptocurrency exchanges, a new type of investing called decentralized finance or DeFi created a new types of 3rd party risk called Bridges.
- Bridges are locations where the value of an investors cryptocurrency on one blockchain is moved to a second blockchain, by a 3rd party called a bridge. The bridge represents 3rd party risk because the persons running the bridge can steal the cryptocurrency or they can be robbed in what we call Hacks.
- And bridges have become the most common places cryptocurrency is stolen.
Summary
- Anytime an investor has to give someone or something their cryptocurrency before it can be invested with another person or another place, or just stored until needed, that person or thing becomes a point of risk, where the cryptocurrency can be lost or stolen.
- I think it’s best to remember this simple mental model to assess all investments.
- Then once you recognize the third party, assess their trust worthiness and security they employ to protect your cryptocurrency.
- You may want to learn more about businesses which conduct security audits, as 3rd parties who are audited, may be more secure, but there are no guarantees that all audit firms are honest or competent.
- I hope this article helps you keep your investment in cryptocurrency safe. Remember cryptocurrency gives us great power over our money, but with great power comes great responsibility.
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Source: Leofinance Graphics
