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The Early Days of Crypto Exchanges

The earliest crypto exchanges operated in a de facto “wild west” — with risk, and without regulation.

Gemini-The Early Days of Crypto Exchanges

Summary

In the first few years following the launch of Bitcoin, there were limited options for purchasing the cryptocurrency and users were often required to interact with unregulated and risky exchanges. Many of the first exchanges were hacked, most notably Mt. Gox, and users’ funds were lost and their information stolen. Today, many crypto exchanges must comply with extensive laws and regulations depending on the jurisdiction they are based in, and a number of top exchanges have led the way in developing processes for digital assets to be traded safely and securely. However, there are many lessons to be learned from early crypto exchanges, reminding us that it is imperative to do careful research before entrusting crypto assets to an exchange.

How Early Users Obtained Bitcoin

Today, buying cryptocurrency is relatively easy, and crypto exchanges are focused on security and user experience (UX), but this hasn’t always been the case. After the pseudonymous Satoshi Nakamoto launched bitcoin (BTC) in 2009, there were a limited number of ways to obtain this novel form of money, and most methods required users to incur significant risks. While the story of crypto exchanges’ early days is punctuated by hacks, scams, and legal scrutiny, the events that transpired planted the seeds for a new global financial system.

Once Nakamoto released Bitcoin’s software in January 2009, there were only two ways to obtain bitcoin — by mining it yourself or arranging a peer-to-peer (P2P) trade via a forum like Bitcointalk, which Nakamoto founded to host Bitcoin-related discussions. In those days, mining required far less computing power than it does currently and could be done on a personal computer. At the time, bitcoin was more accessible to those who were interested, but getting it still required some technical knowledge. Then, peer-to-peer trades were risky given they required trust between the transacting parties, but the stakes were not as high as they are today because each bitcoin was worth virtually nothing. The first bitcoin were transacted at a price of zero dollars, and reached an early peak in 2010 at 39 cents.

By 2010, interest in Bitcoin had grown and new methods for obtaining it emerged. Bitcoin core developer Gavin Andresen created a bitcoin “faucet,” a website that would give anyone with a Bitcoin address five bitcoin for free. It was at this time that the first bitcoin exchanges emerged. Bitcoin Market was announced on Bitcointalk in 2010 and it launched the same year, offering a floating exchange rate for bitcoin. Buyers could purchase bitcoin by sending another user U.S. dollars via PayPal while Bitcoin Market would hold the seller’s bitcoin in escrow until the seller received their money.

More Bitcoin Exchanges Hit the Scene

The most notable exchange to emerge in 2010 was the now infamous Mt. Gox. The Mt. Gox domain was acquired in 2007 by Jed McCaleb, who would later go on to co-found both Ripple and Stellar, and stood for “Magic: The Gathering Online Exchange.” For reference, Magic: The Gathering is a trading card game and the site was intended to function as an exchange for Magic cards. McCaleb converted the site into a bitcoin exchange in 2010, but it did not make headlines until later.

In 2011, several new bitcoin exchanges appeared. VirWoX, an exchange for buying and selling Linden Dollars, the currency of the popular virtual reality game Second Life, began facilitating trades between Linden Dollars and bitcoin. Tradehill, another exchange, allowed users to purchase bitcoin “instantly” instead of submitting limit orders on their exchange. Tradehill enabled users to deposit funds via wire transfers and various payment processors.

In 2011, McCaleb sold Mt. Gox to Mark Karpeles, a software developer. That same year, a hacker compromised a Mt. Gox account that held a significant amount of bitcoin and subsequently sold it, causing the price of bitcoin on the exchange to drop from $17 to $0 within minutes. The hacker also stole Mt. Gox user information and forced the exchange to temporarily take its site offline. Nonetheless, only two years later in 2013, a reemergent Mt. Gox was handling 70% of all global bitcoin transactions. Users predominantly deposited funds into Mt. Gox through two payment services — digital currency service Liberty Reserve and payment provider Dwolla.

Liberty Reserve ran its own private digital currency, a currency exchange, and an unregulated payment processing business that allowed you to send and receive funds. Deposited funds were converted into Liberty Reserve Dollars or Liberty Reserve Euros before being exchanged for another asset. You could then withdraw U.S. dollars or euros. Liberty Reserve was shut down in 2013 after its founders were charged with money laundering and operating an unlicensed money transmitting business, cutting off a key source of funds to Mt. Gox. Dwolla, which enabled users to send and receive money between bank accounts, was ordered to cease sending funds to Mt. Gox in 2013 when the U.S. Department of Homeland Security began investigating Mt. Gox for violating U.S. money transmission laws. Mt. Gox later registered as a money transmitter with the U.S. Financial Crimes Enforcement Network (FinCEN).

Mt. Gox Hack Fallout

In 2014, users began experiencing long delays when attempting to withdraw funds from Mt. Gox, and confidence in the exchange waned. It was revealed that Mt. Gox had suffered a major hack over the course of several years. Management initially attempted to conceal this crypto exchange hack, and halted bitcoin withdrawals, citing technical issues. Days later, the exchange suspended trading and took its website offline. A leaked document emerged showing that 744,408 bitcoin had been stolen from the exchange and that an additional 100,000 bitcoin were missing — a total amounting to around $460 million at the time. Mt. Gox later recovered 200,000 bitcoin, but was forced to file for bankruptcy protection and, subsequently, liquidation.

Mt. Gox was the first victim of what would become a trend in the industry. In the years following Mt. Gox’s hack, major exchanges such as Poloniex, Bitfinex, Bitstamp, Binance, Bithumb, and ShapeShift were all hacked. The vulnerability of crypto exchanges gave rise to the mantra, “not your keys, not your crypto,” which highlights that unless you secure your private keys yourself, your cryptocurrency is vulnerable to hacks and seizure. Some exchanges have nonetheless been able to avoid hacks and security breaches.

Emerging Focus On Compliance and Security

Exchanges have worked more closely with regulators in recent years. Early on, exchanges made little effort to register their businesses properly and comply with Know Your Customer (KYC), Anti-Money Laundering (AML), and counter terrorism financing (CFT) laws. This meant that bitcoin also gained a reputation as a currency for nefarious activities, saddling the crypto community with a negative reputation for many years. Now, however, exchanges in many major markets like the United States, Europe, and parts of Asia are regulated.

Many of the largest crypto exchanges have come a long way since their inception, and exchanges that prioritize security and compliance have helped revive bitcoin’s image as the future of money, rather than the currency of choice for criminal enterprises. Nonetheless, it is still important that you do your own research and carefully select the institutions that you trust with your crypto assets. The early years of cryptocurrency exchanges showed many signs of a disruptive technology on the fringes of society. Within the span of a few short years, as the world began to discover the immense potential of blockchain and digital assets, the industry has rapidly matured. With the development of reputable and regulated exchanges and the adoption of blockchain technology around the world, cryptocurrency is proving to be a lasting part of the global economy.

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