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Nikkei Editorial

Japan's cryptocurrency exchanges need more stringent safety checks

$533mn Coincheck hack highlights holes in current regulatory system

Coincheck President Koichiro Wada speaks to the press on Jan. 27 at the Tokyo Stock Exchange.

Japan's cryptocurrency market received a major jolt recently when 58 billion yen ($534 million) worth of digital currency was stolen from one of the country's leading exchanges. Trading of digital money is growing rapidly around the globe, and Japan is the world's largest market. To ensure the safety and transparency of this trading, it is essential to take a fresh look how cryptocurrency exchanges are operating.

The target of the recent attack was Tokyo-based Coincheck. Hackers stole nearly all of the NEM virtual currency the exchange had been holding on behalf of about 260,000 customers.

SECURITY FAILURES Today, there are more than 1,000 types of digital currencies. The first, bitcoin, remains the best-known and ranks first in terms of total value in circulation. NEM is also among the most popular virtual currencies, ranking around 10th in terms of aggregate market value.

For cryptocurrency exchanges, the risk of cyberattack is ever present. Despite this, Coincheck was not equipped with the fundamental systems needed to protect customer assets. The exchange was particularly negligent when it came to managing "private keys" -- the equivalent to credit card PIN codes -- as it failed to employ a multisignature system, in which one transaction requires multiple keys, each stored in a separate location.

The Financial Services Agency, Japan's financial regulator, has issued a business improvement order to Coincheck, calling for the company to investigate the cause of the incident and take measures to prevent a recurrence. The company has yet to decide how and when it will compensate affected customers. If Coincheck bungles its response to this incident, public trust in virtual currencies as a whole will inevitably suffer.

A smartphone app lets people buy and sell NEM virtual currency through the Coincheck exchange.   © Kyodo

Digital currencies have been traded briskly in Japan for some time, and this is not the first time a cryptocurrency exchange in the country has found itself in trouble. In 2014, Mt. Gox -- then the biggest Japanese exchange -- went under, with its top executive charged with criminal offences. That incident spurred the government to revise the law on fund settlements. The revised law, which took effect in April 2017, introduced the world's first registration system for cryptocurrency exchanges.

The Coincheck hack, however, has shined a light on the shortcomings of this system. While a total of 16 cryptocurrency exchanges have been registered so far, a number of unregistered exchanges continue to operate due to a grace period granted for exchanges already in operation when the new system was introduced. Aggressive advertising has helped Coincheck become one of Japan's biggest exchanges, but the company has yet to go through the registration process.

The FSA should require all exchanges to re-examine their systems and also consider taking stringent steps, such as shutting down exchanges that repeatedly fail inspections. We call on the cryptocurrency business community, too, to redouble its efforts to draw up its own rules regarding investor protection and information disclosure.

Digital currencies tend to fluctuate wildly in value because they are a target of speculative trading. Virtual currencies were initially touted as a perfect example of how information technology can be used to make life more convenient. But the reality remains quite different. The day when digital currencies are widely accepted in society will remain remote as long as it is difficult to ensure even safe trading.

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