South Korea’s crypto exchange market is in deep danger

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QUICK TAKE

  • A high profile Upbit Investigation is slowing down adoption
  • Bithumb token sale controversy is keeping investors busy
  • Coinzest airdrop mishap added insult to injury

For the past six months some of the largest crypto exchanges in South Korea have been involved in major scandals while facing police investigations and criticism from the community.

What happened? The acquisition of Bithumb, the investigation into Upbit, Coinzest’s airdrop mishap, and the arrest of two executives at Komid have caused an overall decline in confidence from investors in the local cryptocurrency exchange market. Let’s run through each event separately.

Controversy surrounds the acquisition of Bithumb

First, there’s Bithumb. South Korea’s largest crypto exchange by reported daily volume found itself in the midst of yet another scandal involving the company’s new owners when reports from mainstream media outlets suggested some untoward selling. The reports suggested that the time frame of the planned pre-sale of a token called BXA developed by the new owners of the exchange and the acquisition of the firm coincides, raising questions on the nature of the acquisition of the company.

Although the new owners of Bithumb have denied such claims, the controversy surrounding the company has not subsided. In October 2018, Kim Byung-geon, the chairman of BK Consortium, a plastic surgery conglomerate headquartered in South Korea and Singapore, acquired Bithumb for $354 million.

At the time, the takeover of Bithumb by a major Asian conglomerate was a positive move for the exchange which then struggled to deal with various scandals throughout 2018 including two consecutive security breaches and questionable listings of unknown tokens.

However, as first reported by The Korea Economic Daily, the process of acquiring Bithumb and how the deal was structured began to raise suspicions.

Initially, they reported that Kim and the heads of several other companies involved in BK Consortium would purchase Bithumb at a valuation of $354 million in installments. They reportedly required the new owners to pay around $55 million upfront and settle the remaining $295 million by the end of February.

A controversy emerged when the new owners of Bithumb disclosed their plans to conduct a token sale for a blockchain project called BXA. Coincidentally, the target date of the token sale matched the time frame of the settlement of the last batch of payments BK Consortium has to process to finalize the acquisition of Bithumb.

As the scandal intensified, BK Consortium chairman Kim Byung-geon held a press conference on Dec. 27, clarifying that the company already had secured $354 million from investors including a major Japanese IT company, a cybersecurity firm in the U.S., a New York-based financial institution, and an investment firm in the UK and noting that the firm will proceed with the acquisition with existing capital.

At the press conference, Kim said:

“We will create a cryptocurrency exchange alliance based on Bithumb, which has the highest level of liquidity in the global market, and create an ecosystem that shares order books and liquidity with other leading exchanges. We also acquired a company based in Shanghai to focus on compliance and to deal with regulatory frameworks.”

Still, suspicions on the Bithumb deal have not diminished since the press conference. Earlier this month, a local publication E-Daily reported that some investors have questioned the necessity of installments in the acquisition process if BK Consortium already has the capital to settle the remaining payments.

Asking for anonymity, an executive in the local cryptocurrency sector told the publication:

“The role of a cryptocurrency exchange is to be able to provide liquidity from a neutral stance but BXA token is not exclusively issued by Bithumb and is led by Chairman Kim, the biggest shareholder of the company, raising issues on a potential conflict of interest.”

The report suggested that there exists no motive for the company to accelerate the token sale of BXA prior to the final settlement of the acquisition if it has the capital to cover the deal.

Questions around the Bithumb deal come in a time during which based on security the exchange was ranked 98th in the top 100 exchange rankings by Crypto Exchange Ranks (CER).

Out of a possible score of 10, Bithumb received 4.67 in the area of cybersecurity by the researchers at CER. In comparison to other major cryptocurrency exchanges in South Korea, in the areas of server security, Bithumb ranked relatively high.

The exchange also ranked higher than BitMEX in user protection, showing major improvements since mid-2018. But, local publications reported that the historical performance of Bithumb has led to an overall low score in security, given that the exchange suffered two consecutive hacking attacks last year.

Local Crypto Exchange Market in South Korea is at its Lowest Point

Prior to the Bithumb controversy, UPbit, South Korea’s second largest cryptocurrency exchange, released an official statement confirming a police investigation into the exchange’s operations in early 2017.

The Supreme Prosecutors’ Office of the Republic of Korea alleged former executives at the company inflated volumes and created fake wallets to alter the balance sheet of the company during the first few months of its operation.

A Hani report disclosed that the authorities accused UPbit of creating more than $200 billion worth of fake orders and selling more than $130 million in Bitcoin.

A UPbit subsidiary’s main shareholder and two executives were arrested by the authorities for fraud on Dec. 21.

At the time, UPbit confirmed the ongoing investigation but denied allegations of washtrading or creating false orders to inflate the company’s balance sheet.

“Upbit did not commit wash trading (cross trading), imaginary orders (provision of liquidity), or fraudulent trading. The company did not trade crypto-currencies which it didn’t own, or have its staff and employees benefit from such trading. Upbit will fully cooperate with the authorities during its trial where the difference of viewpoints between the Prosecutors’ Office and Upbit regarding the methods of transaction will be explained,” the UPbit team said.

Other than the scandals involving the country’s two largest cryptocurrency exchanges, companies such as Coinzest and Komid have also faced harsh criticism from the community in the past several weeks.

Coinzest reportedly made a critical mistake in the process of airdropping cryptocurrencies to its users. The systematic error caused Bitcoin to be sold at $50 and more than $550,000 worth of cryptocurrencies to be released to the public, outside of the company’s internal system.

Eventually, the exchange had to roll back all abnormal trades and issue a formal apology to the affected traders on the platform.

Around a similar time frame, executives at Komid, a small cryptocurrency exchange, were jailed for for two years for faking volume. The CEO of the exchange received a three-year sentence for fraud and for stealing user funds.

How can South Korea’s crypto market recover?

In late 2017, South Korea played a vital role in stimulating a cryptocurrency bull run that led the price of Bitcoin to surge past $20,000 in most regions.

Individuals of all ages were actively investing in the space, some taking on large loans and debt to purchase crypto assets.

For both millennials and struggling middle-aged employees, cryptocurrencies presented a sign of hope and an opportunity to gain wealth.

As Nathaniel Popper at The New York Times reported in August 2018, the aftermath of the 2017 cryptocurrency bull rally turned out to be disastrous for many retail investors that fueled it.

A 45-year-old school teacher Kim Hyon-jeong, who used all of her savings and took a $25,000 loan to invest in the cryptocurrency market, said that she had hoped cryptocurrencies would lead to prosperity for hardworking individuals.

In South Korea, especially in the outskirts of Seoul, teachers make around $55,000 a year on average. But, due to taxes and high rent and insurance costs, many are often left with little to save on a monthly basis.

“I thought that cryptocurrencies would be the one and only breakthrough for ordinary hardworking people like us. thought my family and I could escape hardship and live more comfortably, but it turned out to be the other way around,” Kim told Poppers.

Psychologically and financially, individuals who lost out in the cryptocurrency market in early 2018 will take a long time to recover. Many investors have already lost their confidence and trust in the cryptocurrency exchange market and in the asset class as a whole.

The instability in the local cryptocurrency exchange market and the scandals faced by dominant companies in the space are posing a negative effect on the image and the reputation of cryptocurrencies in the region, which could lead the market to stagnate and complicate the recovery process.

Investors in South Korea are in a situation wherein small exchanges cannot be trusted due to security vulnerabilities that arise from the model of maximizing profit over security, and major cryptocurrency exchanges face scandals and investigations on a fairly regular basis.

While there still are exchanges such as Korbit and Gopax financed by leading conglomerates such as Shinhan Bank and NXC that have maintained a strong reputation throughout the past several years, the industry as a whole will have to improve in many areas to even begin appealing to retail investors in the region once again.

According to Hankyoreh, the country’s four leading cryptocurrency exchanges UPbit, Bithumb, Coinone, and Korbit have partnered to crackdown on crypto-related money laundering.

Previously, UPbit was able to prevent funds from an initial coin offering (ICO) exit scam from being processed on its platform due to anonymous tips sent in to the company.

Although cryptocurrency exchanges in South Korea have struggled in areas of security and investor protection over the years, exchanges aim to demonstrate signs of improvement in money laundering prevention. Hopefully this is the push the ecosystem needs to move forward.

Joseph Young is a finance and cryptocurrency analyst based in Hong Kong. He writes about finance, fintech, cryptocurrency, and blockchain, and has written for many publications within the crypto ecosystem and mainstream media outlets.