Risk Management: A Must-Course for Digital Currency Trading Platforms

The term risk originates from Italian, initially referring to objective dangers in nature. In modern society, risk is more reflected as a choice, closely related to the degree of freedom in our choices.

The famous financial historian Peter Burns pointed out in his classic work that events such as the rise and fall of enterprises, fluctuations in the stock market, wars, and economic depressions seem to recur, yet they always arrive when people are caught off guard.

As a major provider of liquidity in the digital currency market, risk control in exchanges is particularly crucial. These platforms integrate various functions such as asset custody, trade matching, clearing, and information dissemination, and also incorporate characteristics of brokers and funds, making them a financial super center.

It is widely believed in the industry that there are significant deficiencies in risk management within the blockchain sector. This has led to a series of tragedies such as the collapse of FCoin and the theft of exchanges. How to effectively manage risks has become an important issue that the entire industry urgently needs to pay attention to.

The Multifaceted Nature of Risk

In the cryptocurrency market, the most difficult to resist is the systemic risk brought about by policy. Changes in regulatory policies directly affect the direction of the entire market.

Market participants are able to control non-systematic risks, including:

• Technical Risk: Involves system security and stability
• Operational Risk: Arises from decision-making errors
• Liquidity Risk: Assets cannot be traded in a timely manner at a reasonable price
• Trust Risk: Unable to execute withdrawal, transfer and other operations in a timely manner.
• Moral Hazard: Damaging the rights and interests of investors in pursuit of self-interest maximization.

The Risk Management department plays an important role in the exchange, closely monitoring various risk indicators such as liquidity, arbitrage activities, and account anomalies, while maintaining close contact with other departments.

However, during the rapid development phase of the industry, risk management will inevitably constrain the speed of development. Currently, the risk management awareness of many small and medium-sized trading platforms still needs to be improved. Whether at the physical level, system level, or governance level, the overall level of risk management in the industry is obviously inadequate.

If the blockchain industry is to enter the mainstream, the trading platform at the core of the industry must properly address risk management issues.

Asset Security: The Core Objective of Risk Management

In 2019, the asset losses suffered by digital currency platforms reached as high as $283 million. Although the infamous Mt. Gox incident happened many years ago, cases of digital currency "vanishing into thin air" still occur from time to time, and asset security remains a focal point of concern in the industry.

To address this challenge, several trading platforms have adopted a series of measures:

• Establish a strict financial auditing and real-time monitoring alarm system
• Implement cold and hot wallet separation and use hardware wallets
• Establish a pre-compensation mechanism for users
• Establish a user protection fund

In addition, some platforms also focus on real-time and batch reconciliation, tracking blockchain addresses, and enhancing user education.

Custodial storage is regarded as an important means of ensuring asset security and is a key link in the penetration of traditional finance into the blockchain industry. For small and medium-sized enterprises with insufficient technical strength, introducing third-party custodial services or purchasing relevant insurance can effectively enhance asset security.

In addition to external measures, the platform's own moral hazard cannot be ignored. Industry insiders suggest that the platform should maintain openness and transparency as much as possible, and accept peer supervision to reduce the possibility of misappropriating customer assets.

Compliance: Eliminate Regulatory Uncertainty

In the face of numerous uncertainties, actively embracing regulation and operating in compliance has become a necessary choice to reduce policy and legal risks. Currently, leading digital currency platforms generally have established a compliance risk management system that covers pre-event, during-event, and post-event processes.

Specific measures taken by some platforms include:

• Establish a standardized KYC/AML anti-money laundering system
• Establish strict account opening principles and review standards
• Obtain relevant financial licenses and accept supervision from regulatory authorities.
• Mitigate compliance risks through distributed operations.
• Collaborate with professional compliance companies
• Establish a dedicated compliance and legal internal control department

Technology: The Guardian of Platform Security

For trading platforms, technical security issues are the most common risk management challenges, and even leading platforms find it difficult to completely avoid them. For example, several well-known exchanges have suffered DDoS attacks, resulting in temporary downtime.

To address technical risks, major platforms are taking measures:

• Achieve quantitative monitoring of market risk for various businesses and automatic strategy hedging
• Establish a network security, compliance system, privacy data protection, and technical risk management system
• Hire an external company for IT audit consulting
• Develop a data system specifically for Risk Management monitoring, analysis, and disposal.
• Build an intelligent risk management model based on real-time data calculation and machine learning.

Internal Risk Management: An Important Aspect Not to Be Ignored

According to statistics, nearly 2/3 of cybersecurity issues stem from the negligence or misconduct of internal employees. Therefore, internal risk management is crucial for blockchain enterprises.

Major platforms generally take the following measures in internal Risk Management:

• Standardized Process Sorting
• Clarify responsibilities and authority management
• Regular Audit
• Implement the principle of least privilege and information management.
• Establish a Risk Management Committee and Security Incident Handling Framework
• Conduct risk management training for employees and "phishing enforcement"
• Practice "Zero Trust Model"

Drawing on Traditional Financial Experience

The risk management requirements for the digital currency market may be higher than those for traditional finance. On one hand, the market volatility far exceeds that of most traditional financial assets; on the other hand, the anonymity of blockchain payments is stronger, making transactions difficult to trace.

Industry insiders believe that the areas of effort needed in the blockchain field include:

• Effectively extract on-chain information and convert it into risk management decision indicators.
• Promote the separation of trading and assets, with different entities responsible for trade matching, clearing, settlement, and custody.
• Increase investment in Risk Management, enhance the proportion of the security team and budget ratio.

"Investing in risk management can be seen as an opportunity cost. The stricter the risk control, the more resources are required, and the more business opportunities may be lost, but it can reduce the risk of loss of existing assets. Companies that value reputation and long-term interests will naturally pay more attention to the safety of customer assets," said an industry veteran.