I Made Money Trading on Cryptopia. Then They Lost It.

The following is the story of a trader, T.L.T, who lost money on the recent Cryptopia hack. Since his initial writing, Cryptopia has entered bankruptcy proceedings.

The website of New Zealand’s top cryptocurrency exchange is, as of May 15th, just a press release stating:

15/05/2019

David Ruscoe and Russell Moore from Grant Thornton New Zealand were yesterday appointed liquidators of Cryptopia

This follows months of trying to recover from a hack in January (2019) where the company lost millions of dollars’ worth of Ether (ETH) and Ethereum-based tokens. The announcement days ago follows the recent 7000 BTC hack of Binance just earlier this month. Ironically, right after the Cryptopia hack in January, Binance’s CEO “CZ” tweeted out a warning, not that people shouldn’t leave coins on exchanges, but that they should only leave them on secure exchanges such as Binance.

Previously, I used Cryptopia and Binance. And I had good reason to. I was making money daily by trading.

Get that bread

During the crypto bull market of 2017, I had written up some software to explore various markets and identify money-making opportunities. And I found one on Cryptopia. It was an unbelievable arbitrage opportunity. I felt like I struck gold. On some days, this relatively unknown exchange was attracting high volumes on certain coins. With so much demand, punters were willing to pay premiums on said coins over other markets. Nowadays, competition among arbitrageurs has made the markets much more efficient, which means the premiums that used to be everywhere have mostly disappeared. But for much of cryptocurrency’s history, there had been real and long-lasting systemic reasons for the exact same asset to be priced differently in different regions of cyberspace. Being the first asset class where retail traders like you and me came in before the institutional players, with their deep pockets and best practices, could come in and figure out how to run (or ruin) things.

Crypto Arbitrage 101

Here is how arbitrage works. Let’s take a tradeable digital asset, like Ether. If it’s the case that there are at least two markets and in one of the markets people are willing to pay more for ETH at the same time as in the other market, then you could buy 1 ETH in the cheaper market and turn around and sell it in the more expensive market and have an immediate and risk-free profit. (The caveat is in how risk-free this actually is.)

As an example, let’s suppose there are buyers in Chicago ready to pay $250 for 1 ETH and there are sellers in New York who will sell you 1 ETH right now for $220. All you need to do is buy the ETH in New York ($220) and sell this to the buyer in Chicago ($250) and you should be left with $30 minus fees. But after you buy in New York, your ETH is now in New York, not in Chicago. Fortunately, these are digital assets and, unlike physical commodities such as grain or oil, delivery can happen at nearly the speed of light. At least in the ideal case.

In reality, there are a number of delays to deal with.

1. A trade takes time to execute and settle on the exchange. This is the smallest delay.
2. Requesting an exchange to transfer your coins out takes time to get through their authorization and security procedures. (On many occasions, the exchange isn’t currently processing transfers for that coin, and it might be days or weeks before you’re able to finally move them off.)
3. Once the exchange is okay with your withdrawal request, they have their own schedule for broadcasting the transaction to the given blockchain.
4. And then you’ll deal with network congestion where your transaction is competing with all the other transactions happening around the world to get into the next block. Periods of high trading volume also coincide with high demand for transacting on the blockchain.
5. Once you make it into a block, you start the procedure again on the receiving exchange, assuming you did send it directly to the second exchange.
6. But once the exchange in Chicago sees the deposit, they will have their own policy on how many blocks they must wait for before considering the deposit transaction confirmed. At that point, they may credit your account with the 1 ETH and then you can execute the second half of your supposedly risk-free trade.

By this point, the buyers in Chicago at the $250 price level may have gone away or reduced the price they’re willing to pay. Maybe it’s because demand in all markets has dropped. The price could be down to $220 and you could at least break even (except for all the fees). The price might also be lower. After all that effort, you’d now be losing money.

There is a way to get around this risk of price changing. You just need some Ether in Chicago before you even buy it in New York. This would mean that you have to already own or be able to borrow some of the asset and deposit it in places where you potentially want to sell later. This might double the amount of capital you need to do these trades as well as exposing you to any drop in value of your HODLing in ETH. If you bought or borrowed 10 ETH when it was $250/ETH and now the price of ETH is $200 then you’re down $500 whether you’re using the coins or not.

I forgot to mention that just to be able to buy the ETH on the exchange you would need to have already deposited trading capital in dollars or BTC and if it wasn’t there at the time the arbitrage opportunity was available, you would likely not get it in time. Bitcoin deposits often require six 10-minute block confirmations after you’re able to get your transaction accepted by miners. And banks transfer money on the order of days, not minutes. So you’ll need to come up with or borrow Bitcoins or fiat but if you’re calculating your profit in BTC or fiat then you at least don’t need to be concerned with the value of that capital dropping on you.

Let’s stop for a minute and ask ourselves how we feel about leaving dollars at the bank. Bank deposits are insured (in the US, the FDIC insures bank accounts up to at least $250,000). Cryptocurrency exchanges, generally, are not. Of course, banks have a lot of their own problems when we in the crypto industry try to use them. And this can include problems affecting funds in bank accounts, insured or not. You don’t think twice about leaving money in a US bank, but this sense of security should not carry over to deposits on crypto exchanges. And so our arbitrageur is faced with the risks inherent in holding assets with a counterparty, both the capital to buy ETH with and the ETH to sell.

There are plenty of crypto traders who are long on crypto and plan to own Bitcoin and perhaps some altcoins long term. These alts may include ETH or EOS or Bitcoin Cash — digital assets that are not only investments but can be used as capital to purchase other digital assets.

By keeping your crypto assets on two different crypto exchanges you are ready to start arbitraging. Let’s get this bread.

Cryptopia was making $1 million a day

In the good old days, Cryptopia was trading over a hundred million dollars a day. Surely much of this volume was from people buying up cheap low-cap coins hoping to flip them. But for every one million dollars which was traded on the exchange, and for every one percent of profit they were making, they would profit $10,000. It was common to see three to five percent spreads, and when Cryptopia was trading $280 million a day, they reported making a million dollars in fees daily. Their fees were significantly smaller than the profit from arbitrage strategies. Traders were making money and the exchange was making money, but the profit was on paper and not necessarily in the bank.

Of course, no opportunity like this lasts forever. After Bitcoin peaked in December 2017 and the whole cryptocurrency market went into a bear market, the buy-and-flip strategy of the majority of traders stopped working. After that, you could still make money trading crypto but you would need to sell short and that wasn’t possible on Cryptopia. Volume on the exchange dried up through 2018, as it did on a number of exchanges.

Back in January of this year, Cryptopia went into unscheduled maintenance. This wasn’t the first time the exchange was down without prior notice, as anyone who had been using their API in recent years can attest. I was used to all sorts of bugs from their API. One got the sense that Cryptopia’s order matching engine and trading system were thrown together by guys who were figuring things out as they went along but were overwhelmed by how quickly the market grew. Many crypto exchanges had scaling and performance issues during 2017’s boom and websites going down or being unresponsive was a common occurrence. For the most part, Cryptopia got the job done, and they seemed to be trying to do the best they could for their users.

But in the real world, trying your best isn’t enough. In the world of finance, and especially the new cryptofinance world brought to us by Satoshi Nakamoto, security must be taken much more seriously than most of us are used to. The stakes are higher. And the safety nets simply don’t exist in crypto. Crypto exchanges are holding billions of dollars worth in digital assets and neither the FDIC nor private insurance companies are insuring them against losses. So these exchanges are essentially the targets of global 24/7 hacking contests where the winner can anonymously walk away with millions of dollars, or thousands of Bitcoins. Similar to thwarting terrorist plots, you can stop 99.9% of hack attempts but the hackers only need to succeed once. There’s virtually no cost to hackers for attempting and failing over and over.

Unscheduled, not maintenance

As it turned out, Cryptopia’s servers weren’t down to fix routine technical issues. Rather, the exchange had been hacked and the hackers had stolen Ethereum tokens valued at millions of dollars. It does not appear that any Bitcoins were lost. But the site was down and nobody could login to check how they were affected.

The site stayed down for weeks while New Zealand police investigated. Eventually, the site did come back online in limited form. Users could log in and see their accounts but not make any changes. They could not change their orders or change their account balances. They could see their coins but coins were fundamentally just some numbers on a website. These weren’t really their coins and there was no way for them to manage or access those coins.

And finally, the site went offline again on May 15th, being replaced by the announcement which I opened this article with. Cryptopia, and the assets it was holding on behalf of users, was being liquidated.

The hackers managed to steal some ETH and shitcoins like Dentacoin. But now users’ Bitcoins and ZCash and Tethers and so on are also affected. While they may not be permanently lost, at best they will be unavailable for a very long time. Most likely, part or all of the assets (and not just Ethereum) a customer had held on Cryptopia are lost and won’t be recovered.

A lot of people have made good money trading cryptocurrencies. People speculate hoping for quick and easy money but this speculation comes with the risk of losing money when price goes against you, which it often does. Arbitrage is a way to make money without that price risk. Arbitrage in crypto has been a profitable strategy in the past. Cryptopia opened up more arbitrage opportunities and many of us were able to profit from this although over time the profits were split among more and more people. But executing this arbitrage was like playing a game of musical chairs. You keep shifting your capital between exchanges until one day the music stops and you can no longer access your funds, or find that they were never really your funds at all.

Cryptopia was a place for people to come and try to make money. Some of the better profitable strategies required keeping funds on the exchange for extended periods of time. One of the rules for successful trading is to preserve your trading capital, not letting it get wiped out in a single trade.

Unfortunately, that’s what happened on Cryptopia.

You can avoid the risk of losing your money on an exchange by only trading on exchanges which do not take custody of your funds. If you want to learn more, visit ethex.market or email me at randolph@ethex.market.