The president and executives at HTS, a cryptocurrency exchange based in South Korea, were arrested this week for manipulating user funds and illegally reallocating the company’s holdings in cryptocurrencies like bitcoin and ether to the personal accounts of executives according to Korean publication TokenPost.
Illegal Transfer of User Funds
The police department of Southern Seoul and local financial authorities led by inspector Jeong Dae-seong requested an arrest warrant for four executives at HTS including the main developer of the HTS trading platform and operator of the exchange on May 14.
According to the prosecutor’s office of Seoul, HTS president Shin along with the three executives at the company moved user funds stored in the cryptocurrency wallet of the company to external bank accounts, essentially stealing cryptocurrencies from the company’s clients.
In March 2018, Coinnest, formerly the third largest cryptocurrency exchange in South Korea, was temporarily shut down by local authorities after its executives were arrested for stealing user funds. The reports of Chosun and JoongAng, two major mainstream media outlets, revealed that millions of dollars worth of user funds were transferred to the personal accounts of the company’s executives.
This week, the prosecutor’s office of Seoul disclosed that the local police initially planned to raid the headquarters of HTS along with Coinnest, but ultimately decided not to in order to focus the investigation on Coinnest, as the government obtained solid evidence of malpractice.
HTS is the third cryptocurrency exchange in South Korea to be raided and officially investigated by the local police and investigators from the Korea Financial Intelligence Unit (KIU), following Coinnest and Upbit.
On May 15, Upbit, South Korea’s most significant cryptocurrency exchange by trading volume, revealed that the audit report of a Seoul-based accounting firm Yoojin had found the cryptocurrency holdings of Upbit identically match the amount of funds listed on the balance sheet of the company. Upbit hinted that the official police investigation would likely end with a warning against Upbit with no additional charges and penalties.
How are Exchanges Able to Move User Funds?
Earlier in 2018, Binance, the global market’s most widely utilized cryptocurrency exchange, was down for over 48 hours due to a database error. Changpeng Zhao, the exchange’s CEO, and the rest of the exchange’s development team proved that user funds are safe by moving funds from the exchange’s cold wallet to its hot wallets.
Cryptocurrency exchanges rely on both cold and hot wallets to store user funds safely. A cold wallet refers to a cryptocurrency wallet that is not connected to the internet and kept offline while a hot wallet is one that is connected to the internet and readily accessible.
To process immediate withdrawal requests, cryptocurrency exchanges often have funds available in their hot wallets to ensure that users can withdraw funds without 12- to 24-hour delays. But, apart from a small fraction of the exchange’s holdings, the majority of user funds are kept in cold wallets to prevent hackers from breaching into the centralized servers of exchanges and stealing client funds.
Cryptocurrency exchanges like HTS and Coinnest were initially able to move large sums of user funds without alerting the authorities and its clients by moving user funds stored in cold wallets, which are not publicly verifiable. The authorities were only able to discover that user funds were illegally moved and manipulated after carrying out full audits into the systems and balance sheets of the two exchanges.