Online and offline storage of digital currency present conflicting risks for a Bitcoin exchange. While bitcoins stored on online devices are continually vulnerable to malware and other network-based attacks, offline reserves are endangered on access, as transferring bitcoins requires the exposure of otherwise encrypted and secured private keys. In particular, fluctuations in customer demand for deposited bitcoin require exchanges to periodically refill online storage systems with bitcoins held offline.

The authors explore some of the famous issues with Bitcoin exchanges, including hacks and losses.  They directly address the even of January 5, 2015, Bitstamp, the world’s third largest Bitcoin exchange [1], abruptly suspended operations. The UK-based service had detected theft of 19,000 bitcoins, worth $5.1 million at the time of press release.

In this paper, the authors investigate this optimisation problem and develop a model that predicts the optimal ceiling on online reserves, given average rates of deposits, withdrawals, and theft. They evaluate their theory with an event driven simulation of the setup, and find that the equation yields a numerical value for the threshold that differs by less than 2% from empirical results.

For an open discussion on an aspect of Bitcoin security that has received little coverage until now; specifically, the design of higher-level Bitcoin wallet systems and a Bitcoin exchange, make sure you download this research!