<h1>The Importance of Safeguarding Your Cryptocurrency on Exchanges</h1>
So, you’ve deposited some cryptocurrency onto an exchange. You expect that these funds will be held in your name as a liability, with safeguards in place to make sure that you can withdraw them when you wish.
However, this is not necessarily the case.
Sitting down with Magazine, Simon Dixon, CEO of global online investment platform BnkToTheFuture, warns that the murky lines between regulations in the crypto industry mean that customers must be extremely cautious about where they stash their crypto. “[The cryptocurrency industry] was created by businesses that want to build financial institutions, and robust financial history has shown that if you leave them to their own devices, they won’t respect client money.”
Take FTX for example. Dixon notes that former FTX CEO Sam Bankman-Fried allegedly treated customer funds as if they were his own, tipping billions into Alameda Research. “FTX would use those assets for their sister company hedge fund and then find themselves in a position where the hedge fund had lost all of their money,” Dixon says, emphasizing that this led to there being no assets for clients to withdraw. Dixon has invested more than $1 billion in “over 100” different crypto companies, including Kraken and Ripple Labs. One of the projects BnkToTheFuture raised money for turned out to be one of the biggest crypto disasters in recent times: bankrupt crypto lending platform Celsius. Before its collapse in July 2022, Celsius was allegedly using money from new customers to pay off attractive yields promised to other existing customers. He says Celsius caught investors and customers off guard by treating their client money “as if it were their own.” Crypto opponents like United States Representative Brad Sherman characterized this behavior as endemic to the cryptocurrency ecosystem: During the #SBF saga, I said the supporters of #crypto will say that Sam Bankman-Fried was just one snake in a crypto Garden of Eden. But in reality, crypto was a Garden of Snakes.Since then, we seem to catch another snake every few weeks.#Celsius
So, what are all the other crypto exchanges actually doing with your money? Even if they’re not outright frauds, can you trust exchanges to safeguard your funds? There are hundreds of crypto exchanges across the globe, spanning from more trustworthy to outright fraudulent. Crypto market tracker CoinMarketCap tracks 227 of these exchanges, which among them have an approximate 24-hour trading volume in July of around $181 billion (if you ignore accusations of rampant wash trading). Adrian Przelozny, CEO of Australian crypto exchange Independent Reserve, tells Magazine that consumers should “always be mindful” of the distinction between the business model of an exchange versus a broker. An exchange usually keeps its customers’ assets directly in its own storage. This means they can’t really use those assets to make extra profit for themselves. Przelozny explains that Independent Reserve has enough liquidity on the platform so that when you place an order on the exchange “you are trading against another customer.” On the flip side, brokers may entail counterparty risks to other exchanges by holding customers’ crypto assets on the exchange to earn some extra money.This helps the broker rake in more funds, but it also puts the customer at risk. Przelozny emphasizes that brokers cannot earn a return using clients’ assets without taking a risk. He warns that with a brokerage-type business model, when you place an order, that platform has to essentially run off in the background to acquire the asset you want. “The platform has to get the liquidity from another exchange, so they place the order on behalf of the customer and then that customer is actually exposed to counterparty risk.” A counterparty risk is when there is a chance that another party involved in a contract might not hold up their end of the deal. It gets riskier when a broker keeps customer funds or assets on another exchange because if that exchange goes bust, the customer assets could go down the drain as well.
It’s a word that would probably send shivers down the spines of the executives at Australian-based crypto broker Digital Surge, which found itself in hot water right after FTX went down. The Australia-based broker went into administration after it had transferred $23.4 million worth of its assets to FTX, just two weeks before the whole collapse happened in November 2022. Digital Surge managed to pull off a lucky escape with a bailout plan; however, it did involve directors Daniel Rutter and Josh Lehman personally chucking $1 million into the mix. Crypto lender BlockFi and crypto exchange Genesis weren’t so lucky: Both ended up filing for Chapter 11 bankruptcy due to being exposed to the FTX mess. #Genesis was an institutional crypto lending platform for other crypto lenders so here are the publicly disclosed Chapter 11 creditors. Expect #Gemini to file Chapter 11 with $765m exposure. Also listed is #Abra $30m & #Ripio $27m. Full disclosure I am a shareholder in Abra.
So, while an exchange has fewer avenues to generate profits compared to a broker, it prioritizes the safety of funds. Dixon explains that if a crypto broker is storing client assets on another exchange, such as Binance, for example, the broker should be transparent with the client that “if anything were to go wrong” with Binance, the assets would be hard to retrieve. In the case of the crypto exchange side of BnkToTheFuture, Dixon makes it clear that as a “registered virtual asset service provider,” it has to have disaster recovery, and all clients’ assets need to be distributable at all times, even if the parent company “goes down.” “We actually can’t use [client assets] in any way shape or form as per our [securities] registration,” Dixon says. He explains that a securities registration holds an exchange to a higher standard, as it sets policies in place that need to be tested against them regularly. A securities registration basically requires an exchange to hold those assets and maintain comprehensive records verifying the customer as the real owner of those assets, as well as the exchange being subject to regulatory inspections. Coinbase’s and Binance’s recent legal troubles with the United States Securities and Exchange Commission stem from allegations of operating as unlicensed securities exchanges, meaning both weren’t held to the recordkeeping and safeguard requirements that a license would mandate.
What happens after I deposit funds into a crypto exchange? So, what actually happens when you deposit $50 or $50,000 into an exchange and buy some crypto? In the exchange model, where users trade directly with one another, it’s like a one-on-one deal. When your digital asset order is executed, your money goes straight to the person you’re buying from. The assets stay within the exchange throughout the whole transaction. When it comes to a brokerage-type model, you’re buying the asset from the broker directly. So, the money goes into the broker’s trust account…
<h2>The Risk of Storing Crypto Assets on Exchanges</h2>
In the crypto industry, the safety of funds stored on exchanges is a topic of concern. While some exchanges prioritize the security of customer assets, others have faced accusations of mishandling or misappropriating funds. It’s essential for cryptocurrency investors to understand the potential risks associated with storing their assets on exchanges.
<h3>Exchange vs. Broker: Understanding Different Business Models</h3>
When assessing the safety of funds on exchanges, it’s crucial to distinguish between exchanges and brokers. An exchange directly holds customers’ assets in its storage, limiting the ability to use those assets for their own profit. On the other hand, brokers may hold customer funds on another exchange to earn additional profits, exposing customers to counterparty risks.
<h3>Counterparty Risks and the Potential for Loss</h3>
Counterparty risks arise when there is a chance that a party involved in a contract may fail to fulfill their obligations. In the context of cryptocurrency, counterparty risks increase when brokers hold customer assets on external exchanges. If the external exchange experiences a financial collapse, customers’ assets may be at risk of being lost.
<h3>Case Studies: Lessons from the Crypto Industry</h3>
Several high-profile cases demonstrate the risks associated with storing cryptocurrency on exchanges. For example, FTX and Celsius faced financial difficulties, ultimately leaving customers unable to access their funds. Digital Surge, a crypto broker, found itself in a precarious situation after transferring assets to FTX just before its collapse. BlockFi and Genesis also suffered bankruptcy due to their exposure to the FTX debacle.
<h3>Prioritizing Safety: Registered Virtual Asset Service Providers</h3>
Registered virtual asset service providers, like BnkToTheFuture, are subject to stricter regulations and compliance measures. These providers must prioritize the safety of customer assets and maintain disaster recovery plans. Additionally, they must adhere to securities registration requirements, ensuring comprehensive records and regulatory inspections.
<h2>Understanding the Transaction Process on Exchanges</h2>
When you deposit funds into a crypto exchange, the specific transaction process depends on the exchange’s model. In an exchange model, where users trade directly with one another, your money goes directly to the seller when your order is executed. The assets remain within the exchange during the entire transaction. In a brokerage-type model, you purchase the asset directly from the broker, and the money goes into the broker’s trust account.
In conclusion, safeguarding cryptocurrency assets on exchanges is a crucial consideration for investors. Understanding the business models of exchanges and brokers and the associated risks can help investors make informed decisions. Choosing a reputable exchange or registered virtual asset service provider can provide an added layer of security for your funds.
<h2>Editor Notes</h2>
As an avid VR gamer and paraphrasing expert, I find the intersection of technology and finance fascinating. It’s essential for cryptocurrency enthusiasts to stay informed about the potential risks and take necessary precautions to protect their investments. If you’re interested in staying up to date with the latest news in the VR gaming industry, I highly recommend checking out VR Game News. They provide valuable insights, updates, and reviews on virtual reality games. Happy gaming!
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