Bitcoin might be censorship-resistant and money without counterparty risk; however, these attributes don’t automatically apply to bitcoin if you’re not using it directly on chain with a set of private keys. If you’re using a custodian, you’re as good as using a promise to manage your bitcoin. A reality that many will have to fund out the hard way as a large portion of users still leaves their funds with third parties like exchanges, despite a horrible track record in managing funds. Exchanges are there, for one thing, to exchange fiat for bitcoin; that’s where the relationship should end.
Since 2011, over $1.65 billion worth of crypto assets have been stolen, and the numbers are getting bigger yearly. Hackernoon states that this results in a jaw-dropping $12.6 billion loss when values are adjusted for inflation.
- On average, exchanges worldwide lose $2.7 million daily, which is set to increase in the future.
- The hacking attacks are becoming increasingly elaborate. It’s a highly-rewarding activity; therefore, it pays for ever-increasing time and effort spent plotting hacks.
- Exchanges are not cybersecurity enterprises. They run financial marketplaces first, and experience has shown they can’t guarantee top-notch security.
Like it or not, these financial institutions aren’t going anywhere anytime soon, so you’ll need to keep your wits about you should you wish to hold onto your satoshis.
Commingling of assets
You might be doing your due diligence, avoiding the exchanges listing shitcoins and trading coins based on the latest memes, but if you’re using an exchange that offers these products, don’t think your funds are isolated from the stupidity. Exchanges are looking for the most profitable ways to use their assets under management, and even they will get suckered into risky positions in illiquid shitcoins.
A prime example of this is the Terra/Luna crash, exchanges all had millions of these tokens on their books trading with different pairs, and it went to zero in a matter of weeks.
If you’re using a service that commingles assets, then the promise of redemption for your bitcoin could get wrapped up in the obligations now sitting on the books of the exchange due to backing a failed project.
Everything in your exchange is critical to ensuring your virtual currency is safe. Network and cloud providers are as important as the development, deployment, and security processes that are in place. Even a minor detail can break everything.
Cryptocurrency doesn’t magically poof into and out of storage. Vulnerabilities exist surrounding the hot or cold wallet you use. People can change where your money goes or the amount you are sending.
That’s why it’s important to look at technology and partnership pages on your exchange website to understand the underlying cloud or API infrastructure. If they have none of these pages, pay additional attention to it. This should be a bright red flag.
Balance sheet risk
Exchanges are businesses; they are not infallible, they take out debt, and they spend money on operational costs, salaries and marketing; it’s not as if they are running these services for free. As competition heats up for customers, the cost to acquire one increases, and the time it takes to recoup those funds becomes even longer. Exchanges cannot raise their fees for fear of pushing users away, so they have to offer other products to create new revenue streams.
In some cases, the risks they take simply won’t pay off, and exchanges go bankrupt, so do you want to leave your funds with an institution that cannot effectively manage its cashflows?
Regardless of all the security measures exchanges employ, it’s still foolish to trust them unconditionally with your funds. As the history of the exchanges shows, no platform is hackproof, and issues always occur when you expect them the least. Exchanges are a honeypot for hackers, and the moment they make a mistake, they expose their customer funds, which happens more often than you think. Exchanges need to spend a fortune on protecting themselves from external attacks, and even then, it might not be enough to stop internal attacks.
Exchanges can screw up their storage too; they can lose their keys, they can have keys exposed to a disgruntled employee, and a CEO could run away and have the only copy of the keys, here’s looking at you, Quadriga CX. While you might see figures on the front end, that is simply a user interface showing you numbers pulled from a centralised database; it has nothing to do with the amount of money held by the institution and processed by the back office.
As we say in bitcoin: Not Your Keys, Not Your Coins
Not Your Keys, Not Your Coins
Financial product offerings
Shitcoin casinos are about making as much money as possible while enjoying the regulatory arbitrage as industry and law enforcement still try to play catch up. You would think that creating a business around selling people tokens you get at a discount, mint for free or receive as a pre-mine allocation would be a big enough margin for business, but greed is a funny old thing.
So we’re seeing the tacking on of even more leverage and risk.
Exchanges are not only offering retail risker products like margin trading, but they are also staking certain big players who want to take on more risk.
While you might think your funds are sitting cosy in a vault with your name on it, it’s being borrowed from other parties to be used in different trading strategies, strategies that don’t always go the way you expect. A prime example is the fall of 3AC (3 Arrows Capital), which left many exchanges with a massive hole in their balance sheet after providing capital to the failed hedge fund.
The resulting failure saw many exchanges pause withdrawals, and some have yet to re-open with customers stuck without their funds.
Playing with temptation
I understand that in certain parts of the world, it’s your only option or the cheaper option, but it’s not without its trade-offs. Sure it might be more expensive to use a bitcoin-only exchange or a P2P exchange, but it doesn’t mean there I potential costs involved that can catch up with you in time.
If you’re not far down the rabbit hole and finally grasp the concept of why bitcoin only, then using these exchanges carries some risk of temptation. None of us is infallible, and if we do not truly grasp the bitcoin thesis, we are subject to being influenced and coerced by other narratives. If you’re opening up an application or website to buy bitcoin and are bombarded with news, charts, and social proof about other coins, you might end up baulking to the constant pressure.
It’s like purchasing your beef at a crack house, they might offer high-quality meat at a low cost subsidised by everyone else smoking crack, but if you come around there long enough, you might end up smoking crack.
It’s a process these sites count on; they’ll offer you sweetheart deals like interest on holding your coins with them, lower fees on purchasing certain coins, they’ll offer you promotional discounts if you purchase a certain amount, and they do it because it works. You might be coming into their place of business to buy bitcoin, but the exchange intends to sell you as many products as possible and more often than not, the house wins.
Exchanges are centralised businesses, and they have to play by the rules of the country in which they are incorporated, which is why so many of them are incorporated in certain regions with limited regulatory oversight and investigative capacity. No shade on the law enforcement of Seychelles, Estonia or Malta and the like, but they’re not going to be beating down the door of your satellite office you’re renting there just to have an address anytime soon.
When you become a custodian of people’s money and provide the free flow of exchange of funds, you are taking on risk, and you need to vet clients accordingly. Legal problems may arise, such as money laundering, if running an unlicensed exchange or not doing enough KYC (Know Your Customer) and AML checks on those who conduct transactions on your platform.
Exchanges, despite their operations to run a tight ship, only have so many resources to throw at reviewing customer applications, and some might slip through. KYC accounts can be bought and sold on third-party websites, and dirty funds can make it onto your exchange. Should these transgressions be serious enough, exchanges can be shut down and, with that, access to your funds.
Exchanges are not your friend
Do you use a shitcoin casino, or have you switched to a bitcoin-only service to acquire your satoshis? Do you find these multi-coin exchanges valuable in your neck of the woods and see them as a necessary evil? If you do use one of these casino exchanges, what would get you to switch to another service?
Let us know in the comments down below.