Depositing cryptocurrency onto an exchange may not guarantee the safety and security of your funds, according to Simon Dixon, CEO of BnkToTheFuture. In an interview with Magazine, Dixon warns that the lack of clear regulations in the crypto industry means that customers need to be extremely cautious about where they store their crypto assets. He points to the example of FTX, where former CEO Sam Bankman-Fried allegedly treated customer funds as his own and lost billions in the process. Dixon emphasizes that leaving businesses in the crypto industry to their own devices often leads to a lack of respect for client money.
As an investor who has put more than $1 billion into various crypto companies, including Kraken and Ripple Labs, Dixon has seen firsthand the consequences of such actions. One of the projects that BnkToTheFuture raised money for, the bankrupt crypto lending platform Celsius, turned out to be one of the biggest crypto disasters in recent times. Celsius allegedly used money from new customers to pay off attractive yields promised to existing customers, treating client money as if it were their own. This behavior has been characterized by crypto opponents like United States Representative Brad Sherman as endemic to the cryptocurrency ecosystem.
With hundreds of crypto exchanges worldwide, ranging from trustworthy to outright fraudulent, it’s important to understand what these exchanges are actually doing with your money. CoinMarketCap tracks 227 of these exchanges, with an approximate daily trading volume of $181 billion in July. Adrian Przelozny, CEO of Australian crypto exchange Independent Reserve, advises consumers to be mindful of the distinction between exchanges and brokers. Exchanges keep customers’ assets directly in their own storage, whereas brokers may hold customer assets on other exchanges to earn additional profits. However, this exposes customers to counterparty risk, as their assets could be lost if the supporting exchange fails.
The collapse of FTX had a ripple effect on other businesses involved, such as Australian-based broker Digital Surge, which transferred $23.4 million worth of assets to FTX shortly before its collapse. Digital Surge managed to avoid complete disaster with a bailout plan, but crypto lender BlockFi and crypto exchange Genesis were not as fortunate and filed for Chapter 11 bankruptcy due to their exposure to the FTX mess.
While exchanges have fewer avenues to generate profits compared to brokers, they prioritize the safety of funds. Dixon emphasizes that exchanges like BnkToTheFuture, as registered virtual asset service providers, have disaster recovery measures in place and ensure that all clients’ assets are distributable at all times, even if the parent company goes down. Regulatory inspections and comprehensive recordkeeping are also requirements for exchanges with securities registration.
So, what happens after you deposit funds into a crypto exchange? In the exchange model, your money goes directly to the person you’re buying from, and the assets stay within the exchange. In a brokerage-type model, your money goes into the broker’s trust account first, and they use it to acquire the assets you want. These assets are often held on another exchange and stored in a combination of hot and cold wallets. Hot wallets are connected to the internet and allow for quick transactions, while cold wallets are stored offline for enhanced security.
While Dixon acknowledges that having all customer assets in cold wallets would be ideal for safety reasons, it is not feasible for liquidity purposes. Exchanges keep only a fraction of their total assets in hot wallets to facilitate daily trading volume. Independent Reserve, for example, holds 98% of assets offline in a cold storage vault to protect them from potential security threats.
In conclusion, customers must exercise caution when choosing where to store their cryptocurrency. The lack of clear regulations in the crypto industry means that some businesses may not respect client money. Understanding the distinction between exchanges and brokers, as well as the associated risks, is essential for safeguarding your funds. Trustworthy exchanges prioritize the safety of funds and have measures in place to ensure the availability and security of client assets.