So, you’ve deposited some cryptocurrency onto an exchange. You expect that these funds will be held in your name as a liability, with sa
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:
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.
cointelegraph.com