Undoubtedly, cryptocurrency is not the safest investment to make. Aside from extreme volatility risks and loose regulations, there are thousands of tokens with questionable use cases. Although not the safest, you might think crypto would at least be trustworthy, but that is not always the case, either.
What Is a Crypto Exchange?
Crypto exchanges are centralized business entities that allow you to buy, sell, store and trade cryptocurrencies. Some of the better-known exchanges include Coinbase, Binance, Kraken, and — before its fall from grace — FTX.
How Crypto Exchange FTX Collapsed
FTX is a crypto exchange that recently filed for bankruptcy. The company had been commingling customer funds with its sister company, Alameda Research.
Alameda, a crypto trading firm founded in 2017, used leverage to create outsized returns, but when the crypto markets fell, the company struggled to pay back its lenders. The fatal blow came from having secured these loans using FTX’s exchange token, FTT, which subsequently tumbled in price.
Surprisingly, the mass sell-off of FTT was the result of a large sell order from FTX competitor Binance. Some speculate that this was an intentional move coordinated by Binance CEO, Changpeng “CZ” Zhao, to diminish FTX’s crypto exchange value.
The aftermath was nothing short of a crypto catastrophe. Withdrawals from FTX suddenly stopped, and millions of customers lost all of their assets. Consequently, FTX CEO, Sam “SBF” Bankman-Fried, was arrested in the Bahamas for conspiracy, wire fraud and money laundering.
Should You Trust Crypto Exchanges?
The short answer is no, you should not trust crypto exchanges. Not only is the crypto space filled with bad actors, but crypto exchanges also remain subject to booms and collapses in tandem with market sentiment.
However, it’s true that some are more secure than others. To be safe, crypto investors should look out for:
- Proof of reserves
- Exchange locations and regulation
Crypto Exchanges With Proof of Reserves
Proof of reserves (PoR) verifies that a crypto exchange holds the customer assets that it claims to hold. If buying or selling on an exchange, it’s a good idea to see if it has published PoR. However, it’s also wise to take PoR with a pinch of salt.
Some publications claim that PoR can be faked and manipulated by exchanges. In fact, two popular crypto accounting firms, Mazars Group and Armanino, have paused services for crypto companies over concerns that the PoR reports may mislead the public to feel a false sense of security.
As it stands, Coinbase is the only crypto exchange for which people can see the financial health of the company. Not only does it issue quarterly financials as a public company, but it also undergoes audits by the Big Four firm, Deloitte. Even still, Coinbase has faced criticism from BaFin — a regulatory authority in Germany — over its business structure.
Crypto Exchange Locations and Regulation
Many crypto exchanges, like OKX, Huobi and KuCoin, set their operations up in offshore countries, such as Seychelles, which are known tax havens with loose regulations. Others, such as Crypto.com, avoid capital and liquidity requirements entirely by basing operations in Singapore.
Even Kraken, a U.S.-based company, does not have to report liabilities under U.S. law.
Crypto Wallets vs. Exchanges
A possible alternative to a crypto exchange is moving your assets to a crypto wallet, which gives you complete control of your money. There are two options:
- Hot wallets — also known as online wallets
- Cold wallets — also known as offline wallets
The best thing that crypto investors can do to protect their assets is keep them in a self-custody cold storage wallet. This way, crypto is bought on exchanges only to be transferred to a wallet — eliminating exchange risks caused by mismanaged companies.
The collapse of crypto exchanges in the past has caused a lot of distress for consumers. However, these collapses can help people to understand the risks of investing in cryptocurrencies. By putting digital assets into self-custody through wallets, consumers can take full control over their assets instead of relying on exchanges.
FAQHere are some frequently asked questions about investing with crypto exchanges.
- Is crypto safe to invest in?
- Crypto is not considered the safest investment, as it's volatile and unregulated. Instead, stocks and real estate are investment options that pose less risk – though no investment is completely risk-free.
- That doesn't mean you shouldn't invest in crypto – it's entirely possible for your crypto investments to do very well. Just be cautious about where and how you invest, and don't invest more than you can afford to lose.
- What is the danger of crypto?
- Crypto is an industry where scams, fraud and speculation are common. Any investor in crypto must be aware of the risks and take accountability for lost investments.
- What is the safest way to buy crypto?
- The most important thing is to do your research before you invest. Consider a cryptocurrency's use cases, history and realistic future potential before you buy.
- Also consider buying a hardware wallet, or cold wallet, for self-custody. It's easy to move assets from an exchange to a wallet, and no single exchange will have control over the assets held therein.
- Should I keep my crypto on an exchange or a wallet?
- Keeping crypto on exchanges may be useful for traders or for earning staking rewards. Otherwise, move it to a wallet. A hot wallet will allow for easier movement of your crypto, but if you intend to buy crypto and hold it for the long term, the best option is to buy a cold wallet for storage.