“We thought it was safe”: what risks do centralized crypto exchanges actually bear

In mid-December, the number of bitcoins withdrawn from crypto exchanges reached 200,000 per month. The total amount of withdrawn cryptocurrency is estimated at $3.4 billion. Investor panic is associated with a decrease in confidence in centralized trading floors. History repeats itself The founder of the Ethereum project, Vitalik Buterin, believes that the collapse of FTX is “a great tragedy” for the entire crypto industry, but users should “learn from this lesson”. It is important that the stories of the bankruptcy of large centralized trading platforms have already happened before. For example, many have noticed a striking similarity between the events of November 2022 and the case of the Mt.Gox crypto exchange.. In 2014, the platform, which accounted for up to 70% of the total trading volume of the first cryptocurrency, stopped working after a hacker attack.. Unknown people were able to withdraw 650,000 BTC from the site in a few years. The collapse of Mt.Gox also affected the bitcoin rate: if at the beginning of 2014 it was trading at values above $1,000, then in the second half of February, the rate was approaching the level of $250. However, with the current fall in the value of BTC, not everything is so simple. Judging by the situation with FTX, not everyone was able to learn from the history of 2014. But why do crypto exchanges pose a threat, where did they come from and what other risks do they pose for ordinary users? Not like stock exchanges Cryptocurrency exchanges are sometimes said to be like stock exchanges.. However, in reality, they are very different from the stock exchanges in New York or London, which have survived more than one financial crisis. Stock exchanges are themselves highly regulated by governments and also contribute to the strict regulation of stock trading within the platform. But cryptocurrency exchanges are organized differently: they are not regulated and are often organized much more freely.. In essence, these are ordinary private enterprises that make money by helping small investors engage in cryptocurrency trading.. Their profit is obtained from the commission (primarily), which is taken for each transaction. Most of the crypto-exchanges that occupied or occupy a leading position in the market – Coinbase, Binance and FTX – nevertheless crossed out the main, original idea laid down when creating the blockchain and bitcoin. Initially, bitcoin, like many of the first altcoins, is considered to be designed for decentralization and freedom of finance from the power of governments, banks and other intermediaries.. Satoshi Nakamoto directly wrote about this in the White paper BTC. The peer-to-peer (peer-to-peer) network, which is the Bitcoin system, is just what is needed for direct free exchange between end users. On the other hand, centralized crypto exchanges just act as financial intermediaries. Often they impose on users procedures like verification or KYC, which are conceptually different from the ideas of the cryptoanarchists and cypherpunks who created the first cryptocurrencies. On the other hand, crypto exchanges provide the market with liquidity.. It is these large platforms that allow you to make massive trading operations with bitcoin and altcoins.. This is the secret of the popularity of such trading platforms. Trading before exchanges In the early days of bitcoin (we are talking about 2008), the only way to mine was mining – receiving a reward for blocks in the chain, as a result of confirming and recording transactions in a digital distributed ledger. The coins were stored in a digital wallet – an application similar to a private bank account, accessed through a password, or rather a private key.. The wallet has become virtual or physical. In the second case, as a small portable device, similar to a USB flash drive or a small phone. Physical wallets have been and are considered the most secure among crypto enthusiasts, as they can be disconnected from the internet when not in use, minimizing the risk of information being stolen. Before crypto exchanges appeared, trading was carried out directly between sellers and buyers through online forums, by transferring coins from wallet to wallet. It was like an electronic fiat money transfer.. But, firstly, it required a high “entry threshold” from users: not everyone understood the issue at a sufficiently high level. And as a result, secondly, the “over-the-counter” crypto market did not have the same liquidity that stocks, fiat currency and other traditional financial assets have.. The first crypto exchanges made it easier for the average user to interact with cryptocurrencies, such as storage, transactions, and so on. Decentralized vs. Centralized In short, cryptocurrency exchanges have reduced the need for specialized technical knowledge.. They have made it easy for non-tech users to enter the market, in the same way that web browsers have made it easy to navigate the Internet. And then two types of exchanges arose: centralized (CEX) and decentralized (DEX). Decentralized, in fact, are online platforms that are designed to link buyer orders with seller orders. Their purpose is to promote trade. You still need to keep cryptocurrencies in your own wallet. Centralized went much further. It's not just wallets anymore. It offers department store services. At the same time, clients of centralized exchanges no longer need independent external storage of crypto assets. Exchange, broker, bank Centralized exchanges quickly became the most popular market participants. Seven of the top ten exchanges by trading volume are centralized. But as usual, this is a double-edged sword.. On the one hand, customers gain simplicity, on the other hand, they lose control. For example, you do not carry money directly to the stock exchange. You trade through a broker who uses your trading account when you buy some assets and returns money to it when you sell those assets. In turn, the centralized exchange acts both as a broker (takes clients' money and converts them into cryptocurrency and vice versa) and as a bank (holds clients' crypto assets). FTX held up to $50 billion in customer money and crypto assets. It also acted like a bank, borrowing and lending cryptocurrencies.. There is only one but: customers did not know about the banking side of FTX and did not give their consent to this. In addition, FTX was not burdened with any reporting, unlike the same banks. With both wallets and user keys at his disposal, the founder and owner of FTX is believed to have “borrowed assets” from his clients to promote other projects.. Unfortunately, customers realized they had little control too late.. When the collapse occurred, FTX simply prohibited users from withdrawing assets from their accounts. The Power of Marketing Like regular stock brokers, crypto exchanges make money from commissions on every trade they make.. Thus, they have the motivation to maximize trading volumes. FTX did this through an aggressive ad campaign that included celebrities and sports.. Since its inception in 2019, the exchange has spent about $375 million on marketing and support. These activities included, for example, the purchase of the rights to the name of the stadium where the basketball club of the US National Basketball Association plays Miami Heat. Such marketing contributed to creating the illusion that FTX and other exchanges are safe, and the user does not risk anything by investing their money.. Without such marketing, it is unlikely that the value of the cryptocurrency market would have risen from $10 billion in 2014 to $876 billion in 2022. The key is not yours, the money is not yours There is a saying among crypto investors: “If the key is not yours, then the coins are not yours, everything is very simple” (optionally: “not your keys – not your coins”). This means that your crypto assets are at risk until you provide them with proper self-storage, place them in your own wallet, to which only you will have a private key. Personal data at risk As centralized crypto exchanges become more popular and their capitalization increases, governments introduce new rules. Most often, the rules relate to the fight against the anonymity of cryptocurrencies.. As a result, many exchanges set a lot of serious requirements for user verification, including the provision of passport and other personal data. Do not forget that a centralized crypto exchange is a financial intermediary, a third party. In fact, you entrust your personal data to outsiders, and the pretext under which this data is received from you is not so important.. In the event of a leak, it is not the exchange that will suffer in the first place, but the one whose data was stolen. Hackers A risk that is not always obvious to most users. Cryptocurrency (like bitcoin) is a fairly reliable asset if you follow the security rules. It is the trading platforms that are the “weak link” in the chain of transactions between two users. Attackers can find a vulnerability in the program code of a particular platform, gain access to a user account, use social engineering methods, in short, they have a whole arsenal of weapons for misappropriating cryptocurrency. And CEX exchanges are the main place where money is concentrated, so they will always be the first to be attacked.. That is why it is worth considering withdrawing large savings from the exchange to an “external wallet” if you are not trading on a regular basis. Conclusion Crypto exchanges are not like stock exchanges, and centralized exchanges are not safe.. If the worst happens, be it a company crash or a hack, you risk losing everything. Any investment carries risks, and the unregulated crypto market is more dangerous than the stock market.. So follow the three golden rules: Knowledge = power. Learn the structure of the cryptocurrency trading process. Learn how to use non-custodial wallets. Keep your private keys in a safe place. If you are going to use an exchange, then prioritize DEX. This one is just more reliable. Remember, in this ever-changing world, it's only worth risking what you can afford to lose. Do not invest everything in cryptocurrency, and even more so do not buy it with money borrowed.