Anthony* (a friend) called a few weeks ago, very concerned.
Vice-principal of a secondary school in Queensland, over the past year he has spent hundreds of thousands of dollars buying cryptocurrencies, borrowing money using his house as capital.
But now all of her assets, valued at $600,000, were locked up in an account that she couldn't access.
He had bought through FTX, the world's third-largest cryptocurrency exchange, backed by celebrities including Seinfeld co-creator Larry David, basketball champions Steph Curry and Shaquille O'Neal, and tennis player Naomi Osaka.
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With FTX's spectacular collapse, he is now awaiting the outcome of the liquidation process that will likely see him, 30,000 other Australians and more than 1.2 million customers worldwide lose everything
โI thought these exchanges were safe,โ Anthony said.
He was wrong.
Not like the stock markets
Cryptocurrency exchanges are sometimes described as stock exchanges. But they are very different from the London or New York stock exchanges, institutions that have weathered multiple financial crises.
Stock exchanges are highly regulated and help regulate stock trading. Cryptocurrency exchanges, on the other hand, are virtually unregulated and useless. regulatory function.
They are just private companies that make money helping โmom and popโ investors get into cryptocurrency trading, profiting from the commission charged on each transaction.
In fact, the cryptocurrency exchanges that have grown to dominate the market, such as Binance, Coinbase, and FTX, arguably undermine the entire vision that drove the creation of Bitcoin and blockchain, because they centralize control in a system meant to decentralize and freeing finance from the power of governments, banks and other intermediaries.
These centralized exchanges are not required to trade cryptocurrencies and are pretty much the least secure way to buy and hold crypto assets.
Trade before trades
In the early days of Bitcoin (since 2008), the only way to acquire it was to "mine" it: earning new coins by performing the complex calculations required to verify and record transactions on a digital ledger (called a blockchain).
The coins would be stored in a digital โwalletโ, an application similar to a private bank account, accessible only through a password or โprivate keyโ.
A wallet can be virtual or physical, on a small portable device similar in appearance to a USB stick or a small phone. Physical wallets are the most secure because they can be disconnected from the internet when not in use, minimizing the risk of being hacked.
A physical digital wallet is the most secure way to store your cryptocurrency. Shutterstock
Before exchanges arose, trading involved owners selling directly to buyers through online forums, transferring coins from one wallet to another just like any electronic funds transfer.
Decentralized vs Centralized
All this, however, required some technical knowledge.
Cryptocurrency exchanges reduced the need for such knowledge. They made it easier for less tech-savvy investors to enter the market, in the same way that web browsers have made surfing the Internet easier.
Two types of exchanges emerged: decentralized (DEX) and centralized (CEX).
Decentralized exchanges are essentially online platforms for connecting the orders of cryptocurrency buyers and sellers. They are simply there to facilitate trade. You must still have cryptocurrency in your own wallet (known as "self-custody").
Centralized exchanges go much further, eliminating wallets by offering a one-stop service. They are not just an intermediary between buyers and sellers. Rather than custodial themselves, they act as custodians and hold cryptocurrencies on behalf of clients.
Exchange, broker, bank
Centralized exchanges have proven to be the most popular. Seven of the world's 10 largest cryptocurrency exchanges by trading volume they are centralized.
But what customers gain in simplicity, they lose in control.
You don't give your money to a stock exchange, for example. You trade through a broker, who uses your trading account when you buy and deposits money into your account when you sell.
A CEX, on the other hand, acts like an exchange, a brokerage (taking clients' fiat money and converting it to crypto or vice versa), and like a bank (holding clients' crypto assets as custodian).
This Is Why FTX Had Cash Value And Crypto Assets US$10-50 billion. It also acted like a bank by borrowing and lending cryptocurrency, albeit without the knowledge or agreement of customers, and without any of the regulatory responsibilities imposed on banks.
With wallets and keys, founding owner Sam Bankman-Fried "borrowed" his clients' funds to prop up his other businesses. Clients realized too late that they had little control. When it ran into problems, FTX simply stopped allowing clients to withdraw their assets.
The power of marketing
Just like stockbrokers, cryptocurrency exchanges make money by charging a commission on each trade. Therefore, they are motivated to increase trading volumes.
FTX did this primarily through sports and celebrity marketing. Since its founding in 2019, it has spent an estimated 375 million US dollars in advertising and sponsorships, including the purchase of the naming rights to the stadium used by the Miami Heat basketball team.
FTX Arena in Miami. Lynne Sladky/AP
Such marketing has helped create the illusion that FTX and other exchanges were just as safe as mainstream institutions. Without such marketing, it is debatable whether the value of the cryptocurrency market would have risen from US$10 billion in 2014 to US$876 billion in 2022.
Neither your key nor your coins
There is an adage among crypto investors: "It's not your key, it's not your coins, it's that simple."
What this means is that your crypto is not secure unless you have self-custody, storing your own coins in your own wallet in which only you control the private key.
The bottom line: crypto exchanges are not like stock exchanges, and CEXs are not safe. If the worst happens, be it an exchange crash or a cyber attack, you risk losing everything.
All investments carry risk, and the unregulated crypto market carries more risk than most. So follow three golden rules.
First, do some homework. Understand the crypto trading process. Learn how to use a self-custody wallet. Until governments regulate crypto markets, especially exchanges, you are largely on your own.
Second, if you are going to use an exchange, a DEX is safer. There is no evidence to date that any DEX has been hacked.
Lastly, in this world of volatility, only risk what you can afford to lose.
*Name has been changed.
Paul Mazzola is Professor of Banking and Finance at the University of Wollongong School of Business and Law and Mitchell Goroch is a cryptocurrency trader and researcher at the University of Wollongong.
This article is republished from The conversation under a Creative Commons license. Read the Original article.
