Author: Eric Holst

Are crypto exchanges safu?

In what is now the longest “crypto winter” since the market’s inception, crypto exchange founders are among those sweating the most.

Ever since it became known that the former second-largest crypto exchange FTX not only cross-financed the risky bets of its hedge fund Alameda with customer funds. FTX did not keep any bitcoins on its customers’ balances, but only recorded them in its accounting. The trust of business customers and private investors in exchanges has been at an all-time low.

Coinbase was the only public exchange to announce that its business plummeted 50% year-over-year. It additionally depressed their share price by 28%, which had already fallen by 85% last year.

But especially the market leader Binance, ten times bigger than its closest competitor, which also created the third largest stablecoin, is feeling the hysteria in the crypto market on several fronts. Although CEO CZ continously repeated his catchphrase “funds are safu” on Twitter, in press releases, and on financial media.

Although the crypto exchange tried to calm its customers’ uncertainty with the proof of its solvency with a “Proof-of-Reserves” (“PoR”).

To guarantee the safety of customer funds, in the days following FTX’s bankruptcy, Binance and competitors published lists of their wallets where various cryptocurrencies were stored, and all the world could see for themselves via the immutable blockchain.

But this move brought new problems for Binance, which kept crypto investors skeptical.

On the one hand, there is no unified definition of PoR, moreover, well-known critics, such as Vitalik Buterin, complain that it is not enough just to prove “credit”. Instead, crypto exchanges should also state the liabilities facing the credit balance to prove real liquidity for all customers and lenders.

Voices on crypto Twitter further criticize that these PoR were only a snapshot, but did not take into account previous and subsequent transaction movements.

Therefore, these critics assume that the crypto amounts were only hoarded for a brief moment on a few wallets to prove solvency with a snapshot. However, these amounts could only be borrowed in order to pass them on again. Either to lenders or to other exchanges, which wanted to reassure their customers with a similar step.

In the meantime, Binance responded and argued that this account movement was related to the transfer from secure cold storage to hot-storage wallets to meet market demand. Additionally, Binance is seeking independent audits.

A competition broke out among the biggest exchanges. Kraken, Coinbase, Crypto.com, and Binance competed on what level of transparency they could prove. True to the motto “Don’t trust – verify.”

Binance, calmly under pressure

In addition to skeptical and unsettled customers, the published wallets serve as a basis for blockchain analytics firms to further cast doubt on the trustworthiness of crypto exchanges.

A report by blockchain auditor Mazar faulted the quality of internal controls at Binance, how margin loans are liquidated, and a lack of information about Binance’s corporate structure.

Masses of Binance customers reacted unsettled after this announcement resulting in $3 billion of withdrawn funds in the last week.

Apparently, nothing is more convincing than a “proof of withdrawal”, which proves to customers whether their funds actually exist and are safest with them.

Binance CEO CZ calmly welcomed the stress test as a challenge.

Regulators are stepping up

Quicker than expected, CZ’s words were followed by the additional strain of the ill-timed Reuters article, which discussed the U.S. Securities and Exchange Commission and Department of Justice investigations into Binance that have been ongoing since 2018. Binance is accused of money laundering, tax avoidance, and evading sanctions in the process. However, the four-year investigation has not resulted in any specific charges.

Binance has since also commented on this, countering in a blog that it employs the most reputable cyber-crime specialists to ensure that Binance is not a safe haven for illegal activity.

To further prove reassurance and transparency, Binance users could turn to Twitter with questions during an impromptu Ask-me-Anything.

From Kraken CEO Jesse Powel’s perspective, it is only fair for Binance to be scrutinized with similar rigor as U.S. exchanges, which, unlike foreign exchanges, used many resources to meet requirements from authorities and regulations. In the eyes of U.S.-based crypto exchanges, Binance holds too much power. After all, aside from being the largest exchange, two of the ten largest coins belong to Binance. The blockchain tokens BNB and Binance USD add up to a market cap of $62 billion.

Competition on a leveled playing field also provides less systemic risk to the crypto market, as shown by the example of FTX, which was able to grow its fraudulent business under lax Bahamian regulation. This allowed non-criminal market players to get ahead of the game before their fall took the entire market and public perception down with them.

Only trust yourself

In turbulent times, it’s important to focus on the things you have control over and return to the basic principles of crypto.

Someone who can explain these principles most understandably is long-time Bitcoin ambassador Andreas Antonopoulos (“AA”), who most convincingly preached the “Not your keys, not your coins” mantra publicly. The relevance of this principle unfortunately only became obvious again with the FTX debacle. Where in the month before FTX bankruptcy alone 75,294 BTC were withdrawn from exchanges.

Another basic principle coined by AA is you use crypto exchanges like public toilets.

You do your business there and leave the place directly. You don’t party there, leave important things there, or use the restroom to lend or take crypto credit yourself with someone else. Decentralized technology offers safer ways, even if it requires self-responsibility.

Yes, constantly skeptical, and cautiously teaching yourself the necessary knowledge around cybersecurity and self-custody takes some effort, but is necessary to take advantage of the decentralized blockchain world.

Because even in the scenario when only regulated and established exchanges with competent staff and high standards exist, there is a risk associated with their use that is higher than the initial uncertainty of dealing with a hardware wallet.

The winners of fear

The winners of this uncertainty should include decentralized exchanges since they do not hold cryptocurrencies for customers. But their market capitalization continues to stagnate at low levels.

https://www.defichain-analytics.com/general?entry=marketcap

One step for DeFi to regain traction is for millions of crypto investors to acquire self-custody solutions in the first place.

Therefore, especially providers of cold storage and hardware wallets are among the profiteers: Ledger, CoolBitX, Coinkite, and Trezor are the most popular solutions here.

Especially the French market leader Ledger saw sales figures in the week after the FTX fraud that broke all records in the company’s history.

Ledger is particularly well positioned for the lasting trend of self-storage. At the right time iPod designer Tony Fadell, poached from Apple, unveiled his latest work: an elegant new wallet, in the guise of an e-reader.

Not only does the design break with the appearance of a USB stick, but for the first time NFTs can also find a safe home and be displayed.

Indispensable for the Future: Self-Responsibility and User-Friendliness

While the crypto market is volatile, it is also anti-fragile. With each new disaster, hack, and revelation, the industry and its customers learn to navigate the risks.

When Mt. Gox, then the largest crypto exchange, was hacked in 2014, it galvanized a new generation of exchange founders to create better and safer venues for crypto trading.

2022 created new lessons to make the industry more crisis-proof: on the one hand, the necessary transparency and regulation of central exchanges, not only under pressure from authorities but also from customers.

As well as the self-responsibility of all crypto investors, for whom hardware wallet providers previously did not make it attractive and easy enough to make the switch to self-custody.

The guiding principle remains that the industry must attract new and diverse minds to constantly improve the usability and security of its products and services, with the expertise of established banks and the eye for the user needs of designers.

In summary: Watch AA’s videos over the Christmas holidays and put a hardware wallet on your wish list. So you’ll be prepared for your BLOCKCHANCE journey from the start.

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