The collapse of global exchange FTX has been referred to as crypto’s Lehman Brothers moment.
Last month FTX sought voluntary bankruptcy following a run by customers to get their funds out after learning that the company’s balance sheet may be peppered with holes. Many are left wondering if they will ever see their cryptos again.
Many FTX customers made the mistake of leaving their cryptos on the exchange, expecting it to safeguard their investment.
A total of $16 billion worth of assets was entrusted in this way to FTX.
We are now learning that FTX put up $10 billion of these assets as collateral so the company could invest in a number of smaller, struggling crypto exchanges, speculating that these would deliver large returns once the crypto market began to rebound.
This, sadly, was not to be. Many of these smaller exchanges ended up in liquidation, resulting in massive losses for FTX.
FTX gambled with customer funds and had no option but to liquidate these investments to service its debts.
When rumours started circulating about the likely holes in the FTX balance sheet, the company suspended all withdrawals from its platform.
Exchanges should not be regarded as a type of crypto bank
The irony of this situation is not lost on crypto investors. Crypto exchanges have been viewed as a type of crypto bank, where cryptos are purchased, traded and custodied. The truth is that this has never been the intended function of exchanges. Crypto exchanges are not banks and should not be treated as such.
The storing of users’ cryptos on an exchange is of no benefit to the exchange. They do not charge interest or fees for the service but rather offer it as a service to their clients.
Exchanges make their money through small transaction fees every time a user transacts on the platform.
The danger with this is that in the event of an exchange being hacked (it happens far more than one would imagine) or if the exchange is mismanaging funds (as in the FTX case), customer funds are at serious risk of loss.
Mesmerised by the levels of returns achievable with cryptos in years past, the last thing on many investors’ minds was safe custody.
Those high returns have disappeared, and while we may anticipate that a bull market will eventually return, the real focus for investors in these times is securing absolute control over their cryptos.
Custodial wallets, either in the form of hot wallets (which come in digital app form) or cold wallets (a physical USB-type device), are the most secure form of crypto storage as the device itself would have to physically be compromised for stored funds to be accessed.
Storing cryptos on one of these wallets allows one to become entirely self-governing. You are firmly in control of your funds.
Being in control of your funds means the onus is on you to take care of your wallet – the only method for the retrieval of your funds in the event of your wallet being lost, stolen or malfunctioning is a unique 12-24 word recovery phrase you are required to (preferably) write down and store away from a computer.
There are signs that the FTX meltdown has prompted crypto owners to self-custody their cryptos. Coins are moving off exchanges at a fantastic rate. Hopefully it is not too late for the roughly one million FTX customers whose funds are now frozen, awaiting the bankruptcy process to play out.
Matthew Wilson is the founder of CRPTsecure.com, which has developed a safe solution for back-up and recovery of the need to regain access to cryptos rendered inaccessible due to a wallet being lost or stolen.