Exchanges is what crypto platforms call themselves, yet they’re more like banks
“Not your keys, not your coins,” is a well-known proverb that is held in common by crypto professionals as well as skeptics.
This statement, which was popularized by Bitcoin entrepreneur Andreas Antonopoulos, refers to how the contents of a cryptocurrency wallet are the property of whoever has access to that wallet’s digital “keys.” Andreas Antonopoulos is credited with popularizing this concept.
Because of this, if you do not physically hold the keys to your crypto assets and store them offline, you leave yourself open to the risk of being hacked, scammed, or having your funds stolen. The never-ending tide of cryptocurrency scams has been thoroughly chronicled. The number of breaches in security has increased, not to mention the staggering amount of carbon emissions.
Offline storage does, of course, call for an additional degree of comprehension as well as a higher level of technological skill and discomfort. Enter cryptocurrency exchanges such as Coinbase and Crypto.com, which provide customers with straightforward and user-friendly platforms on which they can buy, sell, and trade NFTs and cryptocurrencies.
However, as a result of the cryptocurrency market meltdown, it has become clear that these companies are not merely exchanges; rather, they operate more like banks. If you read the tiny print, you’ll see that defunct cryptocurrency exchanges such as Celsius Network and Voyager Digital were actually just banks. The vast majority of customers, obviously, did not.
Exchanges for cryptocurrencies were extremely popular up until very recently. They utilized A-list celebrity ambassadors, secured naming rights to a stadium, and received public support from influential lawmakers.
Exchanges for cryptocurrencies offer themselves to users as places where they may purchase and sell cryptocurrencies. However, they also perform the functions of stockbrokers, and what is more troubling is that the fundamental models of their businesses are strikingly similar to those of banks.
Historically significant exchanges such as the New York Stock Exchange almost never declare bankruptcy. In addition, because they do not offer account services, their customers will not be responsible for any losses incurred by the company in the event that it declares bankruptcy.
It is possible for brokerage businesses such as Wealthsimple to go out of business, but because their customers’ portfolios are held in the customers’ own names, those portfolios may easily be moved to a new broker if necessary. Both Canada and the United States have laws in place that guarantee compensation for any assets that are stolen or lost as a result of fraudulent activity.
The Royal Bank of Canada is only one example of a bank that has failed despite taking on a greater number of risks. The ability of banks to lend money is contingent on the deposits of its customers, which makes banks susceptible to runs. This is one of the primary reasons why the majority of countries with high incomes, including Canada, have deposit insurance and regulate banking more than other financial businesses.
This is where the difficulty rests. Companies such as Celsius and Voyager promoted themselves as both exchanges and brokers; hence, their apps looked to function in this capacity. However, if anyone were to read the terms and conditions, it would be obvious that they were actually quasi-banks that did not have deposit insurance.
In businesses such as Celsius and Voyager, user accounts were not stored individually in their own wallets but rather were stored in a pool that was controlled by the platform. This pool was used to store customer funds. This pool of capital would either be used by the platform to lend out money (often to other cryptocurrency businesses) or for the platform’s own speculative investments (often in crypto assets).
When depositors cashed out, they were paid out of the pool, which was able to meet routine on-demand withdrawals but did not have the funds to handle everyone cashing out at the same time.
Does this ring a bell?
The fall in the price of cryptocurrencies caused these companies to default on their loans, and several of them were forced to temporarily halt withdrawals. The depositors of Celsius found out that the money in their accounts was worthless after the company filed for Chapter 11 bankruptcy because the money had been gambled away by the corporation.
These companies hid the truth from their customers on purpose in order to maintain their business. In the case of Voyager, the company blatantly lied about having FDIC insurance. After being duped by these companies’ snake-oil salesmen into believing that regulated banks were the source of the problem, customers later discovered the true motivation for the establishment of such restrictions.
To make a bad situation even worse, the lack of transparency that exists in crypto markets makes it relatively simple for executives and developers to unload their holdings well in advance of the time when withdrawals are temporarily halted. When the clients find out that their money has been stolen, those responsible will have already cashed out with a healthy profit.
Where do you see us going from here?
When seen on a more fundamental scale, the answers are readily apparent. It is important that cryptocurrency exchanges be regulated in the same way that brokers are. Client assets must be kept in a separate location that is both secure and confidential, and there must be well-defined guidelines regarding the businesses’ exposure to risk in their own trading.
The actual crypto assets should be categorically labeled as securities, and as a result, they should be subject to regulation. It should be mandatory that exchange platforms have a significant amount of cash in currency issued by the government. If doing this seems contrary to the principles underlying decentralized financial systems, that’s because you’re right—it should.
The macro level is more difficult to understand. Since the financial crisis of 2008, people have a tendency to look up to technology and look down on large institutions. Crypto fans are correct in their assertion that Wall Street is just interested in profiting from the cryptocurrency market for itself. But now they’ve come up with a new system that’s much riskier than the old one.
The wealthy investing class is not the group who arrived late to the cryptocurrency party but is now the one that is clutching the bag. They are everyday people who have a justified mistrust of banks and, by extension, our institutions, and they are seeking fruitlessly for methods to protect themselves from the growing cost of living.
It will take some time and effort to rebuild that trust. To be willing to deal with the injustices that are generated by factors such as a growing cost of living and an exploitative financial system is a requirement. In addition to this, it is necessary to have efficient regulation. If it appears like a bank and performs like a bank, it ought to be handled like a bank.