Cryptocurrencies

Once More for the People in the Back: Get Your Digital Assets off Centralized Exchanges

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Credit: Photo by Kanchanara on Unsplash

By Frank Corva

Just when you thought the coast was clear to take a position in crypto, the bottom has fallen out  — yet again.

This time, it happened because crypto exchange FTX may have become insolvent, and its bailout from Binance is no longer on the table.

Sam Bankman-Fried (SBF), the CEO of FTX, who some have likened to J.P. Morgan due to his bailing out smaller crypto platforms earlier this year — might turn out to be more like Madoff than Morgan.

We’ll know better once the dust around FTX’s accounting has settled.

In the meantime, FTX has halted customer withdrawals, which has served as an unpleasant reminder to many that if you leave the private keys for your crypto assets in the custody of a centralized exchange, you don’t technically own said assets.

So, the lesson here is, by all means, choose the crypto exchange that’s right for you and use it to purchase the digital assets you’d like — but then transfer the private keys to those assets to a noncustodial crypto wallet soon after.

There’s more than one benefit to choosing to self-custody your digital assets.

Please note: You’ll know you are using a noncustodial wallet if you’ve written down a 12- to 24-word recovery phrase for the wallet. Noncustodial wallets include software wallets like Exodus Wallet or Atomic Wallet and hardware wallets like Ledger or Trezor devices.

Benefit #1: Reduce your counterparty risk

Bitcoin was designed to facilitate peer-to-peer transactions.

You can use the Bitcoin network to transact without permission, as no counterparty — or intermediary — is necessary in the process.

But most people don’t use bitcoin (BTC) for transactions. Most use it as a way to save.

Even if you use BTC as a store of value, though, you still have to be mindful of counterparty risk.

When you leave the private keys for your BTC in the hands of an exchange, you only hold an IOU for the asset.

The exchange is the counterparty in this case. In other words, if you don’t take the private keys from the hands of the exchange and store them in your own noncustodial wallet, then your IOU for that asset is only as good as the solvency of the exchange that holds the keys to it.

Now that FTX may be insolvent, the exchange’s clients aren’t guaranteed to ever again receive the assets they left in the custody of the exchange.

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Benefit #2: Increasing the value of your digital asset

When you leave the private keys to your digital assets in the custody of an exchange, you might be suppressing the price of the asset.

Until you move the private keys to your digital asset into a noncustodial wallet, you haven’t officially made a transaction on-chain.

And without such a transaction occurring, you haven’t technically reduced supply of the asset on the open market.

The greater the supply of the asset on the open market, the less the price rises, according to the law of supply and demand.

So, if you purchased a digital asset in anticipation of its price rising, you can help to create this effect by moving the private keys for your digital asset off of an exchange and into a noncustodial wallet.

Benefit #3: BTC in a noncustodial wallet can’t be leveraged

Leverage and BTC don’t mix.

Wall Street vet and crypto industry stalwart Caitlin Long has been ringing this bell for quite some time now.

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BTC is a volatile asset. Because of this, it doesn’t work well as collateral in leveraged trades.

When you store the private keys to your BTC in a noncustodial wallet, you can’t take on leveraged trades with the asset.

The opposite is true when you leave the private keys for your BTC in the hands of a platform like FTX that offers leveraged products for crypto assets.

You’re more prone to take a leveraged trade with the asset when you leave the private keys for it in the custody of a crypto derivatives exchange like FTX.

And when you leave the private keys for your BTC in the hands of an offshore entity like FTX — one that operates outside of the purview of U.S. regulation — you are vulnerable to the exchange using the BTC that it custodies for you as leverage in its own transactions or trades, as unethical as that may be.

Choosing to self-custody for the private keys to your BTC can help you to inhibit yourself from using it as leverage and/or having it be used as leverage.

Back to basics

We’re at the point in the crypto bear market where we can see who has been swimming naked, and few of us could have fathomed just how naked some were swimming.

Regardless, here we are. And in the wake of this FTX-induced destruction, there are lessons to learn and keep in mind for the rebuilding process.

One lesson here is that choosing to self-custody your digital assets has numerous benefits.

If Bitcoin is going to fulfill its promise of taking money out of the hands of institutions and putting it into the hands of everyday people, we need to learn how to embrace the personal responsibility that underlies this prospect of financial self-sovereignty.

Part of this process is learning how to use a noncustodial wallet.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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