The FTX drama and the importance of self custody

The Exchange FTX ran into financial problems this week, which quickly worsened as the news reached the market. Withdrawals of client funds were halted. Competitor Binance was supposed to make an acquisition, but later pulled out. FTX eventually filed for bankruptcy. For FTX customers, there is a lot of uncertainty about whether and when they will see their digital assets again. The price fell to the lowest level of the year.

The past week has been a turbulent one for the Bitcoin market. Much is still speculation, but according to rumors earlier this week, a large part of the balance sheet of Alameda Research, a second company of the CEO of FTX, consists of FTT tokens created by FTX.

That led to uncertainty in the market about the liquidity of Alameida Research and FTX. There was also heavy speculation about the underlying value of the FTT token. In the uncertainty, investors sold their FTT tokens en masse and some even went short. The price of the token collapsed and as FTX’s balance sheet consisted largely of FTT tokens, FTX got deeper and deeper into trouble.

FTX customers felt the storm and massively withdrew their bitcoins from the exchange. A kind of bank run ensued. Customer withdrawals were soon halted, raising suspicions that FTX did not have enough bitcoins to pay all customers.

Within days, FTX’s balance seems to have completely evaporated. According to information from Coinglass, the amount of bitcoin on FTX’s balance had dropped to less than 1 BTC. The price of the FTT tokens has now completely collapsed

FTX, meanwhile, would have started looking for a capital injection of several billions. The market reacted uncertainly to the events, resulting in a first price drop in the bitcoin price.

Acquisition

Competitor Binance, an even larger exchange, played a remarkable role in the developments. Binance was one of the largest holders of the FTT token and when the rumors first spread, the exchange publicly announced that it was selling the FTT tokens for that reason. The announcement, coupled with the sale, caused much of the market’s initial concerns.

It sparked speculation on social media about Binance’s motives. Was Binance trying to break a competitor? Shortly after, however, both parties announced that FTX would be acquired by Binance.

For a moment the story seemed to end, but nothing could be further from the truth. Hours later, Binance backed out, stating that they don’t have the resources nor the ability to fix FTX’s problems. The bitcoin market crashed further, to the lowest level of the year

Bankruptcy

On Friday, FTX announced that it has filed for bankruptcy and CEO Sam Bankman-Fried has resigned. For FTX customers it is a bitter pill to swallow. It is not clear if or when they will get their digital assets back.

A lengthy process of tug-of-war between the various creditors will probably follow. There is a chance that customers will be allowed to join the back of the queue.

Moreover, it can take a long time. In the case of the exchange Mt.Gox, which went bankrupt in 2014 due to a hack, duped customers have been waiting for settlement for almost a decade.

Not your keys, not your coins

Exchange bankruptcy is one of the bigger risks of investing or trading bitcoin. Although the Bitcoin network is decentralized, an exchange is a company that acts as a centralized intermediary.

When you deposit bitcoins on an account of an exchange, you actually transfer them to a service provider and you no longer have them under your own management. That negates most of Bitcoin’s benefits and reintroduces the risks of centralization.

It is therefore at odds with the way Bitcoin is intended to be used: in a decentralized way, where users manage their bitcoins from their own wallet ( self custody ). Only then will users have full control, no restrictions and no dependencies. One of Bitcoin’s most repeated mantras is not for nothing: ‘Not your keys, not your coins’ .

Sometimes people are prevented from taking bitcoins into their own management, because of stories from the past about lost bitcoins due to hacks, viruses or simply because they lost the seed phrase. However, nowadays there are all kinds of solutions, such as hardware wallets, that make self custody easy and offer a very high level of security. Recent reports of bitcoins being lost from personal wallets are therefore relatively rare.

Exchanges and other service providers, on the other hand, remain risky. Due to the huge amounts of bitcoins they manage, they are a constant target of hackers. Moreover, there is a great temptation to reinvest client funds, sometimes through questionable loan constructions, in order to increase turnover or to be able to offer higher returns. The latter happened recently at the now bankrupt Celcius.??

According to Bloomberg, the US authorities have now launched an investigation to determine whether this was also the case at FTX

Exchanges

Exchanges are useful for trading, but preferably use them temporarily and not for long-term storage. Do proper research, compare different service providers with each other and preferably choose a reliable (Dutch) party.

We naturally recommend BL3P, the European Bitcoin-only trading platform from Bitonic, the oldest Bitcoin company in the Netherlands and initiator of bitcoin.nl.

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