Bitcoin Exchanges and Security
Bitcoin was created in large part to return financial sovereignty to individuals who, armed with bitcoin and a private key, hold sole custody over their financial wealth like some sort of libertarian superhero! Unfortunately, bitcoin has not yet replaced good old government-issued cash (maybe next year?), and so all but the most die hard bitcoiners must interact with centralized payment networks, like banks, credit cards, and bitcoin exchanges.
Every time your bitcoin is in an exchange you are trusting that exchange with your financial sovereignty. They become the custodians of your wealth. You transfer your bitcoin to an exchange address and trust the exchange to hold your bitcoin, along with every other customers’ bitcoin, in a safe and accessible fashion. You are no longer in control of your wealth, the exchange is.
And it is with great regret that we inform you: by and large, bitcoin exchanges perform poorly in their role of custodian of your personal wealth.
Why are Bitcoin Exchanges Generally Such Poor Custodians?
An important note: we are not saying your coins are not generally safe in an exchange. By and large, your coins are safer now with an exchange than they have ever been. Gone are the days (although the fat lady has not yet sung, of course) of frequent hacking attacks. Exchanges with weak security have not survived, while the successful exchanges have adapted more and more advanced security protocols. One would hazard a guess that the existing exchanges are also in much better shape financially, which would seem to allow them to remain solvent in all but the most dire of hacking attacks.
That being said.
If we were feeling charitable, we would argue that the exponential growth of the cryptocurrency market caught exchanges by surprise. Exchanges were simply unequipped to deal with literally millions of new customers that poured and continue to pour into the marketplace, and are scrambling to meet new exacting requirements. If we were feeling a bit more cynical, we would argue that seemingly limitless new customers combined with soft competition allow some exchanges (we’re looking at you, Coinbase) to take their customers, and even their product, for granted.
And how does this neglect and/or unpreparedness manifest? During periods of high demand your bitcoin might take an extremely long time to hit the exchange wallet despite the transaction having been confirmed on the blockchain. It might also take an extremely long time for the exchange to transfer your bitcoin when you withdraw. You might sell bitcoin and then wait a month until the cash hits your bank account. Perhaps you notice the market heating up and want to place a trade, only to find that your exchange is inactive due to “congestion”. And then, as a cherry on top, you can expect your support messages to receive an auto response which will usually offer some sort of apology for the inability to get back to you within a reasonable time period. We are all still waiting.
Poor support is a serious issue for the exchanges, epitomized by Coinbase – or perhaps Gemini? Certain regulatory procedures might force a “freeze” on your account for whatever reason. Perhaps you were traveling and accessed the account from a disallowed jurisdiction. Frozen. Perhaps an exchange questions the source of a particular transfer you made. Frozen. Perhaps the exchange decides you must resubmit KYC documents. Frozen. Now you get to play the exhilarating game: “Adventures in trying to speak with a breathing support agent within a reasonable amount of time to unfreeze your account”. Say what you will about the problems with the modern banking system, they at least know how to take care of paying customers.
Additionally, the exchange represents a point at which your real world identity intersects with your crypto anonymity. Have you been naughty and neglected to report crypto earnings? Who really does not think that governments are looking with interest at large account holders at cooperating exchanges?
Scared Yet?
Well, that is sort of our point in writing this article. New bitcoin owners too often leave their holdings in exchanges for long periods of time, trusting the exchanges to provide security and accessibility. This should not be done. If you are a trader, leave only the amount of bitcoin you trade with on an exchange; long term holders, exchanges should be used only when engaging directly in buying and selling. After you find the appropriate bitcoin exchange for your circumstances, get a proper, secure wallet to store the bitcoin you are holding for the long term. And take the time to learn how to properly secure your wealth.