Reasons Centralized Crypto Exchanges Are Terrible Custodians Of Crypto Assets

As of right now, there are more than 300 centralized bitcoin exchanges worldwide. The CEO of Celsius Network and one of the VoIP (Voice Over Internet Protocol) pioneers, Alex Mashinsky, told that nearly all of these centralized exchanges also serve as custodians.

While some of the largest exchanges in the world serve as both exchanges and custody holders, cryptocurrency exchanges also let users swap cryptocurrencies for other assets.

What does this actually mean? Co-founder of Evercoin Exchange Miko Matsumura claimed in a blog post that a custodial exchange retains the private keys to a user’s digital assets. In a non-custodial exchange, user keys are not kept. Whoever holds the private key has complete control over the asset in the world of cryptographic assets. You have absolutely no technical standing or remedy if you don’t have the key.

Although it’s obvious that custodial solutions products provided by third parties that offer storage and security services for cryptocurrencies have become one of the most recent innovations to surface within the cryptocurrency ecosystem, a number of issues frequently arise when significant crypto exchanges also act as users’ custodians.

When digital assets are kept on a centralized exchange, users no longer possess their cryptocurrency, claims Matsumura. Instead, they have the authority to sell or remove it, which creates a number of problems.

“The issue is that once cryptocurrency exchanges assume possession, everything they do is hidden from public view.” Huobi has employed EOS tokens to pay users to vote for their own block producers. This was visible on the blockchain. Who knows what else is going on behind closed doors?” Matsumura continued.

Centralized Exchanges Remain Highly Unregulated

The absence of regulations is another issue centralized exchanges that serve as custody holders must deal with.

“A custodial exchange, like a bank, is enabled by their onerous user agreement to use user assets for whatever purpose they deem fit.” They can lend out user cash like a bank, but unlike a bank, they are mostly unregulated and do not pay interest.” Matsumura said.

Furthermore, many centralized crypto exchanges do not offer insurance for held digital assets, unlike banks governed by The FDIC (Federal Deposit Insurance Corporation, an independent agency of the United States government that safeguards against the loss of your insured deposits if an FDIC-insured bank or savings association fails). This implies that users won’t be able to recover their funds if an exchange is compromised.

It is noteworthy to note that Gemini, a cryptocurrency exchange, got insurance coverage for the digital assets it maintains in custody last month. According to a press statement from The Gemini Trust Company, which Cameron and Tyler Winklevoss Co-Founder, its insurance would be provided by a coalition of insurers formed by the large professional services company Aon. This insurance is in addition to the dollar deposits held by the exchange that are protected by the Federal Deposit Insurance Corporation.

Nevertheless, Mashinsky asserts that “a lot of what the crypto community is seeing in traditional crypto markets is basically a resurgence of poor ideas from the 1800s, all of which are being utilized to take advantage of the fact that regulations don’t cover loopholes.”

Keeping Your Cryptocurrencies Protected In The Hands Of Others

While a large portion of the cryptocurrency community agrees that centralized exchanges are bad custody custodians, there are other approaches that can be used.

For instance, Matsumura thinks that separating exchange services from custodial services is one approach. A nice illustration of this paradigm is BitGo.

This may be done at the regulatory level, according to Matsumura, or users may simply grow more knowledgeable about the misuse of their cash and move on to better alternatives on their own.

Additionally, a certified custodial solution like BitGo paired with a user-controlled key in multi-sig could also be a solid long-term solution, according to Paul Puey, CEO and Co-Founder of Edge Wallet.

Cryptocurrencies are disruptive because they eliminate the middlemen in fund ownership and transfer. Using custodians removes 100% of the value proposition of cryptocurrency, including accessibility, usability, and even the guarantee of a set and assured inflation rate.

If our world only used crypto through custodians, we would unavoidably see leveraged accounts, fractional reserve, and the effective currency inflation that we were attempting to avoid. The future of custodial solutions will be partial custodial solutions, in which corporations retain only one of numerous keys required to spend bitcoin.

This will prevent asset leveraging, necessitate radically alternative business models for custodians, and help deliver the benefits of security against loss and theft, according to Puey.”

Finally, moving to a decentralized exchange architecture may be a safer option for keeping crypto assets.

Centralized cryptocurrency exchanges function similarly to traditional global stock exchanges. These are old-world answers applied to new-world problems. To make a trade, we don’t need old-school centralized solutions. The risk of allowing these centralized exchanges to hold your money is not just great, but also unwarranted.

One of the reasons exchanges make poor custodians is because it is unclear whether they are fiduciaries to those who park their money. Custody, in my opinion, should be a separate duty. The majority of exchanges are not even insured. So if the exchange is hacked, you lose your cryptocurrency. To be honest, the trading community should be aware that they can conduct transactions using non-custodial decentralized exchanges.

There is no need to rely on centralized exchanges to conduct transactions. According to Sam Tabar, AirSwap Strategist, “after the world is more familiar with this, there will be what I call ‘the great liquidity movement’ away from controlled exchanges.”

Disclaimer: The opinion expressed here is not investment advice – it is provided for informational purposes only. It does not necessarily reflect the opinion of EGG Finance. Every investment and all trading involves risk, so you should always perform your own research prior to making decisions. We do not recommend investing money you cannot afford to lose.