The crypto world has been reeling today amid news that FTX, the second-largest and fastest-growing crypto exchange, essentially collapsed overnight amid a takeover by rival Binance.
This is not the first time that a large crypto firm has folded abruptly. Celsius and Voyager provide two similar examples—both went under this past spring. And on their way out, they dipped into customer accounts to try to stay afloat. As the full ramifications of the FTX insolvency and collapse become clear, they raise questions about just how safe it is to keep tokens in exchanges or with brokerages.
The significance of the FTX collapse
For those who don’t follow every twist and turn of the crypto industry, the collapse of FTX is a big deal by any measure.
As the second-largest crypto exchange, FTX and its CEO, Sam Bankman-Fried, who goes by SBF, were rising stars in the crypto world. Just this past August, SBF appeared on the cover of Fortune, and even prior to that he was a very public and well-respected figure, says Josh Fraser, cofounder of Origin Protocol, a company that created Origin Dollar, a yield-bearing stable coin, and Origin Story, an NFT platform.
“This is absolutely massive,” Fraser said during an interview. “SBF has been very visible in the industry—from sponsoring stadiums and appearing on the cover of magazines to being in Washington,D.C., talking to regulators and calling for more regulations of crypto—he’s been really working to make a name for himself and has been a very trusted person. A lot of people respected him and viewed him as a good actor.”
In the end, however, it seems FTX was not all that it appeared and had not been keeping its promises to its customers, says Fraser. This includes promises to not lend out customer deposits and that customer assets were safe with FTX. “Clearly that was not the case. Assets were not safe. So this is absolutely huge and unfortunately a lot of innocent people are getting hurt by this,” Fraser added.
While it remains to be seen just how much damage will be done by FTX’s implosion, there are some lessons crypto investors can learn from this case. Chief among them: Keeping coins in crypto exchanges or brokerages, particularly amid volatility or downturns, is not the safest move.
Should you keep crypto in brokerages and exchanges?
It’s important to make a distinction between investing in crypto generally—which experts say still remains safe when you follow a few key best practices—and keeping your coins in brokerages or exchanges such as FTX.
There is often a lack of transparency with brokerages and exchanges that can be problematic; you’re also allowing someone else to hold your assets, and trusting that they will do so responsibly.
1. Not your keys, not your coins
There’s a well-known expression or golden rule in the crypto industry: “Not your keys, not your coins.” And it essentially boils down to the fact that when you turn your coins over to someone else to hold and keep secure, you’re abdicating control over them.
“When you leave your crypto on an exchange, whether it’s centralized or decentralized, you have given up control. You’re taking their promise that your bitcoins are actually there,” says Peter Eberle, president and chief information officer for Castle Funds, an investment firm that has been managing funds invested in Bitcoin and other digital currencies since 2017.
This is concerning because as the FTX case makes clear, there continues to be a lack of transparency among exchanges, which leaves opportunity for mismanagement. “On the stock market, you leave your stocks with a custodian, and it’s safe because they are more regulated, and they are audited. These exchanges work in this dark hole where you can’t see into it,” continues Eberle. “Just today there were several announcements about how they’re going to have to provide more transparency.”
Fraser offers similar advice, pointing out that keeping coins in an exchange is almost always a bad idea, no matter what’s going on with the broader market.
“FDX is not the first exchange to fail,” says Fraser. “The whole point of crypto is that you don’t have to trust other people anymore. Crypto was designed to save us from this exact problem—these opaque systems where you don’t know what is being done with your money.”
2. Custody your own assets
Related to the points just made, rather than keeping coins on exchanges or with brokerages, it’s far safer to custody your own assets. This means keeping them in a physical hardware wallet similar to a USB drive or alternatively, in an online software wallet. In both cases, you are the one who maintains control over the coins, and access to them is protected through private key cryptography.
“Private key cryptography is the same technology that allows us to visit a website and enter our credit card information online safely,” explains Fraser. “It’s the same technology as that. These keys are what secure your assets, your digital assets.”
When you opt for a hardware wallet, such as a Ledger device, only when you are moving crypto currency around do you put your coins on the internet. The rest of the time, they can be kept in your hardware wallet in a safe, or safety deposit box, says Eberle.
3. Invest in professionally managed accounts
For high-net-worth crypto investors, yet another measure of safety may be achieved by investing through professionally managed accounts. This is what Eberle’s own firm, Castle Funds, does. He specializes in working with accredited high-net-worth investors, and when handling crypto investments the firm uses offline custody tools for client’s assets.
“The vast majority of the time, our tokens are in custody offline, so it does away with the risk, such as an exchange risk,” says Eberle. “The only reason to leave tokens on an exchange is laziness, or lack of understanding in terms of how to put crypto in your wallet.”
If you are new to crypto investing, it’s important to have someone experienced guide you through the process of putting crypto in your own wallet.
Bottom line, says Fraser, is that crypto investing as a whole remains safe. But exchanges and brokerages continue to lack transparency.
“Don’t confuse what’s happening on these exchanges with crypto itself,” says Fraser. “Absolutely do not leave money on exchanges. Pull it off. But that’s true all the time. For people who are too scared to handle self-custody, consider regulated platforms like Coinbase, which is transparent and publishes its reserves. Using platforms like Coinbase, people can see there’s no funny business and that their money is safe.”
EDITORIAL DISCLOSURE: The advice, opinions, or rankings contained in this article are solely those of the Fortune Recommends™ editorial team. This content has not been reviewed or endorsed by any of our affiliate partners or other third parties.