While many crypto exchanges have failed in the past – by one estimate, as many as 300 in the past 5 years – the downfall of FTX is perhaps the most signifiant due to the level of fraud. So it’s not surprising that many individuals in the TradFi space are suddenly losing faith in crypto.
However, financial advisors need to remind their clients that the failure and losses associate with FTX are due to incompetence and mismanagement of funds, not problems with the software or blockchains themselves – and that their client have options to ensure more safety.
Ask an Advisor
Self-Custody of Crypto Offers Protection Amid FTX Exchange Fallout
(Getty Images)
As the fallout from FTX continues, advisors need to understand best practices for themselves and their clients who continue to invest in cryptocurrencies.
The safest way for anyone to hold cryptocurrency is in a wallet that they control. This can be done with a hardware wallet, such as a Ledger, a paper wallet or in their own software wallet. This is called “self-custody” of assets.
As long as the user does not share the private keys with anyone, no one can steal or misuse the assets without accessing the private keys. It is important to note that the cryptographic foundation that cryptocurrencies use is nearly impossible to hack, creating tremendous security for assets held in a private wallet.
👉 Advisors should consider educating their clients on this method. And if done correctly, it will prevent client funds from being stolen or misused by a third party.
Regulated custodians and exchanges
Not all crypto exchanges are held to the same standard. Many exchanges do hold themselves to the highest standard of protecting client deposits.
Certain exchanges like Coinbase and Gemini are governed by strict regulations and are not allowed to mix client assets without user permission.
Some exchanges publish audited financials and prove that they hold client assets 1:1. They often publish reports showing “proof of reserves,” which essentially prove their solvency.
The catch: While this is one measure of security better than a lot of offshore exchanges, the exchange is still holding private keys to control and own the crypto. When a user elects to hold deposits with a third party, they are essentially trusting the third party to properly secure the private keys to their coins.
CeFi is not DeFi
While we’ve seen these CeFi companies fail, it is important to note that many of the large DeFi protocols are still fully operational and are continuing to work as designed.
Although interacting with a DeFi protocol is more involved than using a CeFi platform, DeFi still offers investors the ability to generate yield on their crypto positions without trusting a third party to properly manage asset security.
The bottom line: It is important for all investors to understand the risk they take when they outsource custody and it is worth learning how to self-custody assets and interact directly with DeFi protocols in order to protect their crypto investments.
There’d be no bitcoin without bitcoin mining. Invest in GDIO.
Grayscale Digital Infrastructure Opportunity (GDIO) combines Grayscale’s proven track record in investment management with Foundry’s bitcoin mining expertise as the operator of the world’s largest bitcoin mining pool. GDIO is a new offering for accredited investors that aims to invest in bitcoin mining equipment, mine and sell bitcoin daily, and distribute a portion of its operating income to its investors quarterly.
Diversify your crypto investments with GDIO. Visit grayscale.com/gdio to learn more and for important disclosures.
Investing involves risks and the possible loss of principal.
Decrypting Crypto
Centralized vs. Decentralized Exchanges: What’s the Difference?
(RetroCollage/Giphy)
Most commonly, the first point of entry to trading cryptocurrency is a centralized exchange (CEX). You have probably heard of a few: Binance, Kraken, Coinbase, FTX and so on.
However, the FTX fallout has led a lot of crypto investors to look for alternatives to centralized exchanges. The obvious alternative are a newer type of exchange that is decentralized such as Uniswap and Pancakeswap.
DEXs aim to offer lower transaction fees, let users directly hold their own assets and avoid some regulatory burdens. However, they face the cost of compensating their liquidity providers for a special kind of risk called “impermanent loss.”
CEXs use a business model similar to traditional institutions like the New York Stock Exchange, which is a structure traditional investors understand and may feel more comfortable with. But it also means the central company running the exchange has a lot of power and responsibility for the financial stability and health of the exchange.
If the recent drama around FTX has you considering moving to a DEX, here’s what you need to know.
How do DEXs work?
DEXs aim to complete transactions more quickly and cheaply than their centralized counterparts. They do this by cutting out the intermediary entities that take a cut of transaction fees on CEXs.
DEXs use “automated market maker” protocols to determine the prices of assets without a centralized body orchestrating trades.
Impermanent loss: A big problem for DEXs
Liquidity providers are entitled to withdraw the portion of the value of the pool they contributed, not the exact number of tokens they put in. It could not promise all providers their exact tokens, because the ratio of different tokens held in the pool changes as trades occur. But as the ratio adjusts to reflect current wider market prices, the pool is going to progressively contain more of whatever token is losing value, and vice versa.
This means that a liquidity provider will tend to end up withdrawing more of the token that lost value and less of the one that gained value, compared with their starting assets. Therefore, they will end up poorer than if they had just held onto their assets privately.
The takeaway: When it comes to deciding which type of exchange to use, it boils down to two things: If you are you primarily interested in ease of use and are uncomfortable with being in total control of your own wallet then a CEX is probably the best option for you. If lower fees and more control over your own funds are most important to you, then a DEX is the way to go.
Consensus is a place for the crypto and Web3 communities to come together, take stock of everything that is happening, talk through difficult challenges and figure out what is needed to make this industry stronger. We want you to be a part of that conversation. Use code CFA15 for 15% off.Register now.
The unit, known as Genesis Global Capital, serves an institutional client base and had $2.8 billion in total active loans as of the end of the third quarter of 2022.
FTX collapsed. These were the players closest to the implosion.
Disclaimer: The information contained in this newsletter, and any information linked through the items contained herein, is not intended to provide sufficient information to form the basis for an investment decision. You should seek additional information regarding the merits and risks of investing in any cryptocurrency or digital assets.
Would you like to receive some of CoinDesk’s other newsletters?
