Bitcoin Custodians Facing Liquidity Crisis As Price Falls
This is an opinion editorial by Josef Tětek, the Trezor brand ambassador for SatoshiLabs.
Bear markets can be scary, with bitcoin dropping to unthinkable levels, leverage positions being liquidated and custodians failing on their promises. When FUD replaces FOMO, fortunes are easily lost. Keeping your head cool and your bitcoin in cold storage is imperative to survive in this unpredictable environment.
“Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve.”
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Celsius Is Not The Only One
“You never know who’s swimming naked until the tide goes out.”
It’s quite frustrating to witness people lose funds in essentially the same way as Mt. Gox users did in 2013. Exchanges and custodians fall for the same temptation that bankers did for centuries: leveraging user deposits to squeeze out more than what they would earn from the service fees. It’s quite paradoxical that bitcoin (and most altcoins) offer a straightforward way to offer a proof of self-audit via a cryptographic signature of addresses with sufficient balances, yet no exchange, save for a few exceptions, performs such proofs of reserves.
It may very well be that all the exchanges are perfectly solvent, but the issue is we have to trust them on that. As the “Oracle of Omaha” famously quipped, we’ll never know who’s naked until the tide goes out. So, when Binance, one of the world’s largest exchanges, halts bitcoin withdrawals, we never know if it’s really only a temporary technical hiccup, or a much more sinister liquidity issue.
While we can collectively call for exchanges to offer proofs of reserves, the only real mitigation of the counterparty risk that exchanges pose is to take possession of our coins. The only way to be really certain that nothing shady is happening with our coins is to hold the private keys ourselves. Bitcoin is unique in the way it makes administering one’s own wealth easy, and ever since the first hardware wallet in the form of Trezor was introduced in 2014, there are no excuses not to hold your own keys.
Buying bitcoin in a peer-to-peer fashion is preferable from the privacy standpoint, so if you can find a reliable seller — usually through Bitcoin meetups — making regular purchases through the same channel and stacking straight into a hardware wallet is the way to go. ATMs also can allow for purchasing amounts of bitcoin up to $1,000 with good privacy. But, if for any reason you prefer buying through exchanges, there is no reason to leave your coins off of your own wallet.
And if you’re keeping your coins on an exchange right now, it’s a good idea to consider withdrawing into your own wallet. Even if you earn a yield on your coins, the long-term risks of losing 100% of your coins simply isn’t worth it.
Hardware Wallet Manufacturers Do Not And Cannot Gamble With Your Wealth
Surprisingly, a lot of people misunderstand the nature of hardware wallet devices and the business models behind them. Some people believe that hardware wallet manufacturers are actually in possession of users’ coins and can recover the coins in case the user loses their recovery seed or passphrase — this couldn’t be further from the truth! It’s the wallet users that are always in the sole and exclusive possession of their coins. The manufacturer’s business is to sell devices; not to lend out or otherwise leverage the coins of their users!
Contrary to exchanges and other custodians, there is no counterparty risk with using a hardware wallet. If Trezor or any of the other manufacturers went bankrupt tomorrow, users would be unaffected, because they are the sole owners of their coins. Compare this fact with the disclaimers of the major bitcoin exchanges, which can state that, in the case of bankruptcy, users’ coins are basically confiscated.
Nightmare For Some, Lifetime Opportunity For Others
The discovery of the fractional reserve practices being undertaken by some of the foremost custodians in the space might be an unpleasant surprise for many newcomers, who were seduced by the vision of earning yield on their otherwise “unproductive” assets. The further discovery of there being no bailouts might turn into a nightmare. Yet that is the nature of Bitcoin: in a stark contrast to the fiat system, Bitcoin rewards the prudent and punishes the frivolous. And through that mechanism, Bitcoin helps build a more responsible world.
