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October 09, 2023

The Crypto Exchange Trust Dilemma: Safety, Security, and Transparency

Single Broker Academy

Cryptocurrencies have piqued the interest of both individuals and institutions by promising a decentralized financial system. Central to this system are crypto exchanges, but as the industry grows and activity intensifies, we can hear concerns about the safety, security, and transparency of these getting louder. One specific incident showed the world what happens when risks go unchecked, so let’s talk about it.

The Incident: FTX and the Specter of Mismanagement

In August 2023, Ciaran Lyons penned an article that stirred up lots of discussions throughout the cryptocurrency community. Lyons discussed the case of FTX and its former CEO, Sam Bankman-Fried. The story itself is infamous, but the article revealed alarming details about how FTX had mishandled customer funds and treated them as if they were the CEO’s personal assets.

Bankman-Fried, according to the report, used customer assets for the benefit of his sister company, the hedge fund Alameda Research. This mismanagement resulted in a dire situation where there were no assets left for clients to withdraw. 

But the FTX incident wasn’t special on its own. The bigger issue was the current state of the crypto industry and its lack of regulation and oversight, which can leave investors vulnerable to shady exchanges.

The Trust Dilemma in Crypto Exchanges

The crypto industry was born out of a desire to build financial institutions free from traditional banking constraints. However, this very freedom is the reason why people are concerned about how exchanges handle customer funds.

The distinction between exchanges and brokers is crucial here to understand what happens in worst-case scenarios. Exchanges keep customer assets directly in their own storage (typically), and this choice minimizes the risk of using those assets for additional profit. In contrast, brokers may expose customers to counterparty risks.

Counterparty risk is a situation where one party involved in a contract might fail to fulfill their end of the deal. When brokers hold customer funds or assets on another exchange, the risk intensifies. If that secondary exchange faces financial troubles or collapses, customer assets will be on the line. A prime example of this is the Australian-based crypto broker Digital Surge. The broker transferred a substantial sum of assets to another exchange, FTX, shortly before FTX’s collapse in November 2022. While Digital Surge managed to secure a bailout plan, other crypto lenders like BlockFi and exchanges like Genesis ended up filing for bankruptcy.

So, when exchanges fail and brokers expose you to counterparty risks, can you trust anyone?

The Critical Role of Leadership

While exchanges and brokers can employ various security measures to earn your trust, their effectiveness hinges on the integrity of their leadership. If a dubious CEO gains control of an exchange, even the most robust security measures can be rendered useless. In such cases, customer assets are at the mercy of corrupt management.

To mitigate this risk, platforms are implementing advanced security measures and multi-party technology computation (MPC technology), similar to multisig wallets, to safeguard customer assets. MPC technology ensures that multiple parties must come together to authorize transactions. This ultimately reduces the risk of unauthorized asset transfers.

Moreover, transparency is vital in building trust within the crypto industry. Exchanges and brokers should provide clear policies regarding the use of customer assets and undergo regulatory inspections to maintain customer confidence.

A Few Words on Celebrity Endorsements in Crypto

In Lyons’ article, Simon Dixon, CEO & co-founder of BnkToTheFuture, urges readers not to rush to an exchange just because their favorite celebrity promotes it. The cautionary tale here is the $1-billion lawsuit against influencers who endorsed FTX without revealing their compensation. Even prominent figures like Kim Kardashian settled a lawsuit for $1.26 million for promoting an unregistered security on Instagram.

Dixon firmly believes that mixing affiliate marketing with financial products is a bad idea, and he acknowledges that authentic recommendations from friends and family still play a role in building trust within the exchange industry.

Single Broker: A Solution

Against the backdrop of worries about exchange and broker safety, Single Broker remains a trusted choice for institutional investors. Based in Switzerland, it is a regulated broker platform for crypto trading that places a strong emphasis on safety, security, and transparency.

The platform’s commitment to security includes custodian storage, a closed wallet system, and strict adherence to regulatory compliance, including Know Your Customer (KYC) and Anti-Money Laundering (AML) policies. Single Broker safeguards customer assets by securely storing them with custodian services and using a closed wallet system. Additionally, the company offers $30 million in insurance for customer peace of mind.

This approach ensures that customer assets are handled responsibly. And, with leadership that prioritizes integrity and trustworthiness, Single Broker stands strong in the evolving landscape of digital asset trading.