Not Your Keys, Not Your Crypto

There is nothing more dangerous in life than misunderstanding. One of the worst ways to misunderstand something is to believe what it is called, when its name is not what it is.

Enough voodoo narrative—let me give you an example right now that has cost many a total of billions: Crypto exchange.

A crypto exchange is not an exchange. A crypto exchange is a bank.

Once you understand that you should be very worried. An exchange, for example the Nasdaq, does not hold your stock. If it goes bust you do not lose a single share of AppleAAPL
or any other investment. It just handles your interaction between other financial providers. It is a venue, not a vault.

A crypto exchange is a vault that holds a “liquid asset.” You deposit it and you withdraw it; what goes on between those actions is secondary.

Just like a bank, trading on a crypto exchange is just an accounting entry. You did not sell or buy on the blockchain, the exchange merely kept an accounting record and will settle up ultimately only when you request payment because they are free to do what they like with your deposit once they have received it.

This is how a bank works. A bank will grant you interest, send your actual money off somewhere on a journey to earn it more than it is paying you and your balance is just an accounting record that is satisfied when you want to transact.

Banking has always been a confidence game and always will be and that is just fine but it has its weaknesses.

The key one is people of low ethical constitution can run off with your money and you may never know. Often you are not so lucky and at some point you find out when the bank goes bust. The whole banking system everywhere is unable to satisfy its depositors if they all showed up for a bank run. That has always been the case, but banks have governments standing behind them, so it’s rare for that trust game to implode.

Crypto has no such backstop as we saw with FTX. It also has no regulator making crypto players jump through hoops or a Federal Reserve to bail them out before a meltdown takes on an unstoppable momentum. Rest assured, without these checks, balances and bailout buckets, fiat banks would look just like FTX et al. and in fact they have on a number of occasions in the past. Banking is just like that, because deposits are just that, parked money that an institution can instead of guarding, put to work to make and create money. Apart from some slipups, unintentional or otherwise, banks are quite good at that. Crypto players on the other hand have not covered themselves in glory.

Stock exchanges on the other hand operate in a different world where the traded assets are looked after by custodians whose job it is to protect assets not put them to work. Your broker has been mandated to keep your assets separate from their operations so the temptation to play bank with your deposits is not a legal option.

If you confuse a crypto exchange with a stock exchange you are open to a nasty surprise. Would you hold a life changing amount of money in an offshore bank you’ve never heard of and that isn’t regulated and don’t even have a recognisable HQ or holding company?

I imagine you are saying, ‘That’s a nope.’ Well that is what many crypto exchanges are. That is not to say they are all as huge a farcical shambles as FTX or run by fellows with symptoms of cocaine abuse or evil intent. Nonetheless, most will be banks whether or not they put your deposits to work elsewhere and subject to all the risks of banking and bankers.

Here are some red flags to watch out for:

1. Investments in other crypto ventures. Was it from profits or from deposits?

2. Huge promotional spending. Was it from profits or from deposits?

3. Giant overheads. Was it from profits or from deposits?

4. Is the exchange trying to turn liquid tokens into illiquid tokens or inhouse tokens?

5. Is there promotions paid in inhouse tokens rather the in “real yield” crypto?

6. Is the place run by “shoot from the hip”-sters? I know this is the social media age but….

If we can get to Easter without some other significant default, we might be able to say FTX was “it.” However that is a long shot.

Remember this: “not your keys, not your crypto.”

Squeeze every drop of risk out of your crypto portfolio. Make sure you can tell your spouse, parent or confessor exactly why and where you have what you have. Then you’ve a good chance of passing though the intestinal tract of this crash in one piece. It’s the same for stocks right now, but crypto is, as we know, an accelerated and amplified version.

There will be no defense in the future to say “‘But they said… but I was told that…” Because there is no safety net under the crypto high wire.