Are Cryptocurrency Exchanges Safe?
You may be familiar with cryptocurrency exchanges. There are many out there. Household names include Kraken, Bittrex, Binance, and Poloniex.
I want to provide you with some information that may save you some money and heartache over the long term.
There are three things you need to know:
Cryptocurrency exchanges allow their customers to trade cryptocurrency for other crypto coins on their platforms. They usually leverage an automated platform to allow for high volume trading, including margin and high-velocity, leveraged trading action.
Most crypto exchanges are considered custodial exchanges. They hold all of their user's coins on their own wallets and servers. They also hold the funds in cold storage, or a wallet that is not always active or "hot."
These exchanges are extremely vulnerable to hackers and malicious attackers. The fact they store all of their user's funds on a single server or system means they are a "honey pot" that attracts thieves. In this sense, all their user's funds are potentially at risk. Custodial exchanges are naturally a high risk operation.
From Mt.Gox to Modern Exchanges
With that said, I am not suggesting all the exchanges mentioned above are bad or evil. Most modern exchanges have matured over the years. They have implemented new policies, insurances, and practices that dissuade bad actors from harming their systems or stealing their customer's funds.
When crypto exchanges first emerged --- take Mt. Gox for example --- they implemented very few policies or procedures to protect their customers. Those exchanges were often hacked, and sometimes they lost millions of dollars.
Starting in June 2011,479 Mt. Gox user accounts were compromised; and at the time, 8.5 million dollars worth of crypto vanished.In today's valuations, that amount would be much, much larger.
Suffice it to say, even with all of today's protections and standards, crypto exchanges still aren't fully safe so long as they store user's funds in their own wallets. So long as they keep the private keys, the user is unsafe.
Ironically, crypto was created to be kept, held, and traded by the end user. Satoshi Nakamoto, the creator of bitcoin, wanted to disintermediate third parties --- or in other words, make them obsolete.
The Future of the Safe Crypto Exchange
Times are changing now. Some exchanges --- such as Cryptospace's solution --- allows users hold their own funds, which is in line with Satoshi's vision. This is a huge breakthrough in terms of exchange safety. The Achilles tendon of crypto exchanges has been their practice of acting as a custodian of user funds.
As a final thought, modern cryptocurency exchanges are generally safe...but if they are a "custodial exchange," they will still be at risk.
If a user holds their own funds, they are much less likely to be hacked, because the reward for a hacker is much smaller. If the prize is larger --- like an exchange that holds billions of dollars --- the hacker is more likely to expend resources on the plumper, juicier prey.
However, for a user to be totally safe, they should always try to hold their private keys. Anytime they hand their crypto over to an exchange, they put their faith and trust into those entities. In reality, everyone should only put their faith and trust into the blockchain, encryption and mathematics.