Nowadays, cryptocurrency exchanges have become an important platform for investors to conduct transactions and manage assets. However, as a centralized institution, exchanges face a series of risks and challenges. Therefore, it is very important for retail investors to understand what problems may arise in exchanges and how to deal with them before transferring money to exchanges.
What might happen to the exchange?
Although the theft and hacking of exchanges are partly due to internal security control issues, it is the hackers who actually do the evil. If the scale is not large or the hackers are willing to return the assets, the impact on users may not be great; but if the scale exceeds the compensation range of the exchange, the user's assets will suffer losses. (Justin Sun's platform Poloniex was stolen more than $100 million, and hackers bought TRX to cause the price to soar)
Since the regulatory policies related to cryptocurrencies have not yet been perfected, exchanges may violate the law during their operations, leading to prosecution or fines. (Binance CEO Zhao Changpeng pleaded guilty and resigned, and the company paid a huge fine of US$4.3 billion)
Misappropriation of customer assets is one of the worst things an exchange should do. An exchange is not a bank and has a different operating model from a bank. It should not misappropriate customer assets for other operations and should reserve customer assets in full to ensure safety. (FTX made a big move to lend $10 billion of customer funds to Alameda)
Assuming that the exchange's market strategy is wrong, it slowly loses market share, cannot make profits and gradually goes bankrupt, unless the exchange runs away before the closure, it will not affect the safety of user assets, and there is no need to run away quickly. If it is a formal exchange, even if it decides to stop operating, it will notify users to withdraw their assets as soon as possible and will not occupy assets. Recently, the American Bittrex exchange decided to stop operating and notified users to withdraw their assets quickly.
Should you escape if something happens at the exchange?
For users, whether an exchange is well managed, how high its market share is, or whether there are any disputes within the organization may not be the most important part for users. The most important part is asset security: "Can I withdraw all the money I have in the exchange?"
If the incident has nothing to do with the security of your assets, such as an employee quarrel or gossip about the founder, then there is no need for FUD (unnecessary panic). However, if it is an incident that will affect your assets, such as theft, trading losses, or major information security issues, sometimes even if it does not directly affect you at the moment, as the incident develops, it may trigger a chain reaction. If you have any doubts, run first. As everyone often says: It is better to be safe than sorry. If you have any doubts, run first and seek safety first.
How to know the actual asset status of the exchange?
After the FTX incident, in order to restore user confidence, many exchanges began to show their strength and publicly disclose Proof of Assets (PoA) to allow the outside world to examine the actual asset status of the exchange. However, proof of assets alone cannot completely solve the problem, because users are more concerned about not only how much assets the exchange has, but whether the exchange has enough reserves to fully pay the user's assets.
For example, Exchange A has 50 billion in assets, which seems to be a large amount. But if the total value of users' assets is 100 billion, then this means that the exchange does not have full reserves, but has misappropriated half of the assets, which is a very high risk.
Therefore, if you want to prove whether the exchange has fully reserved user assets, the focus should be on Proof of Reserves (PoR). The assets deposited by users in the exchange are a liability for the exchange. These funds actually belong to the users and are a debt. The concept of Proof of Reserves is to prove that the exchange has sufficient reserves for each liability.
Although proof of reserves may be relatively complex, many large exchanges have already provided relevant pages and verification tutorials. In contrast, proof of assets can provide faster and more immediate information. If there are significant changes in the assets of an exchange, you can quickly understand the situation from the on-chain data. However, this still has certain limitations. If an exchange is hacked or stolen, you can see the outflow of funds from the proof of assets. But if the exchange misappropriates assets, such as using users' coins for activities such as DeFi, this cannot be known from the proof of assets.
Summarize
There have been many exchange closures in the past, and exchange transparency has always been one of the major risks in the cryptocurrency industry. Although exchanges provide proof of assets and proof of reserves, users still need to carefully assess risks and take appropriate measures to protect the safety of their assets. This includes choosing reputable and highly secure exchanges, diversifying asset risks, regularly transferring assets to your own wallet, and staying vigilant and paying attention to announcements and updates from exchanges.
