Sam Bankman-Fried, the founder of the bankrupt FTX crypto exchange, is under investigation and could face years in prison if it’s confirmed that he fraudulently misappropriated users’ funds. Digital asset holders have been warned to explore other options to help safeguard their investments.
FTX imploded over the course of a few days in November after SBF and his accomplices were caught reinvesting users’ funds in broad daylight to the tune of at least $1 billion of misplaced client funds.
Competing crypto exchanges are flaunting their proof of reserves to confirm the existence of users’ funds, but that may not be enough. Digital asset holders are demanding that the exchanges show their liabilities to safeguard the reserves.
“Guys, if you still have Bitcoin on exchanges at this point I don’t know what to tell you. Withdraw,” tweeted Dylan LeClair to his 278,300 followers. LeClair is a senior analyst at digital asset fund UTXO Management and co-founder of 21st Paradigm.
The price of Bitcoin fell to $15,757 on Nov. 11, two days after FTX declared bankruptcy. Bitcoin was trading at $17,048.80 as of this writing.
Standard Chartered predicts Bitcoin could plunge another 70 percent to $5,000 in 2023 if there are more crypto bankruptcies “and a collapse in investor confidence in digital assets,” Global Head of Research Eric Robertsen wrote in a note on Sunday.
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Investors who decide to keep their funds in wallets provided and owned by crypto exchanges often learn the lesson the hard way — “not your keys, not your coins,” Arijit Sarkar wrote for Coin Telegraph. Crypto stored in exchange-provided wallets is ultimately in the possession of the wallet owner, and in the case of FTX, was misused by SBF and associates.
“Evading this risk is as simple as moving the funds out of the exchange to a wallet with no shared private keys,” Sarkar wrote. “Private keys are secure encryptions that allow access to the funds stored in crypto wallets, which can be recovered using a backup phrase in case of misplacement.”
In addition to the FTX crash, other 2022 crypto crashes include 3AC, Terraform Labs, Celsius, Voyager and FTX.
Popular crypto exchanges such as Bitfinex, Binance, OKX, Bybit, Huobi and Gate.io have provided wallet information that allows investors to self-audit the existence of their funds to show proof of reserves.
But this glimpse into an exchange’s reserves fails to provide a full picture of its finances because information related to liabilities is often not made public. On Nov. 26, Kraken CEO Jesse Powell called out Binance’s proof of reserve as “either ignorance or intentional misrepresentation” as the data did not include negative balances.
“Exchanges are prepared to take ownership of your coins if they go bankrupt. Withdraw your bitcoin to cold storage today!” said Josef Tětek, a brand ambassador for Bitcoin hardware wallet Trezor with SatoshiLabs.com in the Czech Republic.
Clients of collapsed crypto exchanges have waited years to get their Bitcoin back. Client funds in Mt. Gox, the first major exchange to crash, were tied up in legal proceedings for almost eight years, with a settlement finally reached in late 2021.
“It’s reasonable to expect that most exchanges apply the same liberal understanding of client-custodian relationship,” the Trezor Blog reported. “Bitcoin held on a centralized exchange simply isn’t yours; at best, it’s a promise that might be physically settled when you attempt to withdraw your coins. They are claiming the right to use your bitcoin to settle their debts.
“Even the act of too many clients trying to withdraw their coins at once could leave the exchange insolvent — just like bank runs under a fractional reserve system, another practice which we had better assume exchanges are engaging in, unless proven otherwise.”