Coins at exchanges and lending platforms are at risk during bear markets. Here’s how to protect your funds
If you are a crypto hodler like me, you should be extra cautious during a bear market. Now we are facing something even worse before, we have a price collapse in the cryptocurrency market paired with a worldwide recession coming. Many companies and projects will not survive this time, while the best ones will thrive and be ready for the next bull run. During this time, you as a crypto investor or holder should look at your holdings and ensure that you and your funds will survive this crypto winter. It is especially important now to move your coins to a private, hardware wallet and store your seed phrase safely. We will explain why your cryptocurrency holdings are at risk and how to protect yourself.
Exchanges and lending platforms use your funds for investments and these can go bad during bear market
Have you heard the old crypto saying “not your keys not your coins”? Probably so. But it is even more valid than usual during crypto downturns. Even if not obvious at a first glance, most businesses in the crypto economy are much similar to regular businesses and operate under a hood just like your regular old banks and investment firms. Crypto exchanges, lending, and staking platforms usually use your funds to profit from investment opportunities or just straight lend your money to someone else. Some companies do inform their customers about this but quite often they don’t. Staking and lending companies like Celsius, Nexo and exchanges like Binance use your deposits to lend money to other crypto projects and regular economy businesses. During crypto bear markets all projects face bigger or smaller hurdles, some will become insolvent and will not be able to return the borrowed sum. Although lending companies are often protected from a single borrower’s bankruptcy by diversification and insurance, they are not quite that well protected from a situation where a third or more of their funds are lost. This is what can happen when blockchain projects are going down, and we will see a lot of them disappear.
Exchanges and deposit platforms often use your funds to allow crypto traders to make leveraged transactions, where they buy 10x, 100x or even 1000x more than their funds will allow. This is a very high-risk endeavor. The trader has to return the money eventually, but it is a risky business for both parties. If the trader becomes insolvent due to bad trades, which happens a lot during downturns, the company might not see its money back.
Moreover, these companies use their own crypto holdings as well as these of their clients as collateral. For example, a crypto exchange wants to borrow money to finance their investment – improve their smartphone app. They borrow $5 million from the financial institution and give $7 million worth of bitcoin as collateral. In case something goes wrong, the financial institution will take the collateral to cover their losses and if everything goes well, they will not touch it. The crypto exchange company used 120 BTC as collateral when the price was $60.000 per bitcoin. When the price of Bitcoin plummeted to $20.000 the financial institution has now collateral worth only $2.3 million which is not enough. They ask the crypto exchange to either increase the collateral or pay the whole sum plus interest back immediately. This is when problems arise because probably the crypto exchange will not have enough bitcoins to increase the collateral and they might not be able to return the whole sum in one go.
All of this can happen while you don’t even about this. The newest story is Celsius which currently blocked withdrawals of their users’ funds because they run into some insolvency problems. They know that users rapidly withdrawing their funds will make their situation even worse, so that’s why they put this restriction in place.
How to protect your funds from the exchange and lending platform bankruptcy?
You should withdraw your crypto holdings from third-party platforms. Every platform that doesn’t give you ownership of your is a potential problem. Only when you are the one holding keys to your cryptocurrencies you can be sure no one has spent your coins. Most platforms however are not giving keys to their users because they make use of clients’ coins like they were their own.
Be aware that some platforms will impose restrictions on withdrawal during a bear market to defend themselves from a “bank run”. Be patient though and move your funds out, even if it takes a bit more time than usual.
You should get yourself a hardware wallet and move all your holding there. This way you are the only person holding the keys. With a hardware wallet, you are truly your own bank. Experts agree that a hardware wallet with a solid seed phrase backup is the safest form of storing cryptocurrency. The hardware wallet can be moved to another device and restored using the seed phrase, which is generated at the first setup. The seed phrase is a set of 24 words that are both password and recovery key.
A hardware wallet’s security can also be a problem sometimes. If you lose your seed phrase you can lose access to your funds forever. This is why It is very important to make a solid backup of your seed phrase. Keeping it on paper is not a good idea, it can be destroyed and lost quite easily. Every user of a hardware wallet should create a metal seed phrase storage medium. The best way to secure your seed phrase and your funds is to use a metal crypto wallet like Coinplate Alpha. This metal seed phrase backup is made from ultra-thick steel plates and will survive almost anything imaginable.