One in seven adult Dutch people owns cryptocurrency. The Netherlands is home to more than 160 blockchain startups and the Dutch have 2.2 billion euros in crypto invested. The Dutch livelihood of real people depends on reliable business practices on the blockchain. As we see certain reckless Web3 empires fall, projects built on a healthy foundation of transparency are easier to spot. But given the recent demise of a handful of well-known crypto exchanges, the confidence of many “HODlers” has been shaken.
For years, centralized exchanges (CEX) have been the most accessible way to get into crypto. They made cryptocurrency trading easier and appealed to new users. Now crypto users should consider the security features of these platforms equally. Simplicity and security are essential components of the ideal centralized exchange.
The three-quarters of Dutch investors those determined to hold their crypto investments for the long term should carefully evaluate the safety of where they hold their assets. They can use three criteria to determine which crypto exchange is the safest: proof of reserves, protection funds, and safekeeping of funds.
A proof of reserves
After the FTX debacle, most centralized exchanges realized they had to provide proof of reserves. Evidence of reserves is the publicly verifiable certainty that the digital assets on a centralized exchange are backed by a “store of value”. If you deposit even one dollar on a CEX, there must be an equivalent of one dollar in reserves on that exchange until you ask for it back. If the total amount of verifiable reserves on a CEX is greater than or equal to 100%, the platform can prove that its users’ funds are safe. Proof of reserves ensures transparency in the CEX market.
Proof of reserves can be provided in several ways. A CEX can prove ownership of wallets or the amount of crypto they hold in a traditional way, such as through an audit. An exchange may also publish a Merkle Tree, which can demonstrate transactions and ownership of money on a blockchain ledger without giving away the addresses of the wallets holding or moving the money in question.
If the reserves of a CEX are not proven, be careful with your money.
Protection Funds
To what extent is your preferred platform prepared for a black swan? Disruptive events in the blockchain industry have jittery investors withdrawing their funds, and 2022 alone saw countless industry-changing events – from UST losing its peg to the dollar and collapsing, to the demise of exchange platform FTX and the wider implications for the entire sector. Any major event can trigger a rush on the stock markets, and if they don’t keep enough liquid capital when a rush happens, it could lead to the stock market going under.
With a customer protection fund, centralized exchanges show that they have built up special reserves to deploy when users want to withdraw their funds en masse. Check if the exchange you want to trade on has a protection fund.
The custody of financial resources
Are you a big investor? Experienced traders or people who own a lot of crypto can check whether the centralized exchange offers financial custody services. These services allow you to hold assets in a separate wallet with its own address and to view and withdraw your funds in complete freedom.
Even if you’re not an institutional investor, whether a CEX offers safekeeping services is a litmus test of how reliable the exchange is with large amounts of money. Like a crypto exchange doesn’t let its users easily withdraw money, alarm bells should ring.
The blockchain sector is still in its infancy. Given the events of 2022, it is not surprising that media attention is focused on the security of centralized exchanges. Investors in the Netherlands and abroad who are eager to take on this nascent sector should also understand the risks when deciding to invest and keep an eye out for blockchain hacks, the stability of the projects and the value for the users. Backed by an exchange that prioritizes the safety of its clients’ money, today’s farsighted investors can break free from the constraints of traditional financial asset classes and enjoy a more transparent, safe and innovative way to invest.