Centralized Exchanges vs. Self-Custody: Which is Safer for Your Crypto?

Ripple’s Chief Technology Officer, David Schwartz, has expressed skepticism about the safety of storing cryptocurrency on centralized exchanges. In a recent online discussion, Schwartz highlighted the potential risks for users’ funds in the event of an exchange’s financial instability.

I have no particular reason to think it’s not safe to keep crypto at Coinbase. But, as with other centralized exchanges, if they screw up enough, your funds will be lost. For many, it’s still better than self-custody because the odds that they’ll mess up are higher.

— David “JoelKatz” Schwartz (@JoelKatz) July 15, 2024

Schwartz commented while responding to Joe Carlasare, a commercial litigator, who analyzed the potential risks of storing funds on crypto exchanges. According to Carlasare, depositing funds into a crypto exchange makes the depositor an unsecured creditor to the exchange.

Carlasare explained that by doing so, the depositor effectively lends money to the crypto exchange without securing the loan with collateral. Furthermore, he noted that exchanges structure the deposit model in a way that the depositor has no lien or security interest in any of the debtor’s assets. Hence, people who deposit funds on crypto exchanges have little or no rights if the exchange goes bankrupt.

To illustrate his point, Schwartz cited the ongoing situation with Synapse, where reports claim there is progress towards releasing deposits of affected customers. According to the Ripple CTO, in the case of Coinbase, the assumption is that the crypto exchange holds enough USD and has sufficient records to determine ownership of the funds.

Regarding the opinion that USD cash on Coinbase is held by an FDIC-insured bank, Schwartz explained that the FDIC would only protect depositors if the bank fails. Hence, if crypto exchanges like Coinbase fail, the depositors will still lose, just like with Synapse.

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