UNITED STATES – MAY 12: Sam Bankman-Fried, CEO of FTX US Derivatives, testifies during the House … [+]
It’s been a story almost as old as bitcoin itself: centralized exchanges failing and taking away with them faith and trust in bitcoin, as well as the assets of people who thought they were holding bitcoin in the first place. It started with Mt.Gox, which failed, leaving many bitcoiners from years ago claiming that they were “Mt.Gox creditors”. Now FTX has come to the fore, leading some pundits to decry that an “Enron”-like failure might sink all of bitcoin and cryptocurrencies into a near-permanent bear market.
We’ve seen failures of exchanges and exchange-like type intermediaries across the board. FTX is a prominent example of a centralized exchange that ended up holding more “paper” than bitcoin for its clients. After a lengthy and protracted bankruptcy process, it is unlikely asset-holders will find much in the way of recovery. We’ve seen centralized exchanges fail because of too much leverage on their part, because they’ve been hacked under mysterious circumstances, or because important stakeholders, such as the founder, died.
What is a centralized exchange?
Centralized exchanges are a way to trade bitcoin for fiat and sometimes, bitcoin for other cryptocurrencies. If they’re centralized, they run similar to a traditional corporation, with a headquarters somewhere in the world, a dedicated team, and most importantly, custodial responsibility for their users.
Instead of buying bitcoin directly from a peer who sends it to your wallet (though perhaps in an escrow system), your holdings are tracked digitally by the exchange’s own ledger: in effect, this serves as a banking layer for…
