Exchanges, centralised and decentralised
Where nearly everyone buys, and where nearly every large loss in this field has happened. The two kinds fail in completely different ways.
A centralised exchange is a company with an order book, a matching engine and customers' money on its balance sheet. A decentralised exchange is a set of contracts that never holds your funds. Almost everything about the risk differs.
Centralised exchanges
They work like a broker. You deposit, they credit an internal balance, and trades between customers are database updates rather than blockchain transactions. That is why they are fast and cheap — most activity never touches a chain at all.
The exchange controls the keys. Your balance is an entry in its system. If it fails, you are an unsecured creditor in whatever insolvency process applies — a position that has, historically, recovered a fraction of the value after many years. This is the meaning of the phrase "not your keys, not your coins", and it is a statement about legal reality rather than ideology.
The record
- Mt. Gox, 2014. Around 850,000 bitcoin missing; creditors waited more than a decade for partial distributions.
- FTX, 2022. Customer funds used for other purposes, then bankruptcy. Its founder was convicted of fraud in November 2023 and sentenced in March 2024.
- Many others, through hacking, insolvency, exit scams and regulatory seizure, across every year of the field's existence.
Every major failure involved an exchange holding customer assets it should not have been using, with no independent verification that it held what it claimed. The technology worked perfectly in each case. The failure was a company doing what unsupervised companies holding other people's money have always occasionally done.
Proof of reserves
After 2022, many exchanges began publishing cryptographic proofs that they hold assets matching customer balances. This is a real improvement and it is partial: it demonstrates assets at a moment, and it generally does not demonstrate liabilities. An exchange with borrowed assets on the day of the snapshot can produce a passing proof.
Treat it as better than nothing and well short of an audited balance sheet.
Decentralised exchanges
You trade directly from your own wallet against liquidity pools. The contracts hold the pool, not your funds, and there is no account, no withdrawal process and nobody who can freeze you.
- Removed: custody risk, withdrawal freezes, insolvency, misuse of customer assets.
- Introduced: contract exploit risk, MEV, slippage on thin pools, and total responsibility for your own key management.
- Also introduced: anything can be listed, including tokens designed purely to be sold to you. There is no listing review because there is nobody to review.
Reducing exposure, practically
- Use a centralised exchange for what it is good at — converting currency and providing liquidity — and withdraw to your own wallet when you are done.
- Do not hold long-term balances on an exchange unless you have decided deliberately that custody by that specific company is what you want.
- Prefer exchanges regulated in a jurisdiction with enforced client-asset segregation, and know that regulation reduces the risk rather than removing it.
- Enable every security control offered, and use an authenticator app rather than SMS, which is vulnerable to number-porting attacks.