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Ask CryptoVantage: What Are the Risks Involved with Bitcoin Exchanges?

Using an online exchange is by far the most commonly used method for buying bitcoin. Bitcoin exchanges provide an easy way to get bitcoin, but like everything else in bitcoin it comes with trade-offs. Both your personal information and your funds could be at risk when using a bitcoin exchange. In this article we explain the biggest risks involved with using bitcoin exchanges and provide some alternative options for buying and storing bitcoin.

Cryptocurrency exchanges are a necessary part of buying crypto but there are some things you should know about using them.

Exchanges Get Hacked

Storing bitcoin on an exchange can be a good idea if you are only storing a small amount. If you own a larger amount of bitcoin, then it becomes riskier to store it on an exchange. Throughout bitcoin’s history, there have been a number of high-profile cases where bitcoin exchanges get hacked and users collectively lose millions of dollars worth of bitcoin. The most famous was Mt. Gox, which saw the hacker get away with hundreds of thousands of bitcoins, worth $350 million at the time. Today, those coins are worth over $30 billion.

Another high-profile case happened in 2018/2019 when the CEO of bitcoin exchange Quadriga CX died. The funds from the exchange were stored on his encrypted laptop which supposedly only he knew the password to. Because of this, hundreds of millions of dollars worth of users’ funds became permanently inaccessible.

These past exchange scandals should serve as a warning to newcomers in the bitcoin space. It has happened before, and it will happen again. If you store a large amount of bitcoin on an exchange, you should consider the very real possibility that the exchange could get hacked and your funds could be lost.

Personal Information Leak

Money isn’t the only thing you could lose from an exchange hack. With most exchanges, you need to prove your identity to them as part of the sign-up process.

This may include uploading a copy of your photo ID and taking a picture of yourself. Make sure you are aware of the risks of linking your identity to your bitcoin purchases – even if your funds weren’t stored on the exchange, if the personal information were leaked then potential attackers could know things like how much bitcoin you own and where you live.

Government Seizure or Censorship

In 1933, the United States Government made it illegal for private citizens to own gold when President Franklin D. Roosevelt signed Executive Order 6102.

Policymakers in the West have been critics of bitcoin for years, and it is possible that in the future they will try to make it illegal for private citizens to own bitcoin in a similar manner. If your bitcoin is stored on an exchange and this were to happen then it could be confiscated from you.

Things are very different now than they were in the 1930s – more likely than not, bitcoin will remain legal to own. However, it is still important to be aware of these risks nonetheless.

Other Options

Bitcoin exchanges can be a good beginner-level method of buying bitcoin. Exchanges can be thought of as a bitcoin gateway, allowing users to acquire bitcoin and learn about it. If the user decides they want to hold a larger amount of bitcoin, they should first educate themselves on the risks and trade-offs involved with various options for storage. For longer term and higher value storage, users should consider using a hardware wallet to store their bitcoin.

For more advanced users, there are other options for acquiring bitcoin without using a bitcoin exchange. There are costs involved, but anyone can use bitcoin miners to earn bitcoin. Other options include earning bitcoin for work that you do or buying it from someone else who either mined it or bought it.

Takeaways

  • Exchanges can be a good way for bitcoin beginners to buy a small amount of bitcoin, so they can become more comfortable and educated when using it.
  • History shows that storing large amounts of bitcoin on exchanges can be very risky due to exchange hacks.
  • Your personal information that was required to make an exchange account could be hacked or leaked.
  • Governments could make it illegal to own bitcoin and confiscate any bitcoin stored on exchanges in those countries.
  • As you become more comfortable with bitcoin, you should consider using a hardware wallet for storing larger amounts.
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CryptoVantage Author Billy Garrison

About the Author

Billy Garrison

Billy Garrison focuses his research and writing on Bitcoin and the Lightning Network. He is interested in the technical details that allow these technologies to survive and grow without the need for a central authority. Billy also loves helping people learn about Bitcoin which led him to start the Halifax Bitcoin Meetup.