How to prevent your crypto from being frozen when a centralized exchange goes bankrupt
A brutal downturn in the crypto marketplace has driven cryptocurrency exchanges such as Voyager Digital to file for Chapter 11 bankruptcy protection. As a result, millions of crypto owners are locked out of their crypto assets, doubtful they'll ever see their assets again.
Earlier this month, a popular centralized exchange, or CEX, called Voyager Digital went bankrupt as the result of the recent plunge in crypto markets, causing it to freeze customer withdrawals. At the time of its Chapter 11 bankruptcy filing, Voyager said it had about 3.5 million active users and more than $5.9 billion in cryptocurrency assets.
Voyager suspended trading, deposits, withdrawals, as well as loyalty rewards, effective at 2:00 pm ET on July 1. If you had funds on the exchange, they're most likely gone now. What's more, you won't be able to retrieve your assets, which has shaken many crypto enthusiasts to the core, so much so that some customers were incensed to the point of making personal threats against company management and their families.
How we got here
ZDNET Recommends
Before we go further, keep this crypto axiom in the back of your mind: Not your keys, not your coins. Crypto exchanges such as Voyager may be convenient and popular to store one's crypto assets, especially for novice crypto investors. However, if an unforeseen circumstance cripples an exchange, your chances of withdrawing your funds might be slim to none.
Let's explore the details of how Voyager managed to freeze the assets of its 3.5 million users; then, I'll offer suggestions on how to avoid being in a situation where your crypto assets can be frozen.
First, meet Three Arrows Capital (3AC), a mega-crypto hedge fund that managed about $10 billion in assets. 3AC also filed for bankruptcy earlier this month. The news went viral, too, blowing up when 3AC defaulted on a $670 million load to Voyager. In addition, 3AC owes roughly $270 million to Blockchain.com. What led to this?
Crypto financial services and trading platforms BlockFi and Genesis liquidated some of 3AC's positions. 3AC couldn't meet the margin call -- that point when a broker wants an investor to deposit more money (or securities, or crypto) into their account in order to bring it up to the minimum value. They couldn't commit more funds to avoid their losses on trades made with borrowed cash.
Crypto Coach Tip: Never leverage traded crypto as it's a disaster waiting to happen. Like gambling in Vegas, the house always wins.
For 3AC, this was like the perfect storm. It lost $200 million with the Terra Luna debacle. Then they had margin calls and demands for loan repayments from Voyager. Game over for 3AC.
What's mind-boggling is how Voyager is so bad at lending money. What genius said, "Let's loan out more than 50% of other people's money unsecured?" Genesis and BlockFi had secured loans with collateral, but Voyager just gave 3AC more than $650 million, unsecured. If the average user on Voyager has only $10,000 of assets stored on the exchange, how could they lend out this money so foolishly? How is that protecting your user base, Voyager? In my opinion, they were reckless.
More Crypto Coach
This goes back to what I've said time and again: Don't invest more than you can afford to lose. I cringe when I hear stories of people taking their life savings -- $80,000, for example -- and putting it on an exchange in search of higher yield. This is just greed. They're not using wisdom. If you have $5,000 in savings and you want to get into crypto, I would invest between 1% and 5%, or between $50 and $250. If you lose it all, you can live to fight another day. Put all of your $5,000 on Voyager or Celsius, and it's game over for your assets.
Remember, these platforms lure you with high yield. The companies behind these crypto coins subsidize the yield to make it even more enticing. CEX's are not banks; there are no Federal Deposit Insurance Corporation (FDIC) protections in crypto, so don't put your life savings in Voyager or any CEX.
Here are a few posts I read on Twitter:
"Very unfair. That's not acceptable, you ruined peoples' money. My father gets [paid] $10 per hour. He is 65. I told him to save and grow his money in Voyager... Now it is gone." -- @artmiss2020
"Why invest your money on a lie (deliberate). It's like the thousands I had invested in Voyager... my WHOLE portfolio is absolutely GONE!! Even two years of history. Anyone thinking of investing in Voyager... DON'T!!! They are thieves. Try to get answers and you get a bot." -- @BrendaD10572797
"We didn't agree to a $650 million loan to 3AC, y'all did that! We want our crypto that's all." -- @DavidVa31953350
So, here's how you can protect yourself from getting your funds frozen or locked up:
- Don't leave coins on any CEX, especially if you invest more than 5% of your total portfolio.
- If you invest more than 5% of your portfolio, you should use either a hot or cold wallet. (If you don't own a hardware wallet, use an online hot wallet.)
- Take some time to learn how to protect your seed phrase.
- Use a decentralized exchange (DEX) to trade, such as Uniswap, Pancakeswap, Curve or SushiSwap, not a CEX. The coins will remain in your control through smart contracts.
- If you decide to use a CEX, make your trades and then move your coins back to your hardware wallet or online hot wallet immediately upon completion. Don't leave your funds on a CEX longer than necessary. Get in and get out.
Let's now talk about a few other hot wallets I like besides MetaMask.
Exodus: is a user-friendly wallet that supports more than 150 coins. You can set it up in less than five minutes, and it is an ideal platform for the beginner-to-intermediate crypto investor. You can download it from the app stores on Android or iOS.
Coinbase Wallet: If you like purchasing your crypto with Coinbase, the Coinbase self-custody wallet is a great choice. Aside from both supporting a variety of coins and giving you the ability to control your keys, it's simple to purchase crypto on Coinbase CEX and transfer it immediately to your Coinbase wallet.
Brave Browser: I love my privacy, and Brave Browser's primary purpose is to protect my online privacy. Brave blocks trackers and ads on every website you visit. Its latest "super app" enables fully private independent search, free video calls, offline playlists, and a customizable news feed. It has all the privacy I love, as illustrated below:
In addition, it has a built-in hot wallet so you can immediately get your funds off a centralized exchange.
How to transfer your funds to a hot wallet
Configuring your funds and sending them to a hot wallet is a relatively quick and easy process. Here's how to do it using Brave Browser.
First, download Brave Browser to your computer. Click "Settings"…
… and then click "Wallet" and toggle the button to "Show Brave Wallet" icon on the toolbar.
You can now click the toolbar's Wallet icon to access your hot wallet.
Select "Hot Wallet" | "Learn More" | "Get Started."
Next, back-up your seed phrase and put it in a safe place.
Write down your phrase and click "Continue." For the purpose of this post, I will reveal. Once again: Never share your seed phrase with anyone.
Select "I have backed up my phrase somewhere safe." and click "Continue" to verify.
You have now set up your wallet. Remember to reset the wallet first and restore it before sending any funds. You can reset it by clicking "Settings" | "Wallet" | "Reset Brave Wallet."
After it confirms reset, click the "Wallet" toolbar icon but this time choose "Restore."
Type in your recovery phrase and the new password, and click "Restore."
You have now tested the restore function and can now send funds to the wallet. (Always test the restore function.)
This hot wallet supports a variety of coins; you can select which coins you want.
I chose Ethereum, Solana, and ApeCoin.
Now that you have set up the wallet, you can purchase funds on a CEX and easily transfer them to your hot wallet. In the event a CEX has frozen its funds or goes bankrupt, your funds are always safe. So, you can say…
Your keys, your coins. You are the bank.
Any wallet, hot or cold, is better than leaving our funds on a CEX. Research your favorite wallet and move your funds once you purchase on an exchange to better protect yourself from what happens if a CEX goes bankrupt or simply decides on a whim to freeze your funds.
The information presented by the Crypto Coach and ZDNet is not intended to be individual investment advice and is not tailored to your personal financial situation. It does not constitute investment, legal, accounting, or tax advice, nor a recommendation to buy, sell or hold any particular investment. We encourage you to discuss investment options with your financial adviser prior to making any investments.