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When purchasing and trading digital currencies, investors have multiple avenues at their disposal. Two prevalent methods include Over-the-Counter (OTC) trading and cryptocurrency exchanges. OTC trading encompasses direct peer-to-peer transactions between two parties, whereas cryptocurrency exchanges serve as platforms where you can trade digital assets for other assets, including both digital and fiat currencies.

OTC and P2P trading share similarities, as they both involve direct transactions between parties. However, OTC trading is often favored by institutions and large buyers, as it provides greater transparency and is less likely to impact an asset's price compared to open market purchases. Certain crypto exchanges, such as Binance, have even integrated dedicated P2P platforms within their systems.

Cryptocurrency exchanges operate as intermediaries, linking buyers and sellers while generating revenue through commissions and transaction fees. A CEX is a traditional business with a centralized/closed marketplace where traders can register with the exchange and then begin buying and selling crypto assets within the rules and walled garden set by the business. Orders placed on a CEX are executed off-chain on their internal infrastructure behind the scenes. Although CEXs own, store, custody, and facilitate trades for cryptocurrencies, it is still very much a TradFi business and revenue model. Therefore, many current laws, best practices, and accounting standards can still be applied to these companies. Similar to when a traditional bank fails, the U.S. dollar is not to blame but, rather, the poor internal decision-making of the business. The same holds true for CEXs: many have and will fail but it is not an indictment on the assets.

Securing Value

Centralized cryptocurrency exchanges act as trusted intermediaries in trades and function as custodians for users' funds. Exchanges are responsible for appropriately securing user funds.

One significant drawback of centralized exchanges is counterparty risk. Large exchanges must secure up to billions of dollars in assets, rendering them prime targets for hackers and theft. Moreover, centralized exchanges impose substantial transaction fees for their services and convenience, posing a problem for handling large amounts. Consequently, long-term investors are often advised to store their cryptocurrency outside of exchanges.

Because of this counterparty risk, not all crypto exchanges succeed. This has most recently been demonstrated by the failure, and subsequent loss of user funds, of FTX.

FTX Exchange Collapse

FTX, a centralized cryptocurrency exchange specializing in derivatives and leveraged products, collapsed in November 2022. The downfall of FTX occurred over a 10-day period following a report by CoinDesk on November 2nd, which revealed that Alameda Research, a sister company to FTX, had reduced its exposure to the FTX platform.

As FTX controlled the keys to users' wallets, those with funds held through the exchange were hit the hardest. The exchange filed for bankruptcy shortly after Binance, the largest centralized cryptocurrency exchange in the world, withdrew its acquisition offer to save FTX. The bankruptcy filing revealed numerous issues, including alleged mismanagement and misuse of user funds.

Lawyers have accused FTX of violating its own terms of service and misusing user funds. The allegations, combined with the exchange’s collapse, resulted in significant losses for FTX users, underscoring the risks associated with centralized exchanges that hold custody of users' digital assets.

Key FTX and Alameda Research executives, Caroline Ellison and Gary Wang, were arrested and subsequently pleaded guilty to criminal charges related to a multibillion-dollar fraud allegedly orchestrated by CEO Sam Bankman-Fried. Caroline Ellison, the former CEO of the cryptocurrency hedge fund Alameda Research, and Gary Wang, a Co-Founder of FTX, were key lieutenants in the company. According to a former Alameda Research chief's testimony, Sam Bankman-Fried and other FTX executives received billions of dollars in secret loans from the crypto mogul's Alameda Research.