The world of cryptocurrencies has witnessed tremendous growth in recent years, attracting millions of investors. However, along with the opportunities presented by crypto trading, new risks have emerged. One such risk is the possibility of bank runs on crypto exchanges. In this article, we will explore the concept of bank runs in the crypto world and provide insights on how crypto investors can protect themselves from such events.
The Potential for Bank Runs on Crypto Exchanges
The concept of bank runs is well-known in traditional banking. Just ask the (former) management of the recently failed banks - Silicon Valley Bank and Signature Bank.
The crypto market players, specifically crypto exchanges, are also highly vulnerable to panic-driven runs. We all witnessed it last year with the FTX and Sam Bankman-Fried saga. In fact, due to low levels of regulation and the general volatility of the industry, runs on crypto exchanges are much more probable than runs on banks and other traditional financial institutions.
The vast majority of crypto trade happens on centralised exchanges. How could crypto investors protect themselves if a run on the exchange they use becomes a reality? Naturally, there is no single method that would completely insulate you from exposure to such runs. However, the six strategies listed below, used as part of a comprehensive risk management framework, will help minimise the risk of crypto run losses.
Six Ways to Protect Yourself Against Runs on Crypto Exchanges
1. Periodically transfer your funds from the exchange to your blockchain wallet: One crucial step to protect yourself from potential bank runs is to avoid keeping a significant amount of crypto on an exchange wallet. Instead, transfer funds periodically to a decentralized blockchain-based wallet that you control. If a devastating run on the exchange occurs, your funds in the exchange wallet might get locked up faster than you could say HODL during a market dip.
2. Choose reputable exchanges with high liquidity: The nature of cryptocurrencies makes exchanges with low liquidity more prone to potential problems during times of panic. It is advisable to use large, reputable exchanges with substantial trading volumes and liquidity. Websites like coingecko.com and coinmarketcap.com provide information on the top exchanges based on trading volumes. Sticking with the exchanges in the top 10 could be a simple rule of thumb.
3. Diversify across multiple exchanges: Try to use multiple exchanges for your trading needs. By spreading your holdings across two or three different exchanges, you reduce the risk of being affected by a single exchange's failure. Consider it a form of diversification.
4. Opt for exchanges with proof of reserves: One essential factor to consider when selecting an exchange is whether it provides the so-called “proof of reserves”. This means that the exchange publicly discloses its crypto collateral reserves held on a blockchain platform. Some of the larger exchanges that have implemented proof of reserves are Binance, Coinbase, and OKX. Make sure to check the exchange's website for proof of reserve information.
5. Stay informed of the latest news and developments related to crypto exchanges: The cryptocurrency industry is highly volatile and can change rapidly. It is crucial to stay ahead of the news and developments related to the exchanges you use. Keep track of any potential red flags or warning signs in the media. Regularly monitoring news outlets, forums, and social media can help you stay informed about any issues or concerns surrounding an exchange.
6. Monitor social media sentiment for native cryptocurrencies of the crypto exchanges you use: Many large exchanges have their own native cryptocurrencies – e.g., BNB for Binance, KCS for KuCoin, or HT for Huobi. Monitoring social sentiment around these coins can provide insights into potential trouble for the associated exchange.
Our social media analytics platform, PUMP, tracks social sentiment for a large number of cryptos, including the native coins of the leading cryptocurrency exchanges. Social sentiment related to these coins is often one of the first signals preceding a run on the exchange.
PUMP also has the ability to distinguish between bot-generated and human-generated social media content. Some exchanges in trouble might resort to bot-driven social media postings in order to improve their deteriorating social sentiment. This is where PUMP can step in to identify bot content and purge it from the real social sentiment for the troubled exchange’s coin.
The methods above comprise a good overall framework to minimise your risks in the event of a run on your preferred crypto exchange. While everyone is currently preoccupied with the bank runs and collapses in the traditional finance industry, one should not forget that the crypto industry is much more volatile, and therefore more “run-prone”, compared to the banking sector.