Can Cryptocurrency Exchanges Run Out of Funds?

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  • The amount of Bitcoin held on cryptocurrency exchanges is dropping at its fastest and most prolonged rate in history
  • The levels are now back to where they were in mid-2018, with no sign of slowing
  • Can a cryptocurrency exchange run out of funds, and what happens when they do?

The amount of Bitcoin stored on cryptocurrency exchanges is falling at a faster rate than ever before, with levels now down to those seen in mid-2018. If this pattern continues, is there a chance that an exchange could run out of funds, and what happens if they do?

Don’t Look Now, George

The worry for cryptocurrency exchange users is that, yes, it is very possible for platforms to run out of funds, as history has shown. However, the likelihood is very slim, with a rare combination of factors needing to be met in order for that to happen.

The vast majority of a cryptocurrency exchange’s balance sheet comes from user deposits, which is why mass withdrawals are the stuff of an exchange CEO’s nightmares. Similar to a traditional bank run, an exchange run would see users flood to withdraw their funds, for example on the back of some worrying news.

This in itself would likely not be enough for the exchange to go under, but the knock on effects could be problematic – no funds means no trading, and no trading means no fees being generated, which is the lifeblood of an exchange.

This is why cryptocurrency exchanges will (or should) have a certain amount of funds set aside, in cryptocurrency and fiat, in order to weather such events, and the typical downturns that come with a bear market. If there were to be a run on the exchange for any reason, exchanges can use these funds to pay staff, engage market makers to help facilitate trades, and work on regaining business.

Hacks and Mismanagement

Aside from an exchange run, there are two other main ways in which exchanges can run out of funds. The first is if they are hacked. Plenty of exchanges have been sent to the wall by hacks in the past (most famously Mt. Gox in 2014), where enough of the exchange’s funds are stolen to render them inoperable. Any remaining funds are used to pay off creditors, with customers often getting the smallest slice of the pie once the remains have been divided up.

The final major way in which cryptocurrency exchanges can run dry is if they are mismanaged internally. The best example of this is QuadrigaCX, whose co-founder and CEO was, months after his death in 2018, found to have lost millions of dollars in user funds by trading cryptocurrencies at other exchanges. In order to cover his tracks he faked deposits into user accounts and used new deposits to pay out existing withdrawal requests.

As a result, the exchange was found to be broke, with claims totaling $171 million compared to the $29.8 million that remained in assets. The company also hadn’t filed any tax returns in that time, so they could well have gone under anyway.

Cryptocurrency Exchanges Better Prepared Than Ever

While there are then clearly ways in which a cryptocurrency exchange can run out of funds, the chances are slim that it will be irredeemable, and most exchanges have plans in place to deal with downturns in fortune, meaning that customers are better protected than ever.