What Are Crypto Exchange Bank Runs and How Do They Work?

The history of bank runs goes back to the appearance of banks. The situation affects banking systems and other financial services that offer similar services. Cryptocurrency exchanges provide services similar to those provided by traditional banking systems, so they are not immune to the problem.

The widespread lack of regulation on exchanges makes it important to understand what crypto bank runs are and how to protect yourself against them. So what are bank runs and how can you protect yourself from their adverse effects? Soon you will know.

What is a bank run?

A run on the bank occurs when customers withdraw their money from a financial institution out of fear of losing their money if the institution goes out of business. As more people withdraw their funds, the likelihood increases that the institution will be unable to continue processing withdrawals, especially if the financial institution’s reserve is insufficient to cover withdrawal requests.

How do bank runs work?

Bank runs have occurred in different aspects of finance over time, but we rarely hear about them in traditional finance of late because measures have been put in place to curb such cases. Banks also often have insurance and reserves to protect against any bad events that could cause them to lose customer funds.

A run on the bank occurs when customers collectively withdraw their funds from banks under the belief that the bank is at risk of becoming insolvent. It stems from a widespread fear that a financial system or institution is at risk of bankruptcy, usually triggered by a series of events. Customers then start withdrawing their money almost simultaneously, increasing the chance that the financial institution will go bankrupt.

Recent events in the world of cryptocurrencies have made bank runs a bit more pronounced. Many cryptocurrency investors began to withdraw their money due to fear, uncertainty, and doubts about cryptocurrency exchanges and cryptocurrencies, which was first triggered by the FTX crash.

After the FTX accident, many cryptocurrency investors began withdrawing their money from various exchanges fearing that the cryptocurrency or other exchanges would crash and fall to the same fate as many FTX clients. Panic withdrawals affected cryptocurrency prices.

The bank run affected many exchanges, making a big name as BlockFi stopped processing withdrawal requests and eventually filed for bankruptcy. Other exchanges also saw an increase in withdrawal requests.

If crypto is to survive and gain more trust from its users, it must adopt practices that can ensure that its customers’ funds are safe even in the event of insolvency. One of the practices could be the strict segregation of client funds from the company’s general fund or at least proof that there is support for each client’s deposits.

4 Ways to Protect Yourself from the Negative Effects of Bank Runs

Here are steps you can take to ensure your funds are safe in the event of a future bank run.

1. Using exchanges that have a reserve test

Providing proof of reservation has become a serious matter since the FTX accident. Some big players, like Binance and Bybit, responded positively to the idea and started showing proof of booking.

Proof of reserve shows users a picture of a crypto exchange’s resources and financial backing, allowing them to make better decisions when choosing an exchange to trade with.

As much as you hope that reputable exchanges can offer some form of trust and protection, the FTX bankruptcy case and subsequent issue have made people discover that using a trusted broker is not enough to stay safe during trouble. of bankruptcy. Rather, users now want to see that the exchange they are using is well audited and has measures in place to protect them in the event of bankruptcy.

Providing proof of reserve is becoming necessary to increase customer confidence in an exchange, as they want to be sure that their funds are backed by tangible assets.

2. Diversification of investment

Diversifying your investment across different crypto assets can be a good way to mitigate the negative impact of a cryptocurrency losing value. You can also diversify your funds across different reputable exchanges to ensure you don’t lose your entire investment in the event of a bank run.

Investing in assets other than cryptocurrencies is another way to diversify your positions. The forex market, the stock market, the real estate industry, and many other industries offer investment opportunities, although they are not as volatile as cryptocurrencies.

3. Use a cold wallet

Using a cold storage device to store your cryptocurrencies is one of the most reliable ways to protect yourself from bank runs. A cold wallet is an offline device where you can store bitcoins and other cryptocurrencies. The device is not connected to the Internet and is usually not connected to an exchange. Thus, it protects you against unauthorized access, attacks, and other vulnerabilities you might face with online exchanges, including bank runs.

bitcoin token and flash drive

When it comes to storing your cryptocurrencies, Cold wallets offer more security than hot wallets or online wallets. Since the cryptocurrency industry is still undergoing security reforms and restructuring that would make it as safe as traditional financial institutions, keeping your cryptocurrency in a non-custodial or self-hosted offline wallet might be the best option.

4. Follow the latest crypto and exchange news

Checking news related to the crypto you are investing in and the platform you are investing in will keep you up to date on the latest developments. It might help to be one of the first people to learn about a crisis or impending crisis on the crypto exchange, as you can withdraw your money faster before withdrawals are suspended.

Always take security measures

You cannot control if or when a bank run will occur. However, you can protect yourself to a large extent from its effects using the measures that we have explained in this article. A bank run can be so intense that an exchange can lose its value and be forced to shut down, causing users to lose their funds.

Since the cryptocurrency industry is still in its early stages, you need to take practical steps to ensure that your funds are safe and not completely dependent on your online or crypto wallet.

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