When you buy Bitcoin from a central exchange, you never know if your account is credited with Bitcoin or paper Bitcoin. The fiat bitcoin is “I owe you” bitcoin, which means that the exchange owes you a certain amount of bitcoin. The only way to be sure that the bitcoin you purchased is genuine is to withdraw it to a self-storage wallet or sell it for another asset or product.
To save on transaction fees, most exchanges will not create a separate wallet for your account and transfer your Bitcoin to this address. The Bitcoin balance displayed in your Central Exchange account is a number next to your name on a spreadsheet. This explains why, despite the Bitcoin blocking time of 10 minutes, exchanges can instantly transfer Bitcoin to your account. That is, the time it takes to transfer Bitcoin from one address to another.
Exchanges keep their bitcoins in a wallet or group of wallets where they own the private keys and store them securely. If they transfer small amounts to your exchange wallets every time you buy and sell within the ecosystem, they will lose a lot of money in transaction fees.
The vast majority of major exchanges do not provide proof of customer deposits. However, some smaller exchanges, such as Luno, are audited on a quarterly basis, and customers are forced to rely on this audit report to ensure that the exchange has a one-for-one backing of the Bitcoin reserves they hold against customer deposits. As a result, for all “I owe you” Bitcoin held on exchanges, there is no transparency as to how much Bitcoin is actually held in reserves to back up customer balances.
If you decide to withdraw your Bitcoin from a centralized self-storage exchange to a noncustodial or hardware wallet, the exchange has to hand your Bitcoin over to your wallet. This ensures that you have real Bitcoin in your wallet and eliminates the possibility that the Bitcoin you purchased is fiat Bitcoin. This action reduces the amount of Bitcoin in circulation provided that you do not buy to resell it soon.
The most significant factor encouraging Bitcoin adoption is the limited supply of 21 million coins. But we must examine this claim and determine what it means. The supply of Bitcoin is increasing every ten minutes until the last Bitcoin is mined in the year 2140. We currently have over 19 million Bitcoins in circulation, and the remaining Bitcoins will be mined between now and 2140. This means that official supply-side inflation will be 0.09 percent annually until the year 2140. Without taking into account the growth in the value of each bitcoin.
When it comes to exchanges that provide a market to buy, sell and mortgage bitcoin, it is possible that they (exchanges) sell more bitcoin than they own. This means that if all Bitcoin holders who own Bitcoin on exchanges decide to withdraw all their Bitcoins at the same time, there is a chance that the Bitcoin paper they have collectively issued will be larger than the Bitcoin they own. This leads to the belief that they are printing fiat bitcoin and selling it to unsuspecting customers.
Under what conditions can bitcoin print paper be exchanged? Therefore, if all Bitcoin held on exchanges accesses a certain pool of Bitcoin and traders deal only with a small percentage (the upper tier) of the total pool, the exchanges can lend (reserve) idle Bitcoin to unsuspecting buyers. This means that two or more people can hold different amounts of bitcoin backed by a smaller amount of bitcoin on the exchange.
What makes this possible? The last saga involving Terra’s Luna
If exchanges sell more bitcoin (both real and fiat) than they own, they will be net exposed. Meaning that if the price of bitcoin goes up significantly, they will have greater claims on their customers’ accounts. This encourages exchanges to call for a drop in the price of Bitcoin. To reduce the price of bitcoin, you must suppress the demand while increasing the supply. This entails taking a larger short position by flooding the market with fiat Bitcoin.
To increase supply, exchanges need to ensure that the amount of bitcoin purchased by new market participants does not reduce the overall market supply. This means that they are either offering derivative contracts on Bitcoin or they are getting fiat Bitcoin.
Most institutional investors seeking exposure to bitcoin buy bitcoin futures ETFs (exchange traded funds) instead of actual bitcoins. They can trade bitcoin using these ETFs without actually owning it. This means that there are billions of dollars in fiat bitcoin deals that do not reduce the supply of bitcoin in the market. These ETFs suppress the demand for Bitcoin and contribute to the Bitcoin price drop.
Moreover, exchanges may offer incentives to bitcoin holders to keep their bitcoins on the exchanges. As a result of fewer withdrawals, exchanges have more bitcoin liquidity and are not forced to cover withdrawals. Lower transaction costs for customers with more bitcoins on exchanges, bonuses, and higher withdrawal fees may help make this happen. Many exchanges are already doing this now.
Retokenization is another term for how exchanges allegedly use their customers’ bitcoin. In this case, the exchange uses customers’ deposits as collateral to back a loan that they use to make a profit. Queen Piece
Of course not everyone will agree with me, but there is a strong case that central bitcoin exchanges practice partial reserve banking where only a fraction of the “I owe you” bitcoin displayed in customer balances is available in their reserves to cover withdrawals.
Customer deposits through the fractional reserve banking system are used to generate more fractions. Therefore, by holding your bitcoin on the exchange, you are providing the exchange with more liquidity, allowing it to generate more fractal. Simply put, the exchange prints more bitcoin backed by your deposit, which increases the supply and lowers the price of bitcoin. As a result, there is a compelling argument that holding your bitcoin on the exchange contributes to lower bitcoin prices.
Bitcoin is a custodian asset. The only way to truly own it is to own your private keys. If you want to take advantage of all the features of Bitcoin, such as unauthorized transactions, false anonymization, and censored funds, among others, you must own your own keys. As we saw in the recent Luna events, the exchange can limit your Bitcoin withdrawals, trade your Bitcoin, and get your Bitcoin in bankruptcy.
Disclosure: I own Bitcoin and other cryptocurrencies.