Podcast
Root Causes 257: FTX Crypto Exchange Collapses


Hosted by
Tim Callan
Chief Compliance Officer
Jason Soroko
Fellow
Original broadcast date
November 18, 2022
"If you don't hold the keys, you don't hold the cheese." Crypto exchange giant FTX recently collapsed, causing ripples through the cryptocurrency world. In this episode we focus on the cryptographic difference between cryptocurrency exchanges and other exchanges and how specific FTX user experience decisions led to the loss of valuable digital assets for investors.
Podcast Transcript
Lightly edited for flow and brevity.
So, if you had any kind of money within it, if you owned the shares of the company, it’s a very bad story and I’m sure it’s a very sore pain point to maybe even some of you listening on this podcast. This is not what the podcast is gonna be about. We just had to address the elephant in the room when we are talking about FTX.
What we are going to address here, Tim, is the PKI part of this. The interesting cryptographic part of this, which is there’s an interesting saying going around on the internet that caught my eye and that’s why, Tim, I wanted to talk about this today. And it’s great. How often do you get to hear about cryptographic keys in the public domain. Just general discourse on Twitter and these kinds of things. It’s great.
Now, here’s the second part of the story. When things started to disappear, people started to ask the question, hey, I use these guys as my broker, my cryptographic currency broker, and I trade on this exchange and now I happen to be very, very worried about where’s my cryptographic currency? Where did it go? And then somebody clever said something very, very true, which is, if you don’t hold the keys, you don’t hold the cheese.
And I thought that was a pretty clever saying. It’s cruel in the sense that it might have been the first time people heard of it but if you listen to this podcast, you heard of it before.
Which basically means quite often when you are dealing with a cryptographic currency broker, they hold the private keys to the cryptocurrency wallet. Ultimately, that is used as your identity on the underlying ledger. So, therefore, unless you hold the keys – essentially the private key itself – the public key is simply the address of your wallet. The private key, of course, being the private key. And the thing that needs to be kept secret and in safe hands. Quite often, these brokerages will keep the private key on your behalf. Your identity is simply to log in and then utilize, deposit funds, withdraw, etc., and all those things happen at the exchange and the broker on your behalf. But ultimately, a lot of people will make the assumption, well, I don’t mind if the broker holds my private key because they’re probably never gonna get into crazy shenanigans and go out of business and maybe use my funds for bad things.
And this is the big difference with cryptographic currency exchanges and brokerages. Well, first of all, as we said earlier, when the entity you are dealing with kind of plays all the roles, it’s already a little weird.
Because the opportunity for them to have shenanigans is higher. It doesn’t necessarily mean there would be shenanigans, it’s just the opportunity for them to put their fingers in all kinds of places and manipulate is kind of potentially – potentially there. But the other thing, of course, as you just said, Tim, the user experience of a securities broker customer, as the retail customer, you just log in and do your thing. And that’s the experience FTX wanted to give you. You log in and do your thing and all that complexity of the cryptocurrency wallets is just in the background.
However, as we’ve talked about on this podcast, the way cryptocurrencies work is that wallet, that cryptocurrency wallet, is your record. Is, in fact, very much tied to anything that was done in your name on your behalf and so, therefore, if you do not possess the private key to that, you are taking some level of risk because if the cryptocurrency exchange goes under, for whatever reason, there may be things that happen that you are not in complete technical control of.

