If you decide to store your bitcoins with a bitcoin exchange, you need to be aware that doing so involves quite a few risks.
The idea behind bitcoin currency and the bitcoin network is that users should be in control of their money. This is one of the reasons why the bitcoin network is decentralized. There is no central server, hub or authority that needs to process or approve transactions. There is no CEO that can make a decision to issue more bitcoins or to withdraw some coins from the market and change the value of the currency this way. The network has also been designed in such a way that it can function without middlemen. Bitcoin is about free markets and value based on supply and demand.
The idea of bitcoin exchanges goes against the philosophy of bitcoin currency. Even though exchanges operate on a decentralized network, they do become hubs for users. This fact makes the exchanges a point of interest to hackers and attackers. Unfortunately, exchanges as a phenomenon on the bitcoin network do not have the best reputation when it comes to securing and storing your digital money.
There are a lot of things that can go wrong, including a hacker attack, owners of an exchange deciding to steal the money and run away, and various technical problems. Whenever issues like these occur, you as a user will not be able to do much because cryptocurrencies are still in their infancy and many government officials would not even understand what you are talking about if you describe an incident involving bitcoins to them. Some people don’t understand cryptocurrencies at all and think of them as fantasy money or money used in computer games.
In developed countries, when you deposit your money in a regular bank, you get protection from the government. For example, in the United States, all the deposits up to $100,000 are ensured by the Federal Deposit Insurance Corporation (FDIC). This is not the case with cryptocurrencies because cryptocurrencies exist independently from any state governments.
When you store your coins with an exchange, you trust the exchange in two ways. First, you trust that it will stay online 24/7. This will usually be the case, even though even this is a risk. Secondly, and more importantly, you are trusting the exchange to keep your money safe. Basically, you are placing your faith in a platform that promises to stay secure enough to safeguard your personal information and money.
While in the last several years most of the cryptocurrency exchanges have been doing an excellent job of staying safe and protecting themselves, there is no such thing as perfect cybersecurity. As is always the case with new technology, understanding the potential, developing functionality and protecting the technology take time.
In the past, some of the exchanges and their users had to learn this the very hard and very costly way.
You should also not confuse cryptocurrency exchanges with wallet services. When it comes to storage of your coins, you have a variety of options that are much more convenient and secure than cryptocurrency exchanges.
While the security of bitcoin was one of the subjects in the original paper on cryptocurrencies by Satoshi Nakamoto, developing and implementing security measures takes quite a bit of time. For example, multi-signature wallets have only been implemented in 2013, four years after the bitcoin network came into existence. Multi-signature in bitcoin is similar to multi-signature in traditional banking. It means that funds can only leave a multi-signature wallet when several people approve the transaction.
Standard bitcoin wallets are “single-signature,” because a transfer of money between two wallets requires only one signature, the one that belongs to the owner of the wallet from which the funds are being sent out. At the same time, many organizations and people discovered a need for multi-signature wallets. The bitcoin network does support multi-signature functionality but it took the developers several years to create the technology. When a hacker tries to withdraw funds from a multi-signature wallet, the task is nearly impossible because for transactions to go through, they need signatures from multiple people.
In addition to multi-signature wallets, it is possible to add more security to coins you store with an exchange by using two-factor authentication (2FA).