Can't Trust the Exchanges - How Do I Buy Bitcoin?
The Bitcoin ecosystem is growing and there are plenty of options
With crypto exchanges and lenders continuing to blow up in a spectacular chain reaction, this has inevitably caused the price of Bitcoin to fall even further. It’s important to understand that Bitcoin is the only asset that can reliably be sold by crypto lenders or exchanges in a downturn when liquidity is needed. This is not dissimilar to the traditional financial system when faced with a liquidity crisis and a need for cash, everything is sold including the best assets like blue chip stocks, real estate, gold / silver, etc. It’s my belief that the market is mispricing the intrinsic value of Bitcoin in the wake of this chain reaction event. At the same time, it’s hard to trust the centralized exchanges for purchasing and even short term custody of your coins (until you can send to cold storage) and indeed you shouldn’t, given what we are learning now about how these exchanges operate.
So far, we have seen the following exchanges / lenders go down:
Celsius
Three Arrows Capital
Voyager
Blockfi
FTX
FTX is by far the biggest one. Indeed only a few months ago FTX was stepping in to rescue the other failed exchanges and SBF was being touted as the “JP Morgan of Crypto.” In reality, FTX was probably owed so much money by these failed exchanges, there was no other choice but to step in to paper over the losses and hope they could raise more money later.
One of the things we are learning in the wake of these collapses is that all of these companies are intertwined, providing custody services for each other’s customer assets and loaning money back and forth, collateralized by crypto assets, most of which (other than Bitcoin) have no real value. In FTX’s case, they created a few crypto’s and sold some coins to create a “market cap” for the coins and then borrowed real money against this fabricated crypto asset, bought more assets and applied more leverage, rinse and repeat.
Then there’s the “yield” product offered to exchange customers. As an example, the exchange would agree to pay you 2% on your Bitcoin and they would then take your Bitcoin and loan it to another exchange who would agree to pay your exchange say 4% and after paying you 2%, they would keep the 2% “spread.” If you read the fine print of these agreements, you basically give up your Bitcoin in exchange for the yield and you have to trust not only your exchange, but also the counterparty to the yield agreement that actually holds your coins. I was in one of these with my Bitcoin IRA sponsored by Digital Capital Group, which thankfully I exited and moved over to self-custody with Unchained Capital before all this mayhem started. I did my homework in that regard and my research indicated that Genesis was a pretty solid counterparty at the time, but not so much now since they recently froze all withdrawals. The borrower of the Bitcoin of course is speculating that the price of the Bitcoin will go up such that they can earn a profit after paying the interest on the loan. However, when the market crashes, this type of leveraged investment no longer works and borrowers either have to pay back the loan or post additional collateral.
Digital Capital Group / Genesis, one of the largest cryptocurrency companies in the space is looking for $1Bn in fresh capital as a result of the knock on effects of the other exchanges going out of business, most recently FTX. If you are interested in a great recap of the DCG/Genesis situation, check out Arthur Hayes’ latest essay here. There are a lot of potentially bad outcomes for Bitcoin, the worst of which would be the liquidation of the Grayscale Bitcoin Trust, which is the largest institutional holder of Bitcoin. This would definitely depress the price of Bitcoin further, although I still believe that would be temporary.
Liquidation is a very low probability event, however. As Hayes points out, the Grayscale Bitcoin Trust (GBTC) is a very valuable asset, mostly due to the 2% management fee the sponsor earns. I guess this is a version of “you are the yield” since as an investor you can’t convert your GBTC shares directly into Bitcoin and your only option (other than holding on and continuing to pay the fee) is to sell them to someone else on the market, most likely at a much lower price than you bought at. You wouldn’t do this if you thought there was a chance that GBTC would get converted into an ETF at some point in the future, which would remove the discount almost immediately since it would directly track the daily price of Bitcoin and / or if you expected the price of Bitcoin to recover substantially. Indeed, there are some investors that see this as an interesting speculation now, although I’d prefer just buying Bitcoin directly. There will be some institutions who will want to buy the GBTC fund and keep it intact, especially since there is no alternative in the US, with no Bitcoin physical ETF’s approved yet and none likely anytime soon plus the “locked in” Bitcoin and fee yield.
Grayscale Bitcoin Trust shares are currently trading at a 40% discount to Net Asset Value, meaning you can theoretically acquire Bitcoin at a 40% discount to market by buying these shares. The huge discount is most likely because there are concerns that the Bitcoin may not be there (suspicions that it may have been loaned out or leveraged away to a counterparty in a bad loan), concerns about the financial viability of the sponsor, or as mentioned above in the event of liquidation the price of Bitcoin would plummet. At this point, there is zero trust and everyone and everything is being called into question. Are the coins really there? Who has them? How do we know? Was there an audit? The fact that Grayscale wasn’t willing to provide cryptographic audit proof got some people nervous:
Here’s one take after Coinbase Custody confirmed that they do in fact have all of Grayscale’s Bitcoin held in cold storage and they haven’t been lent out:
While we may still see further downside to the Bitcoin price in this bear market, long time Bitcoin investors know that the bear market is the time to accumulate more Bitcoin.
It’s important to understand the difference between Bitcoin, which is a truly unique digital asset and “crypto” which is nothing more than a digital version of the traditional finance system we have today, only with less regulation and more fraud.
As a refresher, these are the qualities of Bitcoin:
Absolutely scarce (21M maximum coins)
Transfers are peer to peer without an intermediary; you can send value to anyone, anywhere in the world with a computer and internet connection
The Bitcoin network operates independently of all legacy financial systems; it is the first digital global payments infrastructure
No counter party risk when self-custodied
Trustless; Bitcoin is not controlled by any person or group
A hedge against fiat currency debasement / collapse in the same way that gold is, but doesn’t have gold’s drawbacks of difficulty to validate, store, transfer and secure - especially in large amounts
So in summary, we can trust Bitcoin that we hold ourselves, but we can’t trust “crypto” nor can we trust centralized exchanges. Where, then does a person buy their Bitcoin if you can’t trust the centralized exchanges?
Here are a few places that I have used that are Bitcoin native companies and have worked pretty well for me:
Strike - You can download the app on your phone and purchase Bitcoin for no fee. The only downside is there is a daily cash deposit / Bitcoin purchase limit of $1,000, so if you want to make larger purchases you may want to choose one of the other options. Also, you can setup direct deposit from your paycheck that can go straight into Bitcoin which is great for dollar cost averaging. Strike has a number of different recurring purchase options, so you can setup an auto transfer from your checking or savings account periodically during the month and then schedule recurring Bitcoin purchases. I tried doing daily purchases for a while, but it’s a bit much for recordkeeping so I just went with twice a month with part of my paycheck. You can easily transfer your coins at any time to cold storage (just scan the QR code of your cold storage wallet, verify and send).
Swan - They just launched a mobile app, but I have so far only used their website. You can do recurring ACH transfers from your bank account or wire funds in to your account. Funds have to clear before they can be converted into Bitcoin, so the best way is to wire funds since that clears immediately and you can purchase right away. Swan charges a 1% transaction fee. The coins can be withdrawn almost immediately into cold storage and they also have an option to setup auto withdrawals. Their security is very good (they send you a link and a passcode to login and they also use two factor authentication). Before withdrawing to cold storage for the first time you have to confirm your wallet address and they also send you an email confirming your withdrawal and giving you a chance to lock your account in the event for some reason your account gets compromised.
Unchained Capital - Unchained has always had a trading desk, but the limits were rather high. Now they have made the minimum purchase lower ($2,000) and you can buy spot with a 1% fee and wire funds by the next business day. Once they receive the wire, they deposit the Bitcoin directly into your Unchained multi-sig cold storage, so there’s no need to have to separately move the coins. Unchained also has great security including two factor authentication and they act as a collaborative custodian, which means you always have control over your coins in a two of three multi-signature setup (you hold two keys and they hold one key). I really like the services they offer, which includes a self-custody (multi-sig) Bitcoin IRA, self-custody (multi-sig) vault for non-retirement Bitcoin and they also offer Bitcoin loans in case you need to use your Bitcoin and don’t want to sell. I haven’t done a loan yet but may do one in the future. My understanding is that it’s very quick since they are lending against the value of the Bitcoin so there is minimal documentation, unlike other types of loans like a mortgage for example. I checked and current rates are 12%, the loan to value ratio is 40% and there is a 1% origination fee; minimum loan amount is $10,000. You basically pay interest only every month and then the balance is due at maturity (they offer 6 and 12 month terms). The Bitcoin collateral is stored by Unchained in a multi-sig vault where you hold a key, they hold a key and a third party custodian holds the third key - this helps enforce Unchained’s inability to rehypothecate the collateral (basically loan it out again to someone else to make more money).
As you can see, there are many alternatives to Binance, Coinbase, Crypto.com, or any of the other remaining centralized crypto exchanges to buy Bitcoin. The Bitcoin community is alive and well as I learned at the Pacific Bitcoin Conference a couple of weeks ago - check out my recap here:
There continues to be a lot of innovation in the space and there are many Bitcoin only companies that are developing better financial services on the Bitcoin network that are aligned with the ethos of the Bitcoin community. So stay humble and stack sats and also hold your own keys! As far as self-custody goes, I have a prior post on this that goes in to more detail here:
It’s not really hard to buy a Coldcard, Trezor or Ledger signing device (always direct from the vendor, not from Amazon or other reseller!) and watch a YouTube video or two on how to set up your device. Many people are worried about self custody since we are all trained not to self custody our assets. Instead, we are taught to put our money in a bank or other financial institution and let them take care of it. To take full advantage of Bitcoin, we need to unlearn this and so getting comfortable with self custody is important. The best way is simply to get started with a small amount and try moving the coins around between wallets. Once you do it a few times and have more confidence it gets a lot easier!
Not financial or legal advice, for entertainment only, do your own homework. I hope you find this post useful as you chart your personal financial course and Build a Financial Fortress in 2022. To see all my books on investing and leadership, click here.
Always remember: freedom, health and positivity!
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