Does Owning Crypto on Coinbase Count as Investing in Blockchain?
Centralized vs. Decentralized Exchanges
Coinbase exploded in popularity as the go-to application to buy, sell, and own cryptocurrencies. It was the most downloaded application from the Apple store not once, but twice over the last few years, in 2021 and 2017.
We know it may hurt some people’s feelings when we say this, but sadly if you own some cryptocurrency (“crypto”) on Coinbase, Robinhood, Kraken, or any of the other “centralized exchanges,” you are not actively engaging with blockchain technology.
Let’s break this down. First, exchanges. When we talk about an exchange, we are talking about a marketplace where commodities, securities, derivatives, and other financial instruments are traded. In traditional finance this includes the NYSE and the NASDAQ and they are considered centralized.
The reason they are centralized is because they facilitate the trades between buyers and sellers, acting as the middlemen or trusted intermediaries in the trades. They often are the custodians, which means they store and protect your funds, and as such they are highly regulated entities. This is the standard for traditional finance.
In crypto, we have centralized exchanges such as Coinbase, Kraken, the infamous FTX, and Binance. They work very similarly to the traditional firms in that you can purchase digital assets with cash or other cryptos, and they will facilitate the trade.
As the custodians of your crypto, these exchanges can set the rules on what you can and cannot do with your crypto. The crypto system famously relies upon public and private ‘keys’ to access your crypto assets. Your public key is the address where you can receive crypto assets (like a bank account number), and your private key is how you can access the funds in your public key, or to put it simply, a private password.
When you operate on a centralized exchange, they are the owners of your private keys. This means that they can set the terms of how you receive your crypto (similar to banks). They can set withdrawal limits and they take cuts of all transactions. Furthermore, many of these exchanges have in their terms of use agreements that people who hold assets on the exchange are actually ‘unsecured creditors.’ In other words, customers of these exchanges (they have money or digital assets in their accounts) are considered lenders to the exchange without any collateral, and in the event of a bankruptcy they will receive nothing.
There is a famous saying in crypto: not your keys, not your coins. Quite literally, centralized exchanges are the antithesis of the purpose of crypto, which is trustless transactions (meaning no need for middlemen or custodians) and fees getting distributed back to the people. What’s more, most of these exchanges are operating on typical cloud services such as AWS (aka not using blockchain technology) and are also operating outside the realm of regulatory authorities.
While centralized exchanges are somewhat useful in facilitating the exchange of cash for crypto, it’s pretty obvious that their structure is not ideal. This is where decentralized exchanges come in.
Decentralized exchanges exist on the blockchain using smart contracts. Smart contracts are programs that are stored on the blockchain and execute transactions when certain predetermined conditions are met. So, if you as a user would like to trade one crypto for another, you would go to a decentralized exchange, and engage with the smart contract that facilitates the exchange of the assets you are looking to trade. The technology acts as the middleman. There is no need for trust in a central authority. Furthermore, you are in control of your assets throughout the whole exchange.
This is a brief overview of decentralized exchanges (DEXs), but if you’d like to learn more, feel free to check out our more in-depth piece on them here.
Even though all of crypto and blockchain is unregulated to an extent, it is important to realize this difference between centralized exchanges and decentralized exchanges. Everyone can engage with crypto and blockchain however they see fit, but if the last year was any indication, it is obvious that centralized exchanges are extremely high risk (google the FTX collapse if you don’t believe us!).
We are solely focused on investing and trading on the actual blockchains and utilizing decentralized exchanges. We will continue to put out educational pieces as well as trading strategy pieces to make this a process that everyone feels they understand and can manage.
