This is one article in a collection of 52 articles published weekly throughout 2023 on the basics of Bitcoin. The series is intended for people unfamiliar with Bitcoin or people wishing to enhance their understanding of the fundamentals that underpin the technology. Please contact us, if you have any questions or comments.
Anyone who enters the Bitcoin space will quickly learn that the Bitcoin community has some phrases that are frequently repeated to remind newcomers of the harsh mistakes made by early Bitcoiners in the hopes these fates are not repeated. One of those phrases is “Not your keys, not your coins.” The phrase is a poignant reminder to all Bitcoiners that the bitcoin belongs to the individual who controls and has access to the underlying private keys. With the recent news about Blackrock applying for a spot Bitcoin ETF along with numerous other mainstream financial players, we thought it was an appropriate time to review the concept of paper Bitcoin.
One of the most significant catastrophes in the early history of Bitcoin was the infamous collapse of Mt. Gox. In the early days of Bitcoin it was utter chaos trying to onboard individuals to purchase bitcoin. Mt. Gox was originally created in 2007, prior to the creation of Bitcoin, by Jed McCaleb as a platform to trade cards for a game called Magic: The Gathering Online. McCaleb eventually stepped away from the project but repurposed the website as a Bitcoin Exchange in 2010 shortly after he learned about Bitcoin. In early 2011 McCaleb sold the website to Mark Karpeles who turned Mt. Gox into the first major bitcoin exchange. At its peak in 2013 and 2014 the Mt. Gox exchange was handling over 70 percent of bitcoin trades!
While Mt. Gox had several hiccups along the way, catastrophe struck Mt. Gox and the Bitcoin ecosystem when Mt. Gox filed for bankruptcy in 2014. After the bankruptcy filing Mt. Gox revealed that it had lost 750,000 of its customer’s bitcoin and another 100,000 bitcoin that belonged to the company. This was perhaps the first lesson for the bitcoin community of not your keys, not your coins. Tragically, this lesson has been repeated countless times since Mt. Gox.
More recently, the FTX collapse illustrated the benefits of having access to the private keys associated with your bitcoin. FTX was a crypto exchange where users could purchase and sell a number of cryptocurrencies. After a thorough examination of the FTX assets, bankruptcy documents revealed that FTX held 6 million worth of bitcoin while it owed its clients1.6 billion in bitcoin. FTX created $1.594 billion in paper bitcoin out of thin air!
Paper bitcoin is a phrase used by the Bitcoin community to signify bitcoin IOUs. The risk of purchasing and holding bitcoin on any exchange is the exchange may not hold the bitcoin it says it does for the customers. While this was not a problem for users who bought and sold cryptocurrency on the exchange prior to the collapse as FTX serviced buy and sell orders, eventually the FTX scheme collapsed. This became painfully real for FTX customers who thought they had their bitcoin safely secured by a trusted third party.
In all likelihood FTX bitcoin holders are going to be receiving pennies back on the dollar (or maybe satoshis back on the bitcoin is more apt here). Fortunately, Bitcoin’s public ledger allows anyone to self-custody bitcoin and know with absolute certainty through verification on the Bitcoin network that their private key holds the bitcoin. In fact, the Bitcoin public ledger, which is immutable and open for all to examine, has recorded every single transaction that has ever occurred on the Bitcoin blockchain since the genesis block with exact precision. That's truly astonishing!
A spot ETF has been a feature some Bitcoiners have longed for as it will be easier for players that have been reluctant to participate in the Bitcoin market to join such as corporations and retirement plans. While ETFs are regulated and are better than investing in paper bitcoin from an unregulated exchange, holding bitcoin through an ETF leaves its participants exposed to all the risks associated with third parties. One of the reasons Satoshi created Bitcoin was to create a financial system where individuals could interact without a trusted third party. Any individual who holds his/her bitcoin through an exchange, trust, or ETF is relying on a third party and is putting his/her bitcoin at peril. Remember: Not your keys, not your coins!
