Why centralized exchanges can’t protect users’ assets from the government

If you are thinking of investing in cryptocurrency, the first thing you may have to consider is where to keep your crypto assets. You also have to think of which crypto exchanges to use if you’re interested in buying or selling cryptocurrencies like Bitcoin or Ethereum. In the end, you only have two options to choose from: decentralized exchange (DEX) and centralized exchange (CEX).

Decentralized exchanges (DEXs) are peer-to-peer marketplaces without a central authority. DEXs enable cryptocurrency traders to make transactions directly without handing over management of their funds to an intermediary or custodian. These transactions are often facilitated on blockchain networks using self-executing agreements written in code called smart contracts. Examples of decentralized exchanges include exchanges such Coinbase, Binance, Crypto.com, BlockFi, among others.

The other option you have is a centralized exchange or CEX. Unlike DEX, centralized exchanges (CEXs) are organizations that coordinate cryptocurrency trading on a large scale. Most of these exchanges use a business model similar to the traditional asset exchanges like the New York Stock Exchange. Kraken is one of the well-known centralized exchanges. Others include Bithumb, Bitfinex, Bittrex, Poloniex, Kraken, GDAX, Coinbase and Gemini.

For those that are new to the crypto investing world, centralized exchanges are exchanges that don’t allow their users to control the private keys of their crypto assets, but instead keep those keys in a centralized server. In addition, transactions on centralized exchanges are not anonymous, making it easy for the government to identify owners of the crypto assets. The centralized nature of centralized exchanges also leads to single points of failure, which ultimately opens up the possibilities of hacking by malicious actors.

In recent years, decentralized exchanges are beginning to grow in popularity as a non-custodial way to trade assets without the need for a middleman. However, CEXs offer some advantages including more liquidity and stronger regulatory assurances, which can especially be appealing to institutional clients. However, the question is, how safe are the assets kept in centralized exchanges? Can centralized exchanges protect your crypto assets from government censorship or seizure?

Crypto Censorship

Recent events in Canada are a reminder that centralized exchanges cannot protect crypto assets from the government. Before we deep dive into the Freedom Convoy protest back in February, it’s important to remember that centralized exchanges, just like other financial institutions, are mandated by the government to know their customers under the KYC rules. KYC or “Know Your Customer” is standard practice while opening an account with a bank or exchange, proving that you own your government-issued credentials like a passport.

In Early February, Canada’s “Freedom Convoy” protested against COVID-19 vaccine mandates and restrictions in Ottawa. Then a few days into the protests, Canadian Prime Minister Justin Trudeau invoked the Emergencies Act for the first time since that law was enacted in 1988. Part of this campaign aimed to restrict cryptocurrency transactions in a bid to strangle the flow of funds demonstrators were using to bankroll the illegal protests.

For the uninitiated, the Emergencies Act is a decades-old statute authorizing the Canadian government to take extraordinary temporary measures in response to public emergencies when all other existing laws fail to adequately address the crisis at hand.

“This is about keeping Canadians safe, protecting people’s jobs, and restoring faith in our institutions,” Trudeau said.

The value of your freedom to transact

After the law’s enactment effectively authorized banks and other financial institutions to freeze accounts associated with the trucker convoy, supporters of the protest then attempted to do an end-run around those economic blockades by raising funds through cryptocurrency donations. In response, the Canadian government ordered financial institutions to stop transactions of 34 crypto wallets tied to ‘Freedom Convoy’ anti-mandate trucker protests. The Canadian government also blacklisted several of the dissidents’ Bitcoin wallets.

It should be noted that decentralized cryptocurrencies like Ethereum and Bitcoin cannot be frozen directly within the network. Consequently, the Canadian government has implored centralized entities like payment processors and crypto exchanges to freeze funds connected to specific digital currency addresses. And although it’s unclear how successful they’ll ultimately be in this effort, many industry watchers believe this is an egregious overreach, nonetheless. In a post, popular Twitter user @punk6529 tweeted “Without the freedom to transact, you have no other constitutional rights.”

They continue to explain that in order to freely dispense information, one might require a website, a pamphlet, or an advertisement. Similarly, freedom to practice religion may require renting space to worship, buying food and consumables, and paying the salaries of religious officials. Simply put: exercising one’s rights can cost money, and the state cannot punish people and take away those rights without due process, which generally means proving a specific law was broken.

Major players in the space likewise chimed in after news of the Emergencies Act enactment, including Ethereum founder Vitalik Buterin, who acknowledged the complexities of this issue.

“If the truckers are blocking the roads and that’s breaking the economy, fine, blocking the roads is illegal,” explained Buterin, at a recent industry conference. “But if the government is not willing to follow the laws…and they just want to talk to the banks and basically cut out people’s financial livelihoods without due process, that is an example of the sort of thing that decentralized technology is there to make more difficult.”

Why centralized exchanges can’t protect you and your crypto assets

Regardless of where you fall on the debate, the prevailing sentiment is that these asset freezing attempts will indeed take place, sooner or later.

Fortunately, we have non-custodial and decentralized platforms like Portal that empower individuals to freely transact without censorship. Portal swaps move provable execution of cross-chain contracts to layers 2 and 3, thus allowing speedy transactions like their centralized alternatives while still maintaining the robust security of Bitcoin.

Days after the enactment, Jesse Powell—CEO and cofounder of Kraken, one of the largest crypto exchanges, strenuously advocated people divest their coins out of custodial wallets as a precaution, tweeting: “100% yes it has/will happen and 100% yes, we will be forced to comply. If you’re worried about it, don’t keep your funds with any centralized/regulated custodian. We cannot protect you. Get your coins/cash out and only trade p2p.”

Closing thoughts

Jesse Powell, who had donated one Bitcoin to the Freedom Convoy, admitted that his own crypto exchange Kraken cannot protect users from the authorities freezing crypto. Whether it’s Canada or another country, centralized exchanges such as Kraken will be “forced to comply” with law enforcement. Users who want greater control over their assets need to get their crypto out of centralized exchanges.

Although centralized exchanges may not be able to protect you from government censorship of your digital assets, some crypto providers not going down without a fight. In late February, The Ontario Superior Court of Justice asked self-custody crypto wallet provider Nunchuk to freeze and disclose information about the assets involved in the anti-mandate Freedom Convoy 2022 movement. Nunchuk is a Bitcoin wallet that allows you to manage your bitcoin securely from multiple devices.

In response, Nunchuk rejected the request saying, “Dear the Ontario Superior Court of Justice, Nunchuk is a self-custodial, collaborative-multisig Bitcoin wallet. We are a software provider, not a custodial financial intermediary.