Bitcoin Investors Are Pulling Out of Exchanges in Record Numbers. Should You?

Here's why many investors are moving funds to external crypto wallets.

According to blockchain analytics company Glassnode, investors are moving Bitcoin (BTC) off crypto exchanges faster than ever. The company tweeted, "Despite weak price-action through June, #Bitcoin has been withdrawn from exchanges at the most aggressive rate in history."

The balances on exchanges have dropped by more than 20% from a Jan. 20 peak.

There are two reasons people are taking their crypto off exchanges. One is that some investors are selling. June's performance was one of the worst in Bitcoin's history, and a number of people decided to cut their losses and exit the market. The other reason is that long-term investors are moving assets into external crypto wallets, fearing contagion in the decentralized finance market.

Not your keys, not your crypto

When you first start crypto investing, you may well hear the phrase, "Not your keys, not your crypto." It's often used by old school investors who've already experienced a crypto winter and witnessed the collapse of several major platforms. Keys are essentially a password that controls access to your crypto. A crypto wallet manages those keys -- in fact, it would be more accurate to call it a crypto keyring.

Unfortunately, some investors have learned the hard way that if you don't control the keys to your digital assets, you don't fully own them. For example, withdrawals are still frozen on Celsius, a prominent DeFi lender. Other crypto platforms are also in trouble, and FTX CEO Sam Bankman-Fried says a number of them could fail.

For investors, the issue is that if your funds are in a custodial wallet on a centralized platform, that platform can freeze transactions and you won't be able to access your funds. Coinbase recently warned customers that if it filed for bankruptcy, their assets could be at risk. You may think it is your crypto in your account, but if that platform collapses, your deposits may not be safe. There's no FDIC insurance for cryptocurrency to protect consumers against platform failure.

This is why many investors are moving their digital assets off crypto exchanges to non-custodial crypto wallets. These can come in the form of hot wallets, which are connected to the internet, and cold wallets, which are offline. What's important is that nobody can freeze their access to their funds.

Should you move your assets out of an exchange?

There are two parts to this question. Should you sell your crypto altogether? And if you're keeping it, should you move it out of a custodial wallet?

The decision to buy or sell crypto depends a lot on your financial situation and your long-term view on how crypto might perform. One Bloomberg analyst summed up the situation well this week. Mike McGlone tweeted that Bitcoin could be on the verge of one of the greatest bull markets in history, or it may be a "failing experiment in the process of being made redundant."

It isn't easy to hold on through the tough times, and there are no guarantees about what might happen next. But if you only invested money you can afford to lose and believe crypto might eventually recover and perform well, these are compelling reasons to hold. If you've lost faith in crypto and fear it may fail completely, it could be a different story.

In terms of whether you should move your funds into a non-custodial crypto wallet, there are pros and cons to both approaches. The big issue with a crypto wallet is that you are responsible for its security and management. There's no handy button to press if you forget your password. As a result, billions of dollars worth of Bitcoin are sitting in wallets that people can't access anymore. Wallets can also be less intuitive to use, and some types only hold a limited number of different types of cryptocurrency.

However, there's also significant upside to using an external wallet: If your crypto exchange fails and you don't have any money on the platform, you won't suffer the fallout. If your funds are still on the exchange, they could be at risk. You may have to pay withdrawal fees, and you may also have to take assets out of interest-earning accounts. However, if you have significant amounts of money sitting on an exchange, now may be a good time to take a closer look at how crypto wallets work.