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For example, would an exchange of Bitcoin hold accounts for 100,000 customers, and they collective have 8000 bitcoins, but the exchange itself does not hold 8000 bitcoin, but only 1600 for customers to redeem (to transfer to their own wallet if they want to), and therefore, inflating the bitcoin supply by 6400 bitcoins?

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It's certainly happened before when there was less regulation or among the smaller, less-regulated exchanges. Whenever an exchange disables withdrawals for everyone, it could be due to them running into liquidity issues like that.

Large exchanges are now regulated by various money services authorities in part to prevent this exact scenario.

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  • how is it prevented? what is regulated? It would take a 1 to 1 requirement so that it is not inflated: if all customers have 8000 bitcoins, then the exchange must hold 8000 bitcoins Feb 20 at 10:36
  • @nonopolarity Financial audits by regulators and such as a condition of maintaining a license. The requirements are different for every state/jurisdiction, but regulated exchanges should hold 1 bitcoin for every 1 bitcoin owned by its customers.
    – ieatpizza
    Feb 20 at 11:49
  • "regulated exchanges should hold 1 bitcoin for every 1 bitcoin owned by its customers." Is that an opinion or hope, or is it a fact? You are saying an exchange in US or in Canada or South America or Asia may vary too? Feb 20 at 16:51
  • @nonopolarity That's the goal of properly designed regulation. The exact specifics of how that regulation is implemented is jurisdiction specific.
    – ieatpizza
    Feb 21 at 1:54
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    @ieatpizza: I think there is very little oversight of cryptocurrency businesses. For example see fca.org.uk/consumers/cryptoassets which says "most cryptoassets/services are not regulated". Even the more tightly regulated UK banks only have to meet a minimum reserve ratio of 12%. Mar 22 at 20:30

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