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What are the advantages and disadvantages of keeping bitcoins in an exchange versus a private wallet?

Exchange advantages:

  • Liquidity - you can quickly trade bitcoins for dollars, and vice versa.
  • Can hold dollars directly

Wallet advantages:

  • No reporting requirements
  • Can quickly get at your bitcoins
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It is the trade-off between security (as Sly has elaborated) and flexibility to convert BTC into hard (cough!) currencies. Say you are some miner from the old days and keeping some thousand BTCs somewhere in your private wallet maybe you want to buy a nice car and you need $30,000 you could go to mtgox (or any other exchange) and sell these 1000 BTCs and retrieving the money (several limitations apply)

On volatile BTC exchange rates you may want to sell immediately however the transfer from your private wallet to the exchange account takes some time (around some hours(!) sometimes), maybe the rate has dropped already and you do not want to sell anymore.

You are buying this flexibility with the risk of a compromised account or a hacked website (MtGox was already hacked in the past,though no user bitcoin accounts we stolen ).

So keep a strategy how and where to transfer your BTCs

I usually hold only a limited amount outside my private wallets These are the BTCs I want to sell

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From what I understand it comes down to how you feel about security, to have a wallet stored privately means that you run the risk of equipment damage where you'll have to spend time on the recovery.

On the other hand you have the risk on network security, at least 2 exchanges have had high profile thefts occur in past years which have effected the market, exchanges make for big money targets and there's no real way to recover the funds.

Personally I think there is likely room for a hybrid solution between the two but I haven't seen anything yet.

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