Why would banks and exchanges need to pause withdrawals if they’re in financial trouble?
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Problem often occurs is that customers are requesting more withdrawal than the bank/exchange has in liquid assets: in other words, they don’t have the money to provide to the customers who want it.
Because banks generally don’t hold enough assets to cover all of the deposits, entirely because it’s more lucrative to loan that money out. If too many people try to withdraw their deposits, the bank becomes insolvent and people’s money disappears. The only way to prevent a complete collapse of the bank is to stop people from withdrawing money, but this doesn’t exactly inspire the confidence needed to deposit money in said bank.
In most real banks, the bank deposits are ensured up to a certain amount by the local government, and the banks are forced to keep a certain fraction of their deposits on hand to handle bank runs.
In banks that deal in products not ensured by local governments (i.e. crypto), there are no such rules, so the “banks” can loan out far more than they actually have on hand, because no one’s going to stop them.
But this obviously becomes a problem in the event of a bank run.
If you’re a bank, the worst thing that can happen is someone coming up to the counter asking for their money and you not being able to give it to them. That causes your customers (account holders) to lose all confidence in you, and they will all promptly try to withdraw their money in hopes that they can get some of their money out. This is called a bank run or a run on the bank.
Side note: most if not all privately held accounts at banks are protected by the FDIC, the Federal Deposit Insurance Corporation. The FDIC protects banks and their customers by guaranteeing each account up to $250,000; if you try to withdraw and the bank is unable to pay you, the FDIC will pay out for you instead.
So a bank temporarily stopping withdrawals is a way to get ahead of a bank run. The idea is to buy time while the bank tries to get more funds in (from loan payments or other assets), so that they can reopen later, pay out withdrawals, and not run out of money.
Basically, banks use your money to lend to others to make more money. If you deposit $10,000, and Billy wants to borrow $2,500, I can take that from the money you deposited and lend to Billy and charge him interest. As longs as you don’t come and ask for more than $7,500 before Billy has paid it back, I’m a happy banker. But perhaps Lisa has also deposited $10,000, so even if you do ask for your $10,000 back, I can use $2,500 of what Lisa deposited to make up the difference. As long as I don’t lend too much, and the more customers I have,, the less likely I’m going to be caught out without enough money to cover people’s withdrawals. But if something happens in the economy, and everyone panics, I could be in trouble.
Problems = They don’t have enough money.
Withdrawls = People taking money out of the bank. It makes more problems.
The banks don’t actually have all the money people invested into them. They take your money and loan it out to other people. They only have to keep a small fraction in reserve.
If you’re the first person to withdraw, you get your money. If you’re the last person to withdraw when there’s a run on the bank, you get to hope the federal government will eventually give you your money.
They don’t have the money.
You deposit 100, they lend 80 of it. 20 bucks are at high risk, 60 is loaned against stable assets. Now assume they do this for all depositors and they all decide they want their money back at once. The bank will need to borrow the money themselves OR demand immediate repayment of all loans in full. And forcing everyone to sell assets to repay loans will immediately sink the economy.
And now assume they lend 80 and 20 bucks are against secure assets and 60 is high risk. In troubling times, risky banks can quickly fail.
Now these are very simplistic examples and modern banking can be much more complex and extreme. But this is one example of why it might happen.
Banks loan money out and don’t have all their cash on hand. Halting withdrawals gives them time to either borrow some cash / or call/sell some loans to get cash.
If exchanges are making loans they are in the same scenario.
Banks do not (and cannot) have the amount of cash in the vault that their customers have in their accounts. The fundamental business model of a bank is to take money that’s deposited and then loan out $X of it to other customers.
Banks invest your money to make themselves money, and they can’t necessarily pull out of those investments fast enough. If you add up the totals in everyone’s accounts, this is *way* more than the bank actually has on hand. Your account balance is less an accurate representation of how much of your money the bank is holding and more a promise that they’re totally good for it when you need it. Normally this isn’t a problem – some people withdraw money, some deposit it, it pretty much balances out. But if large portions of their customer base try to withdraw all their money at once, the bank probably doesn’t have the money to give out.
This is exactly what happened to Northern Rock in the UK in 2008. News that they were struggling prompted lots of their customers to try to withdraw their money just in case they couldn’t later. Large numbers of people trying to withdraw money the bank didn’t have on hand is what then caused the bank to actually go under (the British government ended up stepping in to prevent people losing their money).
They don’t actually have all the money anymore. If they get into to trouble everyone wants all their money at once but the bank hasn’t had even close to that amount so they lose everything and a lot of people suddenly do too.
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