Crypto IOUs: The Hidden Risk in Your Exchange Balance
The concept of IOUs in crypto is often misunderstood by traders and investors. An IOU (I owe you) is an informal acknowledgment of debt, a record indicating that one party owes a specific amount to another without the legal structure of a formal bond or promissory note.
When you deposit $100 in a bank, you don't own $100 in cash; you have a $100 IOU from the bank promising to return that amount on demand. This is how the entire modern banking system functions: banks issue deposit IOUs far in excess of their physical cash holdings because the fractional reserve model assumes not everyone will demand redemption simultaneously.
The crypto equivalent played out at FTX in November 2022, where customer balances were IOUs from the exchange promising to return funds on demand. When FTX became insolvent, those IOUs became worthless. Users who had moved their crypto to non-custodial wallets held actual private keys and were unaffected.
IOUs did not disappear in decentralized finance; they evolved into new forms. Stablecoins are a common example of IOUs, with USDT promising to be redeemable for one US dollar. The reliability of this promise depends on the quality and existence of the dollar reserves backing it.