‘Not your keys, not your crypto.’ So goes the modern-day adage of the wise crypto investor.
Events of 2022 have certainly vindicated the statement, given the tsunami of multibillion-dollar collapses, ranging from Terra LUNA’s US$20bn death spiral to the recent FTX catastrophe.
Customers, inevitably, bore the brunt of these collapses, and in lieu of adequate regulation, risk remains extremely high when dealing with digital asset exchanges and crypto lending platforms.
With billions upon billions of user funds in limbo, you could be wondering how to protect yourself from future collapses.
Without a doubt, investing in a decent cryptocurrency wallet is the easiest, most efficient way to safeguard yourself.
Crypto wallets are divided between three categories: Hot, cold and custodial
Custodial wallets
Custodial wallets are easy to explain: They are what digital asset exchanges use to store your crypto. All major exchanges, including Coinbase (NASDAQ:COIN), Binance, Kraken and FTX use/used to use before collapsing, hot wallets.
2022 has gifted us with a firm lesson: Custodial wallets are a bad idea.
Since your coins are held in custody, they are prone to being exploited, even when Terms of Service pledge otherwise- as was the case with FTX.
The same was true of Celsius Network and Voyager Digital (CSE:VYGR, OTCQX:VYGVF).
It should be noted that this is exactly how regular banks work too: Your cash doesn’t just sit there, it gets used by financial traders to compound gains.
The main difference is banks have consumer protections and insurance coverage, crypto exchanges have none.
Hence why, as unsecured creditors, you’re highly unlikely to get all or even part of your crypto back if and when another exchange goes bust.
The lesson is crystal clear: Keep your coins off the exchanges.
Hot Wallets
Hot wallets are the most common of the non-custodial kind, with some popular brands including:
- Trust Wallet
- MetaMask (for Ethereum-based tokens only)
- Atomic Wallet
- Exodus
Trust Wallet recently got the nod of approval from Binance head Changpeng ‘CZ’ Zhao after making the dramatic declaration that “self custody is a fundamental human right”.
Perhaps he should say it louder for the customers who currently entrust Binance with over US$60bn, though in his defence, CZ has been banging the self-custody drum for years.
As a consequence of CZ’s endorsement, TWT token, which gives holders certain benefits and discounts when trading crypto in Trust Wallet’s app, doubled in market value in mere days.
Yes, hot wallets require a small degree of technical knowhow, though that is probably not the biggest risk factor.
To access your hot wallet, a 12 or 24-word seed phrase is required. If you lose that phrase, you lose your crypto, probably forever. Unlike the bank, there is no customer service hotline.
Far from an isolated incident, crypto’s short history is littered with instances of people losing huge sums of cryptocurrency for simply forgetting their phrase, so it shouldn’t be taken lightly.
FYI: Some exchanges, including Coinbase and Robinhood (NASDAQ:HOOD), provide a hot wallet option, though they tend to automatically use custodial wallets as standard.
Cold wallets
Cold wallets, or hardware wallets, are the Fort Knox of cryptocurrency wallets.
Typically resembling a flash drive, cold wallets allow you to store your crypto offline, out of reach from hackers and other malicious actors, locked in a safe if you wish.
Ledger pretty much corners the cold storage market, though Trezor and Ellipal are popular options too.
A typical cold wallet (or hardware wallet) resembles a USB stick – Source: shop.ledger.com
While they can set you back a couple of hundred dollars, cold wallets provide unrivalled security for your crypto assets, though they aren’t foolproof.
Just like hot wallets, cold wallets require a 12 or 24-word phrase to access, but there’s an added danger of physical damage to the device, or loss.
One of the most famous instances involved Welsh engineer James Howell, who accidentally threw away a device containing 8,000 bitcoins in 2013.
Howell paid £200 for those bitcoins; today they’re worth more than one hundred million pounds.
To this day, Howell continues to search the Newport landfill in hopes of retrieving his wallet.
It’s an extreme case but serves as a warning that even hardware wallets have an element of risk, and once again, there is no customer service hotline there to help.
Roundup
There are a range of crypto wallets out there, ranging from free online apps to high-cost hardware devices, and they all come with varying degrees of risk.
Weight up your options and dig into the finer details before deciding what’s best for you.
Given the abundance of choices, many of which are free, there is little reason to entrust a centralised exchange with your bag.
Once again: Not your keys, not your crypto!