Unlike traditional securities that are typically bought, sold and held through a brokerage house, cryptocurrencies allow investors to manage and transfer their assets entirely peer-to-peer. For some, a major attraction of the digital-asset ecosystem is the ability to take custody of assets without the need for intermediaries like banks and brokers. Unfortunately, that means if you lose the seed phrase or private key to the wallet that holds your tokens– equivalent to passwords for online investment accounts–you lose your crypto. There is no email recovery or customer support in the world of self-custodied cryptocurrency wallets.
Luckily, there is a wide range of wallet options that lie on a spectrum from completely self-controlled to completely outsourced. Digital-asset holders should consider what is best for their personal situations. With options like cold storage (explained below), your personal security practices can matter greatly.
For the extremely risk-averse, there are ways to gain exposure to cryptocurrencies via traditional financial markets that provide third-party custody, usually through a broker. These include futures contracts and exchange-traded funds that invest in them, over-the-counter trust and publicly traded companies with crypto holdings or a dedicated business strategy in the industry including MicroStrategy
For those who elect to hold their digital assets outside of the traditional financial arena, deciding what kind of wallet to use is a must. The main options are: custodial versus non-custodial and hot versus cold. Users then have to select a specific wallet from those possibilities. Each option provides trade-offs between ownership, ease of use, and security.
Custodial Wallets
Custodial wallets are those that are held by someone on your behalf. If you keep assets on centralized exchanges like Coinbase, Kraken or Gemini, you have to use a custodial wallet. Custodial wallets are by far the most convenient because accessing your crypto is the same as a login experience for an online broker.
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Custodial wallets can be appropriate for the average crypto investor whose digital assets make up a small percentage of an overall portfolio. It also makes sense if you do not trust in your ability to store crypto. Having a custodial wallet involves opening an account with a third party. You use a username, password and typically a two-tier verification system like a personal-identification number or randomized authentication code. Users can also easily link
The biggest risk to custodial wallets are exchange hacks and the custodian becoming insolvent. Sophisticated exchanges will typically hold most of their coins in cold storage, have multifaceted authenticity measures and use complex firewalls. However, this does not mean that they are immune to attack. In 2019, hackers stole $40 million of bitcoin in an orchestrated attack that used phishing scams and viruses against the popular Binance exchange. Furthermore, as seen with centralized finance lending platforms and exchanges like Celsius
Non-Custodial Wallets
This category comes in two temperatures: hot and cold. Hot wallets are those that require an internet connection to access. They can be in desktop, web or mobile form. Cold wallets do not rely on the internet. Cold wallets are physical devices that are nearly impossible to compromise because they are not connected to the internet.
Hot Wallets
Hot wallets are sometimes referred to as software wallets.
Desktop wallets keep a user’s private keys stored on the computer’s hard drive. Desktop wallets are relatively easy to use. Examples include Exodus Wallet and Atomic Wallet for multiple digital assets or Electrum and Bitcoin
Unfortunately, desktop wallets can be susceptible to malware. A trend with non-custodial wallets is that your assets are as secure as your individual security practices– and people fall victim to phishing scams quite regularly. Between 2019 and 2020, hackers stole over $22 million of bitcoin from Electrum wallets by sending users fake messages telling them to update their software. When this was done, malware was installed that stole their funds the next time they logged into their desktop wallets. Such events can be avoided by retaining the official version of the software or only downloading updates from the official website.
Another kind of hot wallet is web-based. Web wallets include MetaMask, Phantom and Trust Wallet. Coinbase also offers a version for users that prefer self-custody. These wallets do not store private keys or personal information. They also allow users to sign transactions and interact with blockchain protocols. In addition, many popular decentralized applications have built integrations with these wallets to make it easy for users to access their crypto holdings when using them. For these reasons, they are the most popular type of non-custodial wallet. Like desktop wallets, they can also be subject to phishing scams and malware.
Cold Wallets
Storing your digital assets offline begins with choosing a hardware wallet. The most popular manufacturers are Ledger and Trezor. Though nefarious actors have been known to try to steal crypto by tampering hardware wallet devices, sometimes by compromising their supply chains, offline storage is by far the most secure because there is no internet connection involved.
With cold wallets, your crypto is as safe as your personal security practices. Theft, loss and physical destruction of the device does not have to mean a permanent loss of assets, as the seed phrase coupled with a new device can be used to recover the funds on a new device. However, theft or loss of both seed phrase and device usually means the assets are not recoverable. If maintaining physical custody sounds stressful, perhaps a custodial wallet or desktop wallet are options to consider.
One common security approach is to rely on custodial or software wallets for digital assets that will be used in the near
Conclusion
Crypto wallet options are a lot like storing physical gold. Some people don’t trust in their own ability to keep the metal secure in a safe at home. They can forget the combination or a thief who found it written down could access the gold. To avoid such anxiety, this kind of person would outsource crypto storage to a third party and have a custodial wallet, though that brings the risk of government confiscation.
“Not your keys, not your coins” is a common refrain among digital-asset aficionados who dislike third-party custody; but let’s be honest, the horror stories of people losing millions of dollars worth of bitcoin by misplacing their private keys are enough for anyone to second guess their ability to self-custody their tokens.
Crypto owners should know their priorities and limitations. For those that only have or want a small amount of exposure, some exchanges are heavily regulated and prioritize security. Dealing with private keys and cold wallets is not for everyone. At the same time, having all your eggs in one basket may not be the safest bet, especially if it involves a large part of your net worth.
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