How to Keep Your Crypto Safe

November 2022 has been a rough month in the crypto markets. The collapse of FTX has thrust the storage of crypto assets into the limelight. Crypto investors are scrambling around wondering if their assets are safe. Now is a perfect time to understand the safest way to store your crypto.

The first thing you need to understand is the concept of private keys and custody. The private key is a piece of cryptographic data that allows you to move crypto assets. It is similar to the password on your bank account which allows you to manage and move your assets. Without this private key, your cryptocurrencies are immovable i.e. they cannot be sent. Custody is the concept of who controls these private keys for you. When you store your crypto assets on an exchange you are entrusting that exchange with your private key. When you want to send Bitcoins from your exchange account to another address, you are effectively asking that exchange permissions to send the tokens. Your right to ownership is nothing more than a number in a database - much the same as the relationship you have with your bank. When you decide to outsource the custody of your crypto assets to a third party like an exchange, you need to be confident that the third party will always allow you access to these assets.

Consider this extract taken from Coinbase on the issue of preventing access to funds: "In extremely rare circumstances, and only when required by law, Coinbase may block or freeze funds in our platform. We will take this action only when 1) we are required to comply with a court order or other authority that has jurisdiction over Coinbase which compels us to restrict access to funds, and 2) we are required by law to freeze or block assets in compliance with a sanctions program, including, but not limited to sanctions programs administered by the US Office of Foreign Assets Control".

The risk of using a third party for custody of your assets is twofold. The risk can come from within the exchange or externally. The lesson learned from the FTX collapse is that exchanges do not segregate your assets. They can "borrow" them and use them in other transactions. They can lend them out, leverage them, or trade them for their own account with the understanding that they will be there waiting for you when you decide to withdraw them until they are not. With FTX there was a run on the exchange. When the price of FTT tokens - which are exchange tokens issued by FTX - started to fall precipitously, investors got spooked and wanted to withdraw their money. Several billions of dollars were liquidated but then liquidity dried up because the exchange was unable to move all the assets back into the accounts. This commingling of funds is common in finance. Banks have been doing it for decades. They make money from taking your money in, paying you interest, and then lending that money out at a higher interest rate.

The second threat comes from external hackers, the modern-day bank robbers. If you want to steal money, you need to rob a bank. If you want to steal a digital asset like Bitcoin, you need to hack into a crypto exchange. While most exchanges have top-tier security and business practices, you can never be 100 percent sure that your crypto assets are safe. Most bank deposits are insured by the banks, the same is not true with crypto exchanges which are yet to be fully regulated.

The consensus in the crypto space is that you should self-custody of your keys. It is the same as you withdrawing all your cash from your bank accounts and storing those bills under your mattress. The downside of going this route is that you are now fully responsible for that private key - if you lose them or forget how to access it, you effectively lose those assets. Before you sit back and say that would never happen to you, consider the following fact: it is estimated that between 10 and 25 percent have been lost or cannot be accessed. That means that between 2 and 5 million Bitcoins will remain inaccessible forever.

So how can people safely secure their crypto? They do so by making use of wallets. There are numerous software wallets out there that can be downloaded for free and they include Exodus, Atomic Wallet, and Trust Wallet. These allow you to store your crypto by way of your private key on your PC, laptop, or phone. The obvious problem with this is that your private key is stored on your PC or laptop and they are only as secure as the security on these devices. If someone is able to hack into or install malware on your devices, then the security of your assets may be compromised. You also run the risk of installing a fake software wallet that was rigged from the get-go to steal your crypto. In September 2020, someone lost $16 million after installing an older version of his Electrum Wallet which was from a malicious source. You also run the risk of keylogging software that can steal your wallet password.

These wallets are known as hot because they are connected to the internet. This leads us to the alternative which is where you store your crypto in cold wallets that are offline. There are numerous ways you can store your crypto in a cold space, such as through a USB drive or on a piece of paper, which both bring with them obvious risks. USB sticks still need to be inserted into a computer and pieces of paper are vulnerable to numerous obvious threats.

Another option is a purpose-built hardware device. These are known as hardware wallets that store all your private keys. They are pin and password protected and have been designed so as to expose your keys to minimal risk.

There are a few rules when it comes to buying hardware wallets. The most important is to buy it directly from the manufacturer and not through a third party. If you buy through a third party, there is a risk that the wallet have have been tampered with and compromised. Another thing to look for is the tamper-proof seal that covers the input slot of the hardware wallet. If it has been broken, you want to inform the manufacturer immediately. You will then need to download software from the manufacturer's site and this will allow you to set up the wallet.

You will need to set up a seed phrase which is also known as a seed recovery phrase or a backup seed phrase. This is a list of words that store all the information needed to access your crypto. Wallet software will typically generate a seed phrase and instruct the user to write it down on a piece of paper. If your computer breaks or the hardware wallet is corrupted, you can download the software again and use the seed phrase on the paper backup to get your cryptos back. Each hardware wallet will have a different setup procedure and you will need to work through them. Some wallets allow you to set up standard wallets and hidden wallets. You can think of the hidden wallet as second-factor protection. It is not physically stored on the device and is only accessed when you enter the device. The benefit of these two wallets is that you can store a small amount of crypto in the standard wallet. This means that if someone threatens you to access the wallet, you can show them the wallet and they will only see this decoy account and not the main hidden account.

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