For many investors, security is a key component of their personal investment decision. Investing in cryptocurrencies involves certain uncertainties and special risks that investors should be aware of. If the investor has already done his own research and is investing, guaranteed access to his own assets should be ensured. This article focuses on the security aspects of various storage and trading options.
How to choose the right secure wallet in the world of cryptocurrency?
Security depends on the type of wallet you choose. A wallet is mainly needed for direct purchase and trading of cryptocurrencies. Coins (private keys) are stored and traded in the wallet. There are different types of wallets. Most investors use cryptocurrency exchanges such as Bison, Kraken and Binance, which create so-called custodial wallets for their clients.
Custodial (hot) wallet: In this form of investment, investors leave private keys to crypto exchanges. Investors can easily log in online and see the value of their coins, but they do not have access to the private keys. To enable 24/7 trading, some coins in a custodial wallet are usually connected to the internet. These internet-connected storage media are also called hot wallets.
Whether a custodial wallet is suitable for an investor largely depends on trust in the crypto exchange. Convenient 24/7 trading of cryptocurrencies is primarily associated with the possible loss of control, for example:
Theft: Third parties or employees can gain access to the wallet and make irrevocable transactions.
Trading freezes: Crypto exchanges are faced with the need to freeze balances and transactions, for example due to technical glitches or legal requirements.
Bankruptcy: In the event of bankruptcy of a crypto exchange, the location of the wallet balance cannot be reliably determined. The situation is aggravated by the fact that the location of the exchange is often different from the country of the investor, and there are no suitable precedents.
Non-custodial (cold) wallet: For tech-savvy and security-conscious investors, it is also possible to manage your coins yourself using your own wallet. These so-called non-custodial wallets allow the investor to store private keys. There are hot wallets that are connected to the Internet (such as MetaMask), or storage media that are separated from the Internet, such as a USB drive or a piece of paper. This form of investment is also called a cold wallet.
Self-governance gives investors more control over their coins, but on the other hand, personal responsibility also increases. Accordingly, the following risks must be taken into account:
Loss: If cold wallets or their associated private keys are lost, access to credit is no longer possible.
Manipulation: Used and dubious cold wallet offers should be avoided. In the past, there have often been cases of media manipulation, resulting in coins ending up in the wrong hands.
What is a crypto ETP?
Crypto-ETP: Regulation alone is not a guarantee of security. Unlike a wallet, there is an indirect purchase of cryptocurrency using an ETP.
A crypto ETP is a derivative security that is purchased and traded through a deposit account at a bank. All crypto currency ETPs are subject to capital market regulatory requirements and specifications. These rules vary widely and are partly part of the complex design of the product.
Most crypto ETPs approved in Europe are not futures based, but are 100% physically deposited. Physical registration of ETPs is not always based on the goodwill of the issuers, rather it is required by law in some countries to protect investors and has become an industry standard over time. But even if most ETP providers have a strong interest in protecting investors, a physical deposit does not automatically go hand in hand with 100% capital protection. The following sections are intended to highlight the efforts of issuers to provide secure storage while at the same time alerting investors to possible security gaps.
Custodian: For physical deposit, crypto ETP providers often rely on regulated depositories, called custodians. Custodians are primarily responsible and verified for the safety and sale of coins. Established issuers like ETC Group or 21Shares like to use established providers like Coinbase Custody. Similar to a custodial wallet, custodial coins are held by a custodian and therefore have similar security risks.
Access: Coins held by custodians can also be a target for theft. However, compared to direct client businesses, custodians often implement more security mechanisms and are insured against third party interference. Here, however, it is important to keep in mind that the sum insured usually only covers part of the total property.
Trustee and Administrator: An independent administrator and trustee are also often appointed. Both support ongoing business and are intended to protect investors from abuse or improper interference by the issuer.
Jurisdictions: Often the issuer, administrator and trustee are located in different jurisdictions. Even if the parties have entered into agreements between themselves, in the event of a settlement agreement, there will most likely be disagreements and, as a result, delays.
Usage: A still unverified crypto ETP settlement will cause unexpected costs. Expenses such as legal and court fees are usually paid to investors. Therefore, it can be assumed that in the event of a necessary settlement, 100% physical coverage will not result in a full recovery of the investment amount.
Conclusions. How best to use a crypto wallet as an investor.
Investors can use a wallet to take care of the safety of their coins and therefore need to work intensively with different types of wallets and providers. A custodial wallet can convince with its ease of use, which, however, comes with an increased loss of control. With crypto ETPs, investors benefit from common capital market rules and established processes. However, some are very complex and typically cost investors a small annual management fee. Additionally, investors should not be lulled into a false sense of security when it comes to a 100% physical deposit.
