Digital assets are powered by blockchain technology, which is a distributed, immutable, and public ledger that contains a list of all transactions processed within a network. More specifically, blockchain is a chain of blocks or data structures where transaction data are permanently recorded. Blocks also have a record of some or all of the blockchain’s previous transactions. In summary, blockchain technology creates a secure and tamper-proof method of recording transactions.
However, this does not mean that it’s impossible for bad actors to infiltrate someone’s wallet and steal their crypto holdings. Cryptocurrencies are built on public-key cryptography (PKC), a cryptographic system that uses public and private keys. Public keys allow users to receive cryptocurrency transactions—meaning it’s not dangerous to share these keys publicly. However, a private key is needed to unlock those transactions and prove that someone is the owner of the crypto received. Private keys should never be shared—ever.
Private keys are like a gateway to a wallet’s crypto holdings—and the only security measure protecting users from thieves and malicious access to the wallet. Since the key is a highly sophisticated string of letters and words, it is highly improbable for a user to randomly guess it. However, if a bad actor gains access to a wallet’s private keys, they can transfer all of the crypto inside the wallet. Therefore, crypto users need to scrupulously choose a safe place to store their private keys.
Among the different methods of storing cryptocurrencies, there are also different levels of vulnerability. Much of this depends on who has access to a user’s private keys.
Centralised Cryptocurrency Exchanges Are Prone To Hacks And Exploitation
The majority of crypto users prefer to store their crypto holdings on centralised crypto exchanges, and for good reasons. Crypto exchanges constitute the easiest and most user-friendly ways to buy cryptocurrencies. Many of these reliable crypto exchanges provide users with hundreds of trading pairs, the ability to cash out into fiat currency at any time, and the option to choose from a wide range of payment and withdrawal methods. Not to mention that centralised crypto exchanges have done a nice job of creating an easy-to-use and friendly platform—which can be rare in the digital asset space.
However, these exchanges are always prone to security breaches and hacks, as centralised crypto exchanges hold their users’ private keys. As a result, popular exchanges have billions of dollars worth of digital assets, which makes them an attractive option for hackers. Furthermore, at times, the trouble may also originate from within the exchange — i.e., the exchange may mismanage or even somehow lose the private keys.
Just recently, major crypto exchange Crypto.com was hacked for more than $34 million worth of digital assets. The incident affected 483 of the exchange’s users, who were drained from their crypto assets without any authorisation. Crypto.com claims all of the affected users have been reimbursed, but the incident reminds everyone that centralised exchanges—despite their convenience—are not 100% secure when it comes to storing crypto assets.
The Many Ways To Store Cryptocurrencies
Mobile, desktop, web, and most exchange custody wallets are categorised as hot wallets. In simple words, hot wallets are online wallets that run on internet-connected devices like computers, phones, or tablets. Hot wallets are easy-to-use as they enable users to access their funds at any time and make transactions quickly, but they lack security. These wallets generate private keys on internet-connected devices, which creates a vulnerability.
Hot wallets are designed to be used for small amounts of digital assets or temporary purposes. These wallets can be compared to checking accounts, which are suitable for storing only spending money while the bulk of the money is expected to be stored in other forms, such as savings accounts. Examples of hot wallets include MetaMask, Coinbase Wallet, and Edge Wallet.
Another type of wallet is the cold wallet, also referred to as an offline wallet or cold storage. Unlike hot wallets, cold wallets are not connected to the internet which makes them much safer. These types of wallets usually come with software that enables users to view stats regarding their crypto holdings without the need for the internet.
An example of a cold wallet, and arguably the most secure type of crypto wallet, is a paper wallet. A paper wallet produces public and private keys that can be printed out on a piece of paper, without which no one can access digital assets stored in those addresses. Paper wallets are very rudimentary and have no corresponding user interface.
Hardware wallets are another type of cold wallet. In general, these are devices in the form of a USB drive that store private keys but are not connected to the internet. One major advantage of these wallets is that they are not affected by viruses that can easily compromise hot wallets and steal one’s private keys. The two leading hardware wallet manufacturers are Trezor and Ledger.
It is worth noting that cold wallets require some level of technical knowledge to set up. Further, while all types of crypto wallets come with UI/UX hurdles, cold wallets are considered even more difficult to work with. Many users have lost funds due to errors and a lack of familiarity with cold storage.
Beware Of Crypto Scams
The crypto industry’s eye-popping growth has attracted a horde of scammers and defrauders who are constantly trying to discover new and creative ways to trick crypto users and steal their assets. While their techniques evolve every day, their principle is almost always the same: they promise considerable returns within a short amount of time.
Prevalent types of crypto scams include fake celebrity endorsements, fake giveaways, and rug pulls. Therefore, users need to stay attentive and do proper research before investing in a crypto platform.
According to a report by blockchain analytics firm Chainalysis, more than $7.7 billion worth of digital assets were stolen via scams in 2021. Notably, Finiko, a Ponzi scheme that posed as a legitimate BTC investment firm, accounted for more than $1.1 billion of that tally. Finiko attracted big investors by promising returns of up to 30% monthly.
Some traders prefer to avoid the custody of digital assets altogether by turning to various derivatives trading as a means of access to cryptocurrencies. There are several different ways this can be achieved, from futures to options, and even trading binary options contracts. However, all of these represent a sophisticated means of trading and should only be undertaken by experienced traders.
For those who prefer to buy, store, and trade cryptocurrencies directly, a general rule that can help avoid scams is to abstain from new and non-reputable crypto firms, particularly those that offer well-above-average returns. Furthermore, investors should always keep two golden rules in mind, to be safe: only invest what they can afford to lose, and, if it’s too good to be true, then it usually is.