If you have just started investing in cryptocurrencies, storing your coins in the wallet provided by your exchange might seem like a convenient option. The coins you buy are automatically added to the wallet generated by the exchange, and you don’t have to worry about anything, right?
Well not really. Your cryptocurrencies are only as safe as the tools you use to store them. And while exchange-generated wallets offer good security, they’re not entirely foolproof. Over the past few years, hackers have been able to siphon off millions of dollars from exchange-provided wallets.
Take, for example, the Mt. Gox hack, in which 850,000 Bitcoins were stolen from the exchange in 2011, or the Coincheck heist, in which $530 million worth of NEM tokens were stolen in 2018. These hacks are two of the most important in the history of cryptography. .
Read also :
Let’s look at a few more reasons why storing your crypto on an exchange isn’t exactly ideal.
1. You don’t control your private keys
Every crypto wallet has two keys: a public key and a private key. A public key is like your wallet address. It is used when someone wants to send you coins. On the other hand, the private key is like your wallet password. You must enter this key each time you want to access your coins. This key ensures that only you have access to the wallet.
However, for wallets provided by the exchange, your private key is also known to the exchange. This is useful if you forget your private key. Just approach the exchange and they will provide you with another private key after validating and verifying your details. However, at the same time, it is never advisable to share your private key with anyone. Therefore, an exchange having control of your private key is not something you would want.
A recent example is the QuadrigaCX controversy, where the private keys of thousands of users were lost after the owner of the exchange died. Investors reportedly lost access to nearly $190 million worth of crypto in the process.
2. Exchange wallets can be frozen or blocked
On rare occasions, exchanges have been known to freeze or block user wallets. This often happens without warning and can be frustrating for investors. Wallets can be frozen if there is fraudulent activity on the platform or if, God forbid, the exchange itself goes bankrupt. Therefore, if you use a crypto exchange, you should be aware that your account may be frozen or closed at any time.
Binance, one of the largest crypto exchanges, froze the accounts of several customers between late 2020 and mid-2021. Their development team didn’t even explain the reason behind the blocks. In 2020, users also accused crypto exchange, Coinbase, of freezing wallets during a Bitcoin bull run.
Some exchange-generated wallets also take a fee from your transactions. Although these fees are extremely marginal, usually between 0.1 and 0.2%, they can add up over time, especially if you transact frequently. And no one wants their hard-earned money wasted on paying fees!
What is the alternative?
Exchange wallets are known as custodial wallets. This is because an entity other than yourself has custody of the cryptos stored in the wallet. Therefore, instead of storing your crypto on an exchange, it makes sense to invest in a non-custodial wallet. These wallets give complete control, including the private key, to the owner of the wallet.
There are also different types of non-custodial wallets. First, there are non-custodial online wallets. They are similar to wallets provided by exchanges – they can be accessed from anywhere using a private key. Some examples of non-custodial web wallets include MetaMask and TrustWallet. These portfolios are ideal for small investors and for those who make frequent transactions.
However, if you have invested in large amounts of crypto and want to store it securely, a non-custodial cold wallet (hardware wallet) is your best option. These are physical wallets, often resembling USB sticks or external hard drives, that are not connected to the internet. This makes them almost immune to hacks. These wallets also have private keys that only you have access to. They also cannot be frozen or blocked. And while these wallets come at a steep price, the peace of mind they give you is invaluable. Some examples of hardware wallets include Ledger and Trezor.
However, remember that with noncustodial wallets, only you have access to the private key. Therefore, if you forget your private key, you lose all coins stored in the wallet.
If you still want to use exchange wallets, here are some things to look for:
– HTTPs: HTTPS is an encrypted and more secure version of the HTTP protocol. It ensures that your data is neither captured nor modified when it is sent to a web server. All reputable cryptocurrency exchanges usually have a valid HTTP certificate, and your web browser should warn you if the site you are visiting does not.
– Two-factor authentication: It’s like a two-step login process. It ensures that even if the email or login details you used are compromised, hackers cannot access your wallet. Exchanges with two-factor authentication will send a notification to your mobile whenever you try to access your account. If you notice a connection attempt that is not you, you can simply deny access from your mobile device.
– Whitelist IP addresses: Some exchanges will also allow you to whitelist the IP addresses you use to connect to your wallet. At the same time, it will block all connection attempts from unknown/unwhitelisted IP addresses. Some exchanges take this a step further by also allowing you to whitelist certain withdrawal IP addresses. This ensures that your coins cannot be removed by anyone other than you.
– Insurance: Look for an exchange that offers fund insurance. This ensures that, if the inevitable happens, you will be reimbursed to some extent for lost funds. Some well-known exchanges that insure their funds include Binance, Coinbase and Coinbase Pro, Gemini, Circle, etc.