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Cryptocurrency: Custody solutions explained…

24 May 2022 Jonty Sacks, Partner at Jaltech

Though demand for cryptocurrencies is again on the rise, few investors appreciate the risks associated with storing their cryptocurrencies. Most elect to purchase cryptocurrencies directly through an exchange and hold these assets in their exchange wallet. Although this approach is very convenient, exchanges, and by extension, their customers, have fallen victim to billions of dollars in theft.

Hackers target exchange users with sophisticated phishing techniques (by, for example, using emails to get you to disclose confidential information such as passwords) and exploit vulnerabilities in the storage and security systems of major exchanges.

Crypto exchange hacks

What alternative storage options do investors have?

Paper wallet: Given that cryptocurrency is simply a long string of information, investors can remove their cryptocurrency from an exchange and record their keys on a piece of paper. The obvious risk associated with this option is that the paper is trivial to copy, can easily get damaged, and becomes illegible over time.

Hardware wallets: A hardware wallet is a dedicated device (similar to a USB stick) designed to store private cryptocurrency keys. These devices are significantly less vulnerable to external attacks but require technical knowledge to use effectively. There is also a risk that the device can be misplaced, stolen or damaged.

Third-party custodian: This is the option of outsourcing cryptocurrency storage to a custodian. The client enters into a legal agreement where they appoint the custodian to securely store their digital assets.

Custodians

Digital asset custodians are generally used by cryptocurrency funds, financial institutions and investors who hold a significant amount of cryptocurrency. Custodians are akin to the companies providing the physical security used to protect precious metals, except these vaults exist in the digital realm. As a result of the continued rise in the value of cryptocurrencies, custodians have seen a sharp increase in demand for their services.

Custodians are sought after for their proven security methods, which are otherwise too technical or too complex for many cryptocurrency holders to implement themselves, giving clients convenience and peace of mind.

Crypto security options

It doesn’t take a cryptocurrency expert to deduce that an offline storage solution is by far the most secure form of cryptocurrency storage, offering strong protection while remaining convenient to transact when needed.

The best option for an investor will depend on their unique needs and situation, such as:

• The value of the cryptocurrency held
• The frequency of access needed
• Trade frequencies
• Risk appetite, and
• Country-specific regulations.

What these investors should be mindful of is whether it’s the best decision to keep their cryptocurrency on an exchange and, if not, what the best alternative storage solution is for them.

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