6.6 min read
Safety for yor crypto
Written byWilliam Miller
December 4, 2022
- To protect assets from fraud, hacking, and misappropriation, investors need to take certain steps to maintain full control over their assets.
- Hardware wallets provide full ownership of the private keys of the encrypted wallet, limiting access to funds to only the owner of the hardware wallet.
- Exchanges provide wallet information, allowing investors to verify the existence of their funds on the exchange itself.
- While Proof-of-Reserves provides insight into an exchange's reserves, it does not provide a complete picture of its financial health, as information about liabilities is often not made public.
- Popular methods of wresting control away from cryptocurrency entrepreneurs include using DEXs, non-custodial wallets, and conducting extensive research on seemingly investable projects (DYOR).
The demise of the FTX cryptocurrency exchange has forced many to rethink their entire approach to investing — from self-custody to verifying the existence of funds on-chain. This approach is largely due to a lack of trust in entrepreneurs by cryptocurrency investors after they were duped by FTX CEO and co-founder Sam Bankman-Fried (SBF).
FTX crashed after SBF and its associates were found to have secretly reinvested user funds, and misplaced at least $1 billion in customer funds. In an effort to regain investor confidence, competing cryptocurrency exchanges have proactively flaunted their proof-of-reserve credentials to confirm the presence of user funds. However, community members have since called on the exchange to disclose its commitment to safeguarding reserves.
With SBF, the self-proclaimed "most generous billionaire," committing fraud in broad daylight with no apparent legal consequences, investors must take a defensive stance in protecting their investments. To protect assets from fraud, hacking, and misappropriation, investors need to take certain steps to maintain full control over their assets—often considered the best cryptocurrency investment practice.
Move your funds out of cryptocurrency exchanges
Cryptocurrency exchanges are commonly used to buy, sell, and trade cryptocurrencies for a small fee. While other methods including peer-to-peer and direct selling are always an option, higher exchange liquidity allows investors to match orders and guarantees that no funds are lost in the process.
The problem arises when investors choose to store their funds in a wallet provided and owned by the exchange. Unfortunately, most investors here have learned the "not your keys, not your tokens" lesson the hard way. The cryptocurrency stored in the wallet provided by the exchange is ultimately owned by the owner and in the case of FTX users, it has been abused by SBF and employees.
Avoiding this risk is as simple as moving funds from an exchange to a wallet without a shared private key. The private key is securely encrypted, allowing access to funds stored in the encrypted wallet, which can be restored using a backup phrase if misplaced.
Hardware Wallets: The Safest Way to Store Cryptocurrencies
Hardware wallets provide full ownership of the private keys of the encrypted wallet, limiting access to funds to only the owner of the hardware wallet. After acquiring cryptocurrencies from exchanges, users must voluntarily transfer their assets to hardware wallets.
After the transaction is completed, the cryptocurrency exchange owner will no longer have access to the fund. Therefore, investors who opt for hardware wallets no longer have the risk of losing their funds due to scams or hacks that occur on exchanges.
However, while hardware wallets contribute to the overall security of funds, cryptocurrencies are still subject to the capricious risk of loss if the value of the tokens falls irretrievably. Hardware wallet providers have seen a surge in sales as investors move away from storing assets through exchanges.
Verify before trust
Throughout all of the cryptocurrency crashes this year — including 3AC, Terraform Labs, Celsius, Voyager, and FTX — investor betrayal has been a pervasive and palpable theme. Thus, the motto "Don’t Trust, Verify" has finally caught on among investors old and new.
Popular cryptocurrency exchanges, including Bitfinex, Binance, OKX, Bybit, Huobi, and Gate.io, have taken a proactive approach to showcase their Proof-of-Reserves. Exchanges provide wallet information, allowing investors to verify the existence of their funds on the exchange itself.
While Proof-of-Reserves provides insight into an exchange's reserves, it does not provide a complete picture of its financial health, as information about liabilities is often not made public. On Nov. 26, Kraken CEO Jesse Powell called Binance’s proof of retention “either ignorance or intentional misrepresentation” because the data did not include negative balances.
However, Binance CEO Changpeng Zhao refuted Powell’s claims, saying the exchange has no negative balances and will verify this in an upcoming audit.
The three considerations above are good starting points for protecting crypto assets from bad actors. Some other popular methods of wresting control away from cryptocurrency entrepreneurs include using decentralized exchanges (DEXs), self-custodial (non-custodial) wallets, and conducting extensive research on seemingly investable projects (DYOR).
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