Private Wallet or Exchange: Where Should You Keep Your Crypto?
Options available for retail investors
This research was sponsored by Luno, a platform that allows users to buy, save and manage cryptocurrencies.
When an investor buys cryptocurrency today in the United States, they have two main choices to store their assets — holding their crypto themselves, which is referred to as a hard or cold wallet, or on an exchange, also referred to as a hot wallet.
As broker-dealers are not yet allowed to have custody of crypto, coins cannot be held on an investor’s existing brokerage account. They can, however, remain on the exchange the coins were purchased on, including Coinbase, Binance, or Crypto.com, also referred to as a hot wallet. Crypto can also be held off-exchange in a mobile or software wallet.
Note that U.S. citizens should check if the particular exchange they are viewing is available in their residing state.
Conversely, holding your coins privately is considered a cold wallet. In this scenario, coins are typically held in a physical storage device, such as flash drives or hard disk drives that store private keys, tokens, or cryptocurrencies.
Hot wallet
Simplicity
If you purchase your coins on an exchange, keeping them on that exchange is simple — after executing the trade, the exchange holds the funds. And hot wallets provide the benefit of transaction ease — you can easily transfer your coins in and out, liquidate, or purchase additional coins.
Holding your coins on an exchange also means that investors can immediately know the value of their holdings by visiting the exchange to see a snapshot of their holdings at any given time.
Risks
However, the ease of use comes at a cost. While accounts typically have security features, they are held on the internet and are vulnerable to cyber attacks.
Beginning with the infamous Mt. Gox attack in 2014, billions of dollars have been hacked from major exchanges. In 2021, there were over 20 hacks where victims lost at least $10 million in securities, according to a report by Chainalysis. Earlier this year, Crypto.com was hit by hackers for $30 million of stolen bitcoin (BTC) and ether (ETH).
Private wallet
Security
By securing coins on a private wallet, the crypto is effectively taken out of circulation. In turn, the coins are safe from cybercriminals. Held under password-protected encryption, these devices hold the assets under a password.
Risks
However, the reverse effect of having crypto kept safely away is the lack of instant liquidity. In volatile markets, investors would need to access their crypto and if the timing is an issue, those few minutes connecting and uploading your cold wallet and digging it up could cost you thousands or millions of dollars.
There is also the risk of the device or password to the device being lost or stolen. The internet is full of stories of investors that disposed of their hard drives that contained untold amounts of bitcoin. As much as 18.5 million of the coin is reported to be lost.
Making a choice
Both options offer risks and benefits. An informal poll on Twitter showed that the majority of those surveyed preferred hardware wallets. What are some other options investors have?
An investor can choose to use both and place their coins where they deem most appropriate. For example, storing a certain amount with an exchange frequently used, storing currency that is considered a long-term allocation on a hardware wallet and then using a mobile or desktop wallet for more speculative purchases.
Regulatory outlook
As cryptocurrencies become more mainstream, global governments will likely come up with a plan to regulate the crypto industry. In the U.S., the decision on whether brokerage firms can custody crypto for retail investors is still out. Would the ability for investors to hold their crypto at a bank or mainstream financial institution lead to broader adoption?
Banks in the U.S. were given the authority to custody crypto but it has been a winding road. The Office of the Comptroller of the Currency (OCC) — the bank regulator of the U.S. — was first granted approval under former President Trump’s appointee Brian Brooks.
However, acting Comptroller Michael J. Hsu has been more cautious in his approach. In November 2021, the OCC issued a letter stating that banks needed “adequate controls in place,” before engaging in crypto activities.
Currently, private unregistered funds targeting accredited investors and qualified purchasers are able to access custody services at certain banks, but as of yet, retail investors do not have that option.
…
This content is for educational purposes only. It does not constitute trading advice. Past performance does not indicate future results. Do not invest more than you can afford to lose. The author of this article may hold assets mentioned in the piece.
If you found this content engaging, and have an interest in commissioning content of your own, check out Quantum Economics’ Analysis on Demand service.
