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Storing Cryptos Safely: Are Digital Wallets Safer Than Custodial Wallets of Exchanges?

As the crypto exchanges around the world face bankruptcy and hacking threats, let’s look at how we can safely keep cryptos in a digital wallet with a private key.

While cases of cryptocurrency frauds and hacks through exchanges are rising, there have been cases where exchanges have paused withdrawals due to internal troubles.

It is becoming difficult to trust exchanges in recent times. While cases of cryptocurrency frauds and hacks through exchanges are rising, there have been cases where exchanges have paused withdrawals due to internal troubles. In one of the biggest crypto heists recently, hackers stole cryptocurrency worth almost $615 million from blockchain company Ronin Systems in March this year.

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Crypto platform Vauld  paused withdrawals and trading on July 4, 2022, citing market volatility and financial troubles of business partners. In such a scenario, storing your crypto safely is becoming a key concern. Let’s explore how that can be done.

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How Are Cryptos Stored?

There are two ways to store cryptocurrencies—you can either buy from an exchange such as Binance or FTX and store them in their custodial wallets or you can buy from a platform like crypto.com or Metamask, which provide you with a digital wallet address on the blockchain, a public key and a private key. When you buy crypto from an exchange, your currency is stored in the specific platform's account and when you make a payment to someone, it goes through the exchange and is, therefore, traceable. This type of wallet is known as a custodial wallet. This system is Centralized Finance (CeFi), and is similar to the one followed by traditional banks. When you store crypto in a digital wallet, you get a wallet address and can make person-to-person transactions, without the currency going through any exchange. This system is known as Decentralised Finance (DeFi).
 

How To Keep Your Crypto Safe?

Spread Your Investments: Always distribute your crypto into different wallets, so even if one wallet gets hacked, you still have cryptos in other wallets. Dileep Seinberg, founder and CEO of MuffinPay, a crypto payment and e-commerce platform, says, “CeFi acts as your bank and custodian, holding and safeguarding your digital assets and funds on your behalf. You can create an account using either your email address or your phone number. In the event that you forget your password, it is simple to recover.”

The advantage with digital wallets in the DeFi system is that you get private keys, which help you access your holdings on the blockchain, and you do not have to rely on exchanges to store your crypto.

Michael Peng, chief compliance officer at Paxful, a P2P crypto trading platform, says, “Both types of wallets provide their own unique sets of pros and cons, and each will appeal to different traders. Custodial wallets mean that a third party is holding on to your Bitcoin private keys for you—in most cases, it’s the exchange or platform you bought the Bitcoin from. On the other hand, non-custodial wallets allow you to hold your own private keys, giving you complete control over your funds.”

Keep Your Private Keys Safe: It is important to keep the details of the private key safely. Keeping the details on your computer can be unsafe in case your system gets compromised. One option is to transfer your private key to an encrypted USB flash drive (cold storage) and keep it offline (one-gigabyte flash drive is enough to store private keys). Ledger, Trezor and Safepal are some examples of hardware wallets.

Typically, if you lose your private key, you won’t be able to access your cryptos again. Gaurav Dahake, CEO and founder of Bitbns, a crypto exchange, says, “Around 4.5 million Bitcoins can never be redeemed, as some people misplaced their private keys. Think of it this way, a bank locker security is better than your home security.”

However, you can try to recover it through Recovery Phrase, which is a “master key” for all your crypto accounts. Basically, this phrase refers to the private keys in mnemonic form, a string of 12 to 24 words. You can keep bits of the recovery phrase in different locations, so even if one of your systems gets compromised, the hackers only have a part of it.
 

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