9 min readMany newcomers to crypto underestimate the importance of safeguarding their digital assets. They leave their crypto in the hands of exchanges or don’t take proper precautions when transferring assets to cold wallets. Luckily, there are safer and affordable ways to own crypto.
Securing Your Crypto: No Easy Task
Crypto is decentralised by nature: it is not backed by institutions (such as governments or banks) that implement various rules and security measures to protect assets. Instead, investors are responsible for securing their crypto against a variety of risks, from hacking to password loss.
Crypto is held within wallets, which are pieces of software or hardware that are accessible via a private key. Think of it as a password that grants complete access to the wallet: losing or getting this private key stolen would mean losing funds forever. The safety of your assets therefore boils down to how, and by whom, your private keys are stored.
There are two broad storage options:
Self-custody. You hold the private keys that open your crypto wallet, and you are on your own if anything goes wrong.
Third party-custody. You delegate custody to an exchange or a traditional financial entity like a bank.
What are the advantages and drawbacks of each alternative? Who should you trust? Let’s dive deeper into each storage solution to find out.
Holding Your Crypto on Exchanges is Not Safe
Crypto exchanges are platforms that make it easy to buy and sell crypto. When you buy crypto on an exchange, it is stored in the exchange’s wallets until you transfer it to your own wallet. The exchange effectively owns your assets, as it holds the key to your crypto.
There are several risks associated with storing your crypto on an exchange:
Your account gets hacked. Somebody gets hold of your password, you fall victim to a SIM swap fraud, your computer or phone is stolen while you are still connected to your exchange… Researchers estimate crypto investors lost nearly $4 billion to hackers in 2022.
The exchange itself gets hacked. This is not a hypothetical situation, and has already happened several times. One notorious example is Mt Gox’s, a major Bitcoin exchange, downfall. In 2014, hackers took off with 850,000 Bitcoins, worth around $450 million at the time.
The exchange mismanages funds. Some exchanges are unregulated, which unlocks the potential for fraud. Once leading exchange FTX is currently being accused of engaging in manipulative practices, such as using clients' funds to trade on their own. This lack of regulation also puts assets at risk, as exchanges are not held accountable for their security measures.
You lose access to your account because of an issue with your email or phone. While most exchanges have recovery processes in place, their customer service is usually not as strong as a broker’s or a bank, and recovery could take precious time. Lengthy identity checks could prevent you from taking part in key market phases.
A common motto in the crypto community sums it up: “not your keys, not your coins.” So is self-custody better?
Self-custody: You’re in Charge
Rather than entrusting their private keys to a third party, proponents of self-custody use their own crypto wallets and store their keys themselves.
There are two main types of crypto wallets:
Hot wallets. Connected to the internet, and more convenient for daily use.
Cold wallets. Offline pieces of hardware. They are considered to be more secure, as they are isolated from potential cyber threats. However, setting them up and transferring funds requires some technical skills.
Self-custody is the digital equivalent of stacking cash under your mattress. You have full control over the assets, but there is no one to turn to if your house gets broken into or burns to the ground. Same applies to wallets, and losing access is easier than it might seem at first: you misplace the piece of paper you wrote your private key on, your hard drive containing a copy of the private key breaks, is stolen or lost, somebody gets their hands on your cold wallet… Simply put, a 100% secured self-custody option does not exist.
Is there no other option to securely own crypto, without transferring funds to untrustworthy platforms or turning oneself into an offline cyber-security expert?
Crypto ETPs: Convenient and Secure Exposure to Crypto
Crypto ETPs combine the best of both worlds: safety and ease of use. When investing in a crypto ETP, you are not buying crypto directly. It is therefore a third-party storage solution, but it is considerably safer than exchange-custody, and we will explain why in a minute. But unlike self-custody, this extra safety does not come at the expense of your peace of mind.
How do ETPs work?
An ETP (short for Exchange Traded Product) is a security that trades on “traditional” financial exchanges such as Euronext. ETPs come in many forms and shapes, and allow exposure to a variety of assets, from gold to… crypto.
Crypto ETPs are set up by a sponsor, usually a fund management company. The ETP is then made available to traders through a broker, typically a bank. Once you invest in an ETP, you are free to trade it on an exchange, like you would with any other type of security. Refer to the companion article What are crypto ETPs for more details.
Crypto ETPs come with several advantages:
Regulation: ETPs are regulated financial assets, and their sponsors have to follow strict accounting rules, preventing mismanagement of funds.
Security: assets are held by a regulated custodian following institutional standards.
Ease of use: you invest in an ETP through your usual broker (that’s likely your bank), seamlessly add it to your portfolio, and trade it on your exchange of choice. It’s a great option to diversify your portfolio with crypto.
Of course, delegating also has drawbacks:
Exposure does not fully match real crypto prices, as ETPs strive to replicate performance but can’t completely mirror it.
You are not as independent as with self-custody - that’s the price to pay for an extra security layer.
How safe are crypto ETPs?
With ETPs, your investment remains in the sponsor’s secured custody. The sponsor can choose to either physically own the assets (physically-backed ETP) or replicate their performance through future contracts (synthetic ETP). In this case, the sponsor enters into an agreement with a third party to make sure assets are collateralized, i.e that other assets are available to secure operations. This is in contrast to most exchanges that have little to no obligation to properly collateralise assets (this is partly what led to FTX’s debacle listed above). The exact collateralisation level depends on each ETP’s type: we explain it all in our article on the differences between ETF, ETN and ETC.
The safety of a given crypto ETP therefore strongly depends on its sponsor and nature. That’s why choosing your ETP sponsor wisely is extremely important. CoinShares is a regulated actor, operating under the supervision of national financial authorities, whose objective is to protect investors' funds.
CoinShares’ Physical Crypto-ETPs: 100% Physically-Backed by Industry Experts
Physical ETPs purchase the assets they are designed to track. As a result, CoinShares Physical ETPs are fully physically-backed by real crypto. More information on our Physical ETPs can be found in their Product Guide.
Assets are then held by Komainu, a regulated custodian created by CoinShares, Nomura and Ledger. Ledger is the world’s leading hardware provider for crypto, having sold over 3 million cold wallets, while Nomura is an authority in finance.
Komainu was designed to meet the specific requirements of institutional investors. It provides a hybrid custodial service for digital assets, secured by industry-leading security, and supported by strong risk and compliance standards.
As a result, Komainu provides a high level of security for digital assets by keeping them offline, and protected by advanced encryption and governance. The solution also allows for easy management and monitoring of assets.
Conclusion: Securing Your Crypto Can Be As Easy - Or Complicated - As You Make It
Ultimately, it’s up to you. You can choose to trust an exchange, and store your assets there. Or you might go completely independent, and set up security protocols for self-custody. Crypto ETPs combine both routes for easy and safe storage.
Curious to explore CoinShares' ETP offering? Head over to our catalogue.