For many investors, security is a key component of their personal investment decision. An investment in cryptocurrencies involves some uncertainties and particular risks that investors should definitely familiarize themselves with. If the investor has already done his own research and is invested, it should be ensured that access to his own assets is guaranteed. The following article is dedicated to the security aspects of the various storage and trading options.
Wallets: Security varies with the chosen wallet type
A wallet is generally required for direct purchases and trading of cryptocurrencies. The coins (private keys) are stored and traded in the wallet. There are different types of wallets. The majority of investors in Germany use crypto exchanges such as Bison, Kraken and Binance, which create so-called depot wallets for their customers.
Deposit wallet (warm).: With this type of investment, investors entrust the private keys to the crypto exchanges. Investors can easily log in online and see the value of their coins, but they do not have access to the private keys. To ensure 24/7 trading, some of the coins from the depot are usually connected to the Internet. These storage media connected to the Internet are also called hot wallets.
Whether a depot is suitable for an investor largely depends on the confidence in the crypto exchange. The practical 24/7 trading of cryptocurrencies is mainly associated with possible loss of control, such as:
- Theft: Third parties or employees can access the wallet and perform irrevocable transactions.
- Trading freeze: Crypto exchanges are sometimes forced to freeze balances and transactions, e.g. B. due to technical errors or legal requirements.
- Insolvency: In case of insolvency of the crypto exchange, it is not yet reliably clear where the wallet balance is located. To make matters worse, the location of the exchange is of course often different from the investor’s country and there are no appropriate precedents.
Non-custodial (cold) wallet: For tech-savvy and security-conscious investors, self-management of the coins is also possible using their own wallet. These so-called non-depot wallets enable the investor to store the private keys. There are hot wallets connected to the Internet (eg MetaMask) or storage media that are separated from the Internet, such as a USB stick or a piece of paper. This type of investment is also called a cold wallet.
Self-administration gives investors more control over their coins, but on the other hand, personal responsibility also increases. The following risks must therefore be taken into account:
- Loss: If the cold wallets or the associated private keys are lost, the credit can no longer be accessed.
- Manipulation: Used and questionable cold wallet offers should be avoided. In the past, cases were often known where storage media were manipulated, and the coins thus fell into the wrong hands.
Crypto ETPs: Regulation alone is no guarantee of safety
Unlike the wallet, there are indirect purchases of cryptos using ETPs. A crypto-ETP is a derivative security that is bought and traded through a custodial account at a bank. All crypto ETPs listed in Germany are subject to the requirements and specifications of capital market regulation. These rules vary widely and are partly part of complex product designs.
The majority of crypto ETPs approved in Europe are not based on futures but are 100% physically deposited. The physical filing of ETPs is not always based on the goodwill of issuers, but rather is required by law in some countries for investor protection purposes and has become the industry standard over time. However, although the majority of ETP providers have their own strong interest in investor protection, physical deposit does not automatically go hand in hand with 100% capital protection. The following sections are intended to show the efforts of issuers to ensure safe storage and at the same time make investors aware of possible security gaps.
guardian: For physical deposit, providers of crypto-ETPs often rely on regulated depositories, so-called custodian banks. The depositories are essentially responsible and controlled for the storage and trading of the coins. Established issuers such as ETC Group or 21Shares like to use well-known providers such as Coinbase Custody. Similar to the escrow wallet, the escrow coins are held by a custodian bank and therefore have similar security risks.
access: Coins held by custodians can also be the target of theft. In relation to the direct customer business, however, the custodian banks have often implemented several security mechanisms and are insured against third-party interference. Here, however, it is important to remember that the sum insured usually only covers a part of the total assets.
administrator and administrator: An independent administrator and a trustee are often also appointed. Both support ongoing business activities and are intended to protect investors from abuse or improper intervention by the issuer.
responsibility: Often the issuer, administrator and trustee are not located in the same jurisdiction. Even if the parties have entered into agreements among themselves, in the event of a settlement there will most likely be differences of opinion and delays.
recovery: The hitherto untested processing of a crypto-ETP will entail unforeseen costs. Usually, the costs, such as court costs and court costs, are borne by the investors. It can therefore be assumed that the 100% physical coverage in the event of a necessary settlement will not result in full repayment of the investment amount.
Investors can use a wallet to take care of the storage of their coins themselves and should therefore intensively deal with the different wallet types and providers. The Depot button convinces with its simple handling, which is, however, accompanied by an increased loss of control.
With a crypto ETP, investors benefit from the general capital market rules and established processes. However, some of these are very complex and usually cost investors a small annual management fee. Additionally, investors should not feel a false sense of security when it comes to 100% physical deposit.
René Louis Delrieux is married and has worked in the fintech sector for over ten years. Since 2019, he is the father of a boy. His passion for developing innovative investment solutions led him to comdirect in 2020, where he established the savings plan universe on crypto ETPs as Product Manager. Disseminating financial knowledge is just as important to him as promoting broad diversification across different forms of investment. He likes to celebrate price increases with Californian Shiraz (red wine) and a good Italian meal.
This article previously appeared in the August issue of BTC-ECHO Magazine. Go to the store here.
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