Can Your Crypto Ever Really Be Safe?
Money is not a client of any investment adviser featured on this page. The information provided on this page is for educational purposes only and is not intended as investment advice. Money does not offer advisory services.
The past year was challenging for crypto investors, and 2023 isn’t shaping up to be much better.
Confidence in the industry took a huge hit after the high-profile implosion of FTX, which was one of the world's largest crypto exchanges. The collapse of the stablecoin Terra as well as bankruptcy filings by the crypto lenders Voyager and BlockFi and the crypto hedge fund Three Arrows Capital rattled investors and weighed on crypto prices.
High inflation and interest rate hikes also put pressure on cryptocurrency and mainstream financial assets like stocks and bonds, which nosedived last year. Bitcoin's price started the year at around $47,000 per coin and is now near $17,000 per coin.
The outlook for crypto prices remains uncertain.
“We won’t know where the bottom [for crypto] is until we’re past it, and there’s no indication of a thaw yet," Morningstar senior research analyst Madeline Hume told Money in December. Meanwhile David Marcus, a former PayPal and Meta executive who now runs a Bitcoin-focused company, recently predicted that the ongoing “crypto winter” could last through 2024 and beyond.
After crypto's chaotic year — and an extreme erosion of trust — investors may be wondering if their investments in assets like bitcoin and ether are ever actually safe. With the potential for even more upheaval ahead, here’s what you need to know.
Is it safe to invest in crypto?
Cryptocurrency is a volatile, unpredictable asset. Bitcoin, for example, soared to an all-time high of around $68,000 per coin in November of 2021 before plummeting to less than $19,000 just seven months later.
If you are buying and selling bitcoin, ether or another digital asset, you are assuming risk related to those extreme price swings. Financial advisors tend to say you should never invest anything in crypto that you aren’t prepared to lose.
Regulation is also a concern. Crypto trading platforms are not regulated in the same way more mainstream exchanges are, and security measures can vary widely by exchange, which is why investors need to be extra-attuned to preventing theft and loss and willing to take on additional security measures themselves. More on that below.
But the regulatory landscape is also evolving, meaning investors need to keep up with new rules as they take effect. In the wake of the FTX meltdown, experts say the crypto industry will face even more scrutiny.
"It’s true that now regulation is probably going to be stricter than it would have been otherwise," Northwestern clinical strategy professor Sarit Markovich recently told Kellogg Insight, adding that "regulation that helps stop fraudulent activity and Ponzi schemes" is good for the industry in general.
The risks of storing your crypto on an exchange
Volatility aside, much of the safety issues surrounding cryptocurrency have to do with how it is stored.
When you store your crypto on a crypto exchange, you're using what's called a "custodial wallet." That means the exchange holds the keys to your account on your behalf, and you are able to conveniently trade with assets in your account.
But as investors witnessed firsthand in 2022, exchanges like FTX are not completely safe. When an exchange goes bankrupt, it's unclear what exactly individual investors can do to get their money back if the exchange doesn’t have the cash to pay them.
Right now, for instance, it's estimated that FTX could owe money to more than one million creditors, many of whom are retail investors. It's not yet clear how or when those individual investors will be able to get their money back — if they can get it back at all.
Crypto deposits at exchanges like Coinbase — or anywhere else, for that matter — are not protected by the federal government like cash is protected at banks. That's because cryptocurrency is not considered legal tender, and it isn't regulated by any central authority. Many crypto enthusiasts are drawn to the space because of that lack of regulation, but it's also the source of some of the biggest risks associated with investing in digital assets.
The safest way to store crypto
Rather than keeping your cryptocurrency in a custodial wallet with an exchange, Ahmed Ismail, president and CEO of digital asset liquidity aggregator FLUID, recommends holding it in hardware wallets that only you can access.
These crypto wallets store your cryptocurrency offline, which significantly reduces the risk of a hack. If you want to trade those assets, you can move them back onto an exchange for the transaction and then back to your hardware wallet. Hardware wallets are considered one of the safest ways to hold crypto assets.
Using a hardware wallet requires keeping track of both the device and its password: If you lose one or the other, you could lose access to your assets. Ismail says you should be comfortable with these types of wallets and able to implement sound cybersecurity practices if you are planning to hold digital assets.
Using a hardware wallet ensures you are the one managing your assets, not a third party like an exchange, he says. “Whoever has the keys to the wallet controls the crypto.”
More from Money:
Why Crypto Assets Aren’t Protected by the FDIC Like Bank Deposits