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Wallet or Crypto ETP: Which is Safer?

For many investors, security is a key component of their personal investment decision. An investment in cryptocurrencies involves some uncertainties and special 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 different storage and trading options.

Wallets: Security varies with the chosen wallet type

A wallet is generally required for the direct purchase 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 set up so-called custodial wallets for their customers.

Custodial (hot) wallet: With this form of investment, investors leave 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. In order to ensure 24/7 trading, some of the coins from the custodial wallet are usually connected to the internet. These storage media connected to the Internet are also referred to as hot wallets.

Whether a custodial wallet is suitable for an investor depends heavily on trust in the crypto exchange. The convenient 24/7 trading in cryptocurrencies is mainly associated with possible loss of control, such as:

  • Theft: Third parties or employees could gain access to the wallet and carry out irrevocable transactions.
  • Trading stop: Crypto exchanges are sometimes forced to freeze balances and transactions, e.g. B. due to technical failures or legal requirements.
  • Insolvency: In the event of insolvency of the crypto exchange, the whereabouts of the wallet balance has not yet been reliably clarified. To make matters worse, of course, the location of the exchange often differs from the country of the investor and there are no suitable precedents.

Non-custodial (cold) wallet: For technically savvy and security-conscious investors, self-management of the coins is also possible using their own wallet. These so-called non-custodial wallets allow the private keys to be stored by the investor. There are hot wallets connected to the Internet (e.g. MetaMask) or storage media that are separate from the Internet, such as a USB stick or a piece of paper. This form 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. Accordingly, the following risks must 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 dubious cold wallet offers should be avoided. In the past, cases were often known in which storage media were manipulated and the coins thus fell into the wrong hands.

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Crypto ETPs: Regulation alone is no guarantee of security

In contrast to the wallet, there is the indirect purchase of cryptos using ETPs. A crypto ETP is a derivative security that is purchased and traded through a depository account at a bank. All crypto ETPs listed in Germany are subject to the requirements and specifications of capital market regulation. These regulations vary greatly 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 benevolence of the issuers, rather it is required by law in some countries for the purpose of investor protection and has become the industry standard over time. But even if 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 issuers’ efforts to ensure safe custody and at the same time to sensitize investors to possible security gaps.

custodian: For physical deposit, providers of crypto ETPs often rely on regulated depositories, so-called custodians. The custodians are essentially responsible and vetted for the safekeeping and trading of the coins. Established issuers such as the ETC Group or 21Shares like to use well-known providers such as Coinbase Custody. Similar to the custodial wallet, the stored coins are held by a custodian and accordingly have similar security risks.

access: Coins held by custodians can also become the target of theft. In comparison to the direct customer business, however, the custodians have often implemented more security mechanisms and are insured against third-party interference. Here, however, it is important to bear in mind that the sum insured usually only covers part of the total assets.

trustee and administrator: An independent administrator and a trustee are often also appointed. Both support ongoing business activities and are intended to protect investors from misuse or incorrect intervention by the issuer.

responsibilities: Often the issuer, administrator and trustee are not located in the same jurisdiction. Even if the parties have concluded agreements between themselves, in the event of a settlement there will most likely be different views and delays.

recovery: The hitherto untested processing of a crypto ETP will incur unforeseen costs. Usually, the costs, such as legal and court costs, are served before the investors. It can therefore be assumed that in the event of a necessary settlement, the 100% physical cover will not lead to a full refund of the investment amount.

Conclusion

Investors can use a wallet to take care of the safekeeping of their coins themselves and should therefore intensively deal with the different wallet types and providers. The custodial wallet can convince with its simple handling, which, however, is accompanied by an increased loss of control.

With a crypto ETP, investors benefit from the general capital market regulations and established processes. However, some of these are very complex and usually cost investors a small annual management fee. In addition, investors should not feel a false sense of security when it comes to 100% physical deposit.

Above

René Louis Delrieux is married and has been working 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. Imparting financial knowledge is just as important to him as promoting broad diversification across different forms of investment. He likes to celebrate price gains with Californian Shiraz (red wine) and a good Italian meal.

Disclaimer

This article previously appeared in the August issue of BTC-ECHO Magazine. Go to the shop here.

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