For serious cryptocurrency investors, risk management is a major concern. Once you have accumulated a certain level of cryptocurrency wealth, you don’t want to lose it to hackers, scammers, or cybercriminals. As a result, one of the common risk management techniques is cold storage, which is a way to store your cryptocurrency offline and away from bad actors on the Internet.
Cryptographic cold storage can take many different forms. For billionaire investors, cold storage can include armed guards, fortified underground bunkers, and giant bank vaults. For retail investors, cold storage usually includes a physical device that looks like a USB drive that you can buy online for less than $150. For both billionaire investors and individual investors, there are three main reasons to consider cold storage for cryptocurrencies.
Cryptocurrency exchange risks
Over the past six months, the perceived risks of storing cryptocurrencies on cryptocurrency exchanges have increased exponentially. After all, there have been a number of high profile bankruptcies and bankruptcies in the crypto world during the current “crypto winter.” At the same time, there are constant speculations about the possible bankruptcy of popular cryptocurrency exchanges. In cases like Voyager or Celsius, investors lost access to their crypto holdings for an indefinite period of time once financial hardship was announced. At some point, people began to wonder if these cryptocurrency holdings might be permanently frozen or used to pay off creditors later. All this has some cryptocurrency investors worried.
Not surprisingly, people are exploring alternatives to storing their cryptocurrency on an exchange, and cold storage offers a relatively affordable solution. Even before the start of the crypto winter, some investors had a simple general rule of thumb for how much of their cryptocurrency should be kept on the exchange and how much to keep it off-exchange. For example, they may decide to hold 20% of their cryptocurrency on a cryptocurrency exchange, and the rest in cold storage.
Hackers and cybercriminals
Another reason to consider cold storage in crypto is the constant danger posed by cybercriminals and hackers. To paraphrase Willie Sutton, the notorious bank robber: Hackers steal cryptocurrency exchanges because that’s where the crypto is. Throughout the history of cryptocurrencies, there have been some legendary exploits involving major cryptocurrency exchanges. Perhaps the most famous example is Mt.Gox, where hackers broke into the stock exchange, withdrawing $350 million in Bitcoin Over a long period of time, he disappeared into thin air. In fact, there is an entire Wikipedia page dedicated to major cryptocurrency thefts around the world.
Extreme market volatility
The final reason to consider cold storage is to protect your crypto during periods of high volatility or high market uncertainty. For example, when Ethereum Flip the switch on merging, people are not 100% sure what will happen next. As a result, some major cryptocurrency exchanges have said that they will pause Ethereum withdrawals and deposits on the day of the merger, possibly for a longer period. Coinbase Global He also warned users to be aware of merger scams, due to all the confusion about “old” Ethereum and “new” Ethereum. And the Robinhood He has already alerted cryptocurrency investors that out of extreme caution, he will pause withdrawals from several other cryptocurrencies in addition to Ethereum. If you are concerned about what might happen to your cryptocurrencies, one option would be to move them to cold storage.
Is cold storage right for you?
As they say in the crypto world, “Not your keys, not your encryption.” Keys refer to the encryption keys that protect your encryption. When you keep your funds on a cryptocurrency exchange, the exchange keeps your keys in a custodian role. But when you use cold storage, you are responsible for your keys. Hackers cannot access these keys because the keys are not connected to the Internet.
However, there is one downside risk here. Since you only own the keys, if you ever lose them, no one will be able to return them to you. Cryptographic records are filled with examples of people who lost hundreds of thousands of dollars in Bitcoin simply because they lost their keys. This is one of the reasons why people store their cryptocurrency on exchanges – it prevents them from experiencing this unfortunate scenario at all. Major cryptocurrency exchanges can offer some form of cold storage themselves to help clients protect against the risks described above.
At the end of the day, some form of cold storage makes sense if you have a lot of cryptocurrency at risk. It really depends on your tolerance for risks and how much encryption you need to access daily. If you’ve been planning on HODL (the coding language for “Hold”) for a long time, cold storage might be one way to protect your Bitcoin during what could end up in a very long crypto winter.
Dominic Bassolto He has positions in Bitcoin and Ethereum. Motley Fool has positions in and recommends Bitcoin and Coinbase Global, Inc. and Ethereum. Motley Fool has a disclosure policy.