Notable crypto disasters

Transactions on the blockchain are irreversible. If a criminal infiltrates an online wallet and transfers its contents, there is no hope of a resolution. In the case of Japanese exchange Mt. Gox, for example, a breach saw the company’s ‘hot wallet’ – essentially an online account used to hold cryptocurrency for quick transfers or sales – emptied by hackers, losing 7% of the world’s Bitcoin, most of which belonged to its customers . The attacking party transferred and ‘washed’ the coins, automatically scattering them between anonymous wallet addresses to make tracing their whereabouts on the blockchain impossible.

It is also a given that the company behind the exchange is operated properly and is trustworthy. The recent high-profile collapse of crypto exchange FTX happened because customer deposits were mishandled, loaned to owner Sam Bankman-Fried’s hedge fund second business, and otherwise lost to risky bets. When this was discovered, major investors bailed, a potential takeover was dissolved, and the crypto market itself crashed. End-user customers were left without financial recourse, their fiat currency gone, and their crypto deposits locked into FTX’s platform while a block on withdrawals was instituted.

An exchange alternative

Crypto exchanges are not inherently unsafe. Yet FTX’s fall has certainly created increased wariness from investors. Exchanges are a necessary means to trade digital currency for hard currency, but that’s as far as trust should go. Taking the decision to store crypto offline provides full control over funds and isolates them from any potential online disaster. Setting up an offline wallet, otherwise known as a ‘cold wallet’, is a simple process which allows the movement of funds away from exchanges and into a software package stored on a device controlled by the funds’ owner.

Once that currency has been transferred, it becomes completely hidden from the internet. The token that then represents the cryptocurrency itself remains stored on the blockchain, but its location – and the cryptographic keys required to access it – are known only to the offline wallet. For all intents and purposes that currency disappears. Although, as we will discuss, a cold wallet comes with its own vulnerabilities, its offline nature makes it the safest way to store cryptocurrency.

Protecting the cold wallet

There are some downsides to moving cryptocurrency offline. Managing offline storage requires a little more attention than simply relying on the streamlined tools of an exchange. Cold wallets such as Ledger, Trezor, and KeepKey can remain safe offline indefinitely, but they must be periodically connected to the internet to update the value of their crypto portfolio, to update the investor on their contents, or to transfer money away from them. They are by far the most secure method of cryptocurrency storage, but cold wallets are also not impervious to hacking. If an attacker were able to gain access to the hardware containing the wallet itself, or the seed phrase (a mnemonic phrase to recover a lost or broken crypto wallet) used to generate its private key – both of which should be securely stored by their owner – they could steal its funds.

Perhaps most importantly, a cold wallet’s practice of security by obscurity makes it fragile in its own way: if a wallet is physically lost, or if its access credentials are forgotten, its contents permanently go with it. The fact that it is cryptographically secured means that no amount of searching, hacking or computation will ever get its contents back. Managing an offline wallet is, essentially, to manage one’s own bank: protecting one’s assets is critical.