The crash of crypto exchange FTX forced many to reconsider their overall approach to investing, from self-custody to verification of on-chain funds. This shift in focus was primarily driven by the lack of trust crypto investors have in entrepreneurs after being misled by FTX CEO and co-founder Sam Bankman-Fried (SBF).
FTX collapsed after SBF and its cronies were caught secretly reinvesting user funds, resulting in at least $1 billion of client funds missing. Efforts to regain investor confidence saw competing crypto exchanges proactively flaunt their reserve tests to confirm the existence of user funds. However, community members have since demanded that the exchanges show their responsibilities in safeguarding the reserves.
With SBF, the self-proclaimed “most generous billionaire”, committing fraud in broad daylight with no visible legal implications, investors must maintain a defensive stance when it comes to protecting their investments. To safeguard assets from fraud, hacking, and misappropriation, investors must take certain steps to maintain full control of their assets, which is often considered best cryptocurrency investment practice.
Move your funds off of crypto exchanges
Cryptocurrency exchanges are widely used to buy, sell, and trade cryptocurrencies for a small fee. While other methods, such as direct and peer-to-peer selling, are always an option, increased exchange liquidity allows investors to match orders and ensure no funds are lost during the transaction.
The problem arises when investors decide to keep their funds in wallets provided and owned by exchanges. Unfortunately, this is where most investors learn the “not your keys, not your coins” lesson the hard way. Cryptocurrencies that are stored in wallets provided by the exchange are ultimately in the possession of the owner, which in the case of FTX users, SBF and their associates misused.
Avoiding this risk is as simple as moving funds from the exchange to a wallet without shared private keys. Private keys are secure encryptions that allow access to funds stored in crypto wallets, which can be recovered using a backup phrase if lost.
Hardware wallet: the safest bet for storing cryptocurrencies
Hardware wallets offer full ownership over the private keys of a crypto wallet, limiting access to funds to the owner of the hardware wallet only. After obtaining cryptocurrency from an exchange, users must voluntarily transfer their assets to a hardware wallet.
Once the transaction is complete, the owners of the crypto exchange will no longer be able to access the fund. As a result, investors who opt for a hardware wallet will no longer be at risk of losing funds due to fraud or attacks that occur on exchanges.
Related: What is a Bitcoin wallet? A Beginner’s Guide to Storing BTC
However, while hardware wallets add to the overall security of funds, cryptocurrencies remain at risk of temporary losses when the value of a token falls beyond recovery. Hardware wallet providers have witnessed a sharp rise in sales as investors slowly move away from storing their assets on exchanges.
Do not trust, verify
In all of the crypto crashes that have occurred this year, including 3AC, Terraform Labs, Celsius, Voyager, and FTX, the breakdown of investor confidence was a common and glaring theme. As a result, the motto of ‘Don’t trust, verify’ finally resonated with both new and seasoned investors.
Popular crypto exchanges including Bitfinex, Binance, OKX, Bybit, Huobi, and Gate.io have taken proactive approaches to display their proof of reserve. The exchanges provided wallet information that allows investors to self-audit the existence of their funds within the exchange.
While the reserve test offers a glimpse into an exchange’s reserves, it does not give a complete picture of its finances, as information related to liabilities is often not made publicly available. On Nov. 26, Kraken CEO Jesse Powell called Binance’s reserve test “intentional ignorance or misrepresentation” as the data did not include negative balances.
However, Binance CEO Changpeng Zhao refuted Powell’s claims by stating that the exchange has no negative balances and will be verified in an upcoming audit.
The three considerations above are a good starting point for safeguarding crypto assets against bad actors. Some of the other popular methods of taking control away from crypto entrepreneurs are the use of decentralized exchanges (DEXs), self-custodial (non-custodial) wallets, and extensive research (DYOR) on ostensibly investable projects.