User Problems Inherent In Cryptocurrency Cold Storage Custody’s Imperfection
Cryptoeconomics: Developing Improved Storage Solutions For Digital Assets
Cold storage solutions for crypto assets have been developed by established and trusted companies including French hardware wallet manufacturer, Ledger and Trezor, another leading Europe-based offline storage provider for digital assets.
Private keys associated with cryptocurrencies are kept securely in cold storage, in order to prevent hackers from stealing them. As crypto enthusiasts know, there have been numerous security breaches of centralized digital asset exchanges. To date, these attacks have resulted in the loss of billions of dollars worth of digital currencies. It’s easier for malicious entities to steal users’ funds when they’re stored online with an exchange or even in a hot wallet.
Crypto Stolen Due To Phishing Scams, Ledger CEO Recommends Hardware Wallets For Everyone
Wallets and exchanges that hold a cryptocurrency account’s private keys are putting the owner of those digital assets at (a certain level of) risk. Crypto investors that use hot wallets have been targeted by phishing scams, which have caused users to lose their cryptocurrency – as bad actors managed to obtain access to their private account information. In fact, the users of one of the world’s most popular and trusted online crypto wallet providers, Blockchain.com have lost over $50 million due to phishing attacks (as of early 2018).
Because of many different security issues with storing cryptocurrencies and their private keys online, the CEO of Ledger, Eric Larcheveque has recommended that everyone use hardware wallets. In an official company blog post, Larcheveque explained (last year) why all users must keep the majority of their digital assets in cold storage. He noted:
“All types of users including people who are brand new to the crypto world, early adopters, advanced traders with a great deal of wealth in crypto, institutions, and everyone in between must use a hardware wallet to store their cryptocurrency.”
According to Larcheveque, most people acquire crypto assets by purchasing coins or tokens on a custodial crypto exchange, however, they make the mistake of leaving their funds on the trading platform. As explained by Ledger’s CEO, leaving cryptocurrency on an exchange is basically “entrusting a third party with [the] private keys [of your account] and mandating them to serve as a safeguard.” However, the only thing users are entitled to from their crypto asset holder is an IOU (“I owe you”), or in other words, a promise that the exchange (or whoever is keeping a user’s digital assets) will give your funds back to you.
“Not Your Private Keys, Not Your Bitcoins”
Explaining the concept of a private key to users, Larcheveque wrote in the company blog:
“When you own cryptocurrencies, what you really own is a ‘private key', a critical piece of information used to authorize outgoing transactions on the blockchain network. Whoever has the knowledge of this key can spend the associated funds. Hence the famous expression ‘not your (private) keys, not your bitcoins'.”
Although user funds may be held more securely in a cold storage, digital asset investors are unable to take advantage of price fluctuations and high volatility levels in the crypto market.
Participating In Cryptoeconomics Networks
As explained by Robert Hackett in a blog post on Fortune,
“Freezing crypto assets hinders traders from taking advantage of the market’s frequent, fleeting fluctuations. [Keeping funds in] cold storage will [also] restrict people from participating in so-called cryptoeconomic networks.”
Cryptoeconomic networks allow digital asset holders to stake their funds, in order to support and help improve a blockchain project. This is usually done by users taking part in “game-like activities”, Hackett noted.
As pointed out by the Fortune contributor, “Investors who fail to take up active roles in blockchain projects will eventually lose out.” That’s because they will not be able to take advantage of earning a return on their investments.
Nathan McCauley, the CEO and co-founder of Anchor Labs, a digital asset custodial firm, explained: “Imagine holding traditional equities and not being able to capture dividends. The cold storage providers are effectively going to be dropping dividends on the floor.”
Using Biometrics, Behavioral Data To Secure Digital Assets
Notably, McCauley’s firm, Anchor Labs, is currently developing technology that uses biometrics and behavioral data to secure digital assets. Anchor Labs’ sophisticated cryptocurrency storage solution also incorporates human reviews and a “multiple approvals” process to secure user funds, without requiring cold storage (or being disconnected from the internet).
Sherwin Dowlat, an analyst at the cryptoasset advisory firm, Satis Group, cautioned (in a report published in September 2018) that partners in investment funds could think of the lack of participation in cryptoeconomic networks as “a breach of fiduciary duty.” In other words, “leaving money on the table in this way … could be interpreted as an act of negligence”, Hackett wrote.
Chris Dixon, an investor at giant venture capital firm, Andreessen Horowitz, believes “custody is the single biggest piece of infrastructure holding back the growth of the digital asset space.” Realizing that there will be a strong demand for better storage solutions for cryptocurrencies, Dixon decided to invest in Anchor Labs’ technology.
At present, there are other more established crypto custodial solutions provided by San Francisco-based crypto exchange operator, Coinbase, Winklevoss-owned Gemini, BitGo, Wences Cesares’ Xapo, and Kingdom Trust. Fidelity Investments and Bakkt, a digital asset subsidiary of Intercontinental Exchange, or ICE (the parent company of the New York Stock Exchange) have also announced plans to launch crypto assets products – including regulated custody solutions.