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Insights: Key Lessons From The Recent FTX Fallout For Crypto Investors

First, remember this: self-custody.

This article was contributed to us by Deborah Tan-Pink, APAC Head of Marketing & Communications at Bitstamp

I must admit that when I first got into crypto investing, I had the implicit faith that the exchange I was using would be “safe”. Then in 2020, an ex-colleague said something, “If you don’t own the keys, you don’t own the tokens.” By “keys”, he meant the private recovery phrases one needed to unlock a crypto wallet (I’ll get to what a “crypto wallet” is later in this piece).

My first reaction was, “Huh? Really? Aren’t we being a bit paranoid here?”

After all, when I trade on the stock market using an app, I don’t expect to take away whatever shares I’ve bought to stash them elsewhere in a vault. But if that trading app should fold overnight, I too may stand to lose my investment; ultimately, people don’t consider who is taking custody of their shares (rightly or wrongly).

It would take another 2 years for me to appreciate the importance of that statement. The arrival of the crypto winter this year made it clear that many customers, such as myself, are in need of more education around investing in this asset class. Frozen accounts and halted withdrawals by exchanges and companies facing financial difficulties have proven to many that when it comes to crypto, the safest place to store your assets may not necessarily be the exchange you’ve bought them from.

Lesson #1: Get A Non-Custodial Wallet

When a tweet can inspire a bank-run like situation, you don’t want to wake up in the middle of night to find yourself scrambling with the crowd to get your money out. The fact that the crypto market operates 24/7/365 makes it all the more important for customers to have some form of control over their crypto ownership.

What does this mean? It means that if you don’t already have a wallet that you can take self-custody of your crypto assets, it’s time to get one.

When it comes to self-custody wallets, there are, primarily, 2 types: Cold storage (not the supermarket) and Hot storage. The former is a hardware wallet, a physical drive that is offline and disconnected from the internet. The benefit of doing this means keeping away hackers looking to steal private keys and digital assets. The flipside? Well, if you lose your recovery phrases, you lose everything.

Hot storage, or hot wallets as they are often called, are web-based. A hot wallet makes it easy for a customer to make transactions using crypto. It lets you manage your private keys directly on your device and isn’t (and shouldn’t) be linked to an exchange or brokerage. This keeps your assets from being moved without your authorization. Hot wallets are sometimes built with the ability to help you recover your private keys so you won’t face losing your assets completely in the event you lose your keys.

Lesson #2: Evaluate The Opportunities In Front Of You

An exchange token entitles its holders to benefits such as trading fee discounts, rebates and early access to token sales. Besides its function as an exchange token, it can be traded on secondary markets or held for financial gain. FTT is FTX’s in-house token that hence, the price of such a token is a function of the belief of an exchange’s success.

For holders of any exchange tokens, it means that such a token is only as valuable as the exchange it is tied to. So it is worth researching not just the token but also the exchange itself. I’ll get to this in the next point.

Of course, exchange tokens aren’t the only tokens you can invest in. Crypto exchanges offer anything from under 100 tokens to over 1,000. Just because a token is listed it doesn’t mean it is (1) secure (2) sound and (3) going to turn a profit. As an investor, you need to understand the project and the use-case associated with a token. Putting money into a token you do not understand, in the hopes of making a quick buck, exposes you not just to losses but, potentially, to scams and rug-pulls.

A good example to cite would be the launch of Squid Coin — a “play-to-earn” cryptocurrency inspired by the popular Netflix series Squid Game, which saw its price soar to US$2,861 per coin. The creators cashed out their coins for real money, plummeting the coin to $0, making off with an estimated US$3.38 million.

Investors were so enamored by the reported 83,000% price increase over just a few days that they ignored red flags including spelling and grammatical errors in the project’s whitepaper and that there wasn’t actually any official tie-in with Netflix.

Lesson #3: Research The Exchange

There are hundreds of crypto exchanges, so which one should you be using? For one, long-standing reputation counts. And, thankfully, there are objective places to go to for your research. A site like CryptoCompare, for example, releases an Exchange Benchmark that ranks over 150 exchanges to inform investors on which are the most trustworthy, secure, and possess the highest quality of governance.

Reputation, however, goes beyond advertising and sponsorships, which could distract investors from the risks they should be aware of when it comes to investing, not just crypto investing.

You should also — if you can — find out if your exchange holds customers’ funds separately from corporate funds, holds funds 1:1 in custody or in bank accounts, holds the majority of assets in cold wallets, and does not lend or repurpose funds without customers’ instruction.

Despite these lessons, it bears mentioning that crypto is subject to price fluctuations. Following the advice above mitigates your risks but is not a surefire way of making a profit. A general rule of thumb all retail investors should follow is to not be over-leveraged in any one asset class. Finally, if you do not trust who you’re dealing with, the surest way to ensure your coins are yours is self-custody.

Views expressed here are the author’s own and do not represent the views of Bitstamp.