The U.S. SEC's Office of Investor Education and Assistance released this investor bulletin to help retail investors understand how to hold crypto assets. This bulletin outlines the types of cryptocurrency custody and provides some tips and answers to help you decide how best to hold your crypto assets.
Crypto asset "custody" refers to how and where you store and access your cryptocurrency assets. You typically access your cryptocurrency assets through a device or computer program called a cryptocurrency wallet. Crypto wallets themselves do not store cryptocurrency assets; instead, they store the "private key" or password for your cryptocurrency assets.
Crypto assets. Crypto assets are assets generated, issued, and/or transferred using blockchain or similar distributed ledger technology networks, including assets referred to as "tokens," "digital assets," "virtual currencies," and "cryptocurrencies."
Crypto assets. Crypto assets are assets generated, issued, and/or transferred using blockchain or similar distributed ledger technology networks, including assets referred to as "tokens," "digital assets," "virtual currencies," and "cryptocurrencies."
Investors should understand that the characteristics and design of crypto assets, as well as the distributed ledger or blockchain technology used for issuance and/or transfer, can vary significantly. In other words, different crypto assets may offer different returns or risks. When creating a crypto wallet, the following two keys or passwords are generated: Private Key. A private key is a randomly generated alphanumeric password used to authorize transactions involving crypto assets. The private key is like a password for your crypto wallet. Once created, a private key cannot be changed or replaced. If you lose your private key, you will permanently lose access to the crypto assets in your wallet. Public Key. A public key is another code used to verify transactions and allow others to send crypto assets to your crypto wallet. The public key cannot access the private key in the wallet and cannot be used to authorize transactions. The public key is like your crypto wallet's email address. These keys together prove your ownership of the crypto assets and give you the right to send, receive, or use them.
II. Hot Wallets vs. Cold Wallets
There are many types of cryptocurrency wallets, and retail investors hold them in various ways. Cryptocurrency wallets are mainly divided into two categories: "hot wallets" and "cold wallets."
A hot wallet is a cryptocurrency wallet connected to the internet, which can be a desktop application, mobile application, or web application. Hot wallets allow you to easily access and trade crypto assets, but they also expose your crypto assets to cyber threats.A cold wallet is usually a physical device that is not connected to the internet, such as a USB flash drive, external hard drive, or even a piece of paper. For crypto asset trading, cold wallets are generally less convenient than hot wallets. However, because cold wallets are not connected to the internet, they are usually more resistant to cyber threats than hot wallets. Nevertheless, the physical device of a cold wallet can still be lost, damaged, or stolen, resulting in the permanent loss of your crypto assets.
Protect your mnemonic phrase!
Many cryptocurrency wallets generate a "mnemonic phrase," also known as a mnemonic recovery phrase, backup mnemonic phrase, or memory phrase. A mnemonic phrase is a string of random words that can help you recover your wallet if you lose it or your private key, or if your wallet's hardware or software is damaged. Keep your mnemonic phrase in a safe place and never share it with anyone. III. Self-Custodial vs. Third-Party Custody
You also need to decide whether to self-custody your crypto assets (self-custody) or entrust them to a third party (third-party custody). Both self-custody and third-party custody offer hot and cold wallet options.
Self-Custodial:
With self-custodial, you have complete control over your crypto assets and are responsible for managing all your crypto wallet's private keys. This means you have complete control over access to your crypto asset private keys and are fully responsible for their security. If your crypto wallet is lost, stolen, damaged, or hacked, you may permanently lose access to your crypto assets.
Key Questions When Choosing a Self-Custed Crypto Asset Solution Are you capable of easily setting up and maintaining your crypto wallet? Setting up and maintaining a crypto wallet yourself may require some technical knowledge. Please ensure you are competent in all the technical aspects required to set up and maintain your crypto wallet. Do you want full control over your crypto assets? With self-custody, you have complete control over your crypto assets. You are fully responsible for safeguarding the private keys and mnemonic phrases of your crypto assets. If these keys or mnemonic phrases are lost or stolen, you may lose access to your crypto assets. What type of crypto wallet do you want to use? As mentioned above, you can use hot wallets or cold wallets to store your crypto assets. When choosing the type of crypto wallet that best suits you, carefully consider your convenience and security needs. How much does a crypto wallet cost? Physical devices for cold wallets typically require purchase, while hot wallets may initially be free. However, using a wallet for transactions usually incurs fees. Be sure to understand these fees before choosing a crypto wallet or making transactions. Third-Party Custody: Third-party custody allows you to choose a professional custodian or service provider to hold your crypto assets. Third-party custody institutions include cryptocurrency exchanges and specialized crypto asset custody service providers. The third-party custodian is responsible for managing and controlling access to your crypto asset private keys. The account used by the third-party custodian to hold your crypto asset private keys may be a cold wallet, a hot wallet, or a combination of both. If the third-party custodian is hacked, goes bankrupt, or becomes insolvent, you may lose access to your crypto assets. Key Issues When Choosing a Third-Party Custody Institution Have you investigated the background of the custodian? Be sure to take the time to carefully investigate any third-party custodian. Search online for any complaints about the custodian. Learn how this custodian is regulated. While the regulatory framework for the crypto asset industry is still in its early stages, a degree of regulation already exists. What types of crypto assets can I hold with this custodian? Each custodian allows different types of crypto assets to be held. Make sure the custodian allows you to hold the types of crypto assets you wish in your account. What happens if the custodian goes bankrupt? Find out if the custodian offers insurance against lost or stolen crypto assets and make sure you understand its terms and conditions. How does the custodian store and protect your crypto assets? Ask the custodian how they protect your crypto assets and private keys, and who has access to them. Does the custodian store your crypto assets in their own facilities or outsource their storage to a third party? Does the custodian use hot wallets, cold wallets, or other methods? What type of crypto wallets do they primarily use, and how do they determine the location for storing your crypto assets? In addition, inquire with the custodian about the types of physical and cybersecurity protocols and procedures they use to protect your crypto assets. How do third-party custodians use your crypto assets? Some custodians use your deposited crypto assets as collateral for their own purposes (e.g., lending). This is sometimes called "recollateralization." To reduce costs, some custodians may also commingle crypto assets rather than holding them separately for clients. Find out if your custodian uses any of these practices, and if so, whether your consent is required. What privacy protections do custodians offer? Look for custodians that can protect your sensitive personal information (such as your name, address, Social Security number, and the types of crypto assets you own or have bought or sold). Inquire whether the custodian will sell any client data to third parties, and if so, whether your consent is required. What account fees do custodians charge? Please inquire with your custodian about annual asset management fees (annual fees based on the value of your crypto assets), transaction fees (the cost of using or trading your crypto assets), asset transfer fees (the cost of transferring your crypto assets outside of your custodian), and account opening and closing fees.
IV. General Recommendations for Protecting Your Crypto Assets
Carefully research and choose any third-party custodian.
Never reveal your private key or mnemonic phrase.
Protect your crypto asset privacy. Do not share the quantity or type of crypto assets you own with anyone.
Beware of crypto asset phishing scams.
Use strong passwords and multi-factor authentication for all online crypto asset accounts.
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