Is Keeping Crypto On Exchanges Safe?

There are several significant downsides to leaving crypto on an exchange. A key philosophy of crypto is taking control away from monopolistic banks, but storing digital assets with a third party is almost exactly the same practice. Additionally, if that third party is to be hacked or go bankrupt, investors might end up losing their entire portfolio. That’s why security-conscious traders should always consider self-custody, whether via a hardware crypto wallet, browser extension, or mobile application.

Key takeaways:

• It can be convenient for active traders with smaller portfolios to leave their crypto on their preferred trading platform
• Holding crypto on an exchange isn’t inherently unsafe, however, it is much riskier than self-custody
• Leaving crypto on an exchange opens vulnerabilities such as hacks, bankruptcies, and fraud
• A cold, hardware wallet is widely considered the safest storage solution for hefty crypto portfolios

Should You Keep Your Crypto In Brokerages And Exchanges?

There is no one size fits all answer to this question. In general, it is recommended that long-term crypto holders strongly consider using a reputable cryptocurrency wallet such as ZenGo, Metamask, or Exodus Wallet. However, active traders that need fast access to their digital tokens may benefit from mixed storage – holding some coins on an exchange, and others in a hot or cold wallet.

Valid Reasons To Store Crypto On Exchanges

There are several reasons why an investor might want to keep their crypto away from an exchange. These include trading cryptocurrencies to exchange between different coins and tokens. However, the convenience of storing smaller amounts via a third party might be worth the risk for some – especially when we consider that transferring crypto to a self-custodial digital wallet can be risky in itself. Additionally, active investors using crypto day trading exchanges will likely need to store a sum of money (either fiat or crypto) on the exchange to ensure they can react quickly to a fast-moving market.

Pros & Cons Of Using An Exchange To Store Crypto

What Are The Risks Of Leaving Crypto On An Exchange?

Keeping assets in self-custody doesn’t completely absolve the risks of exchange hacks – but it reduces them, while also taking away the possibility of a centralized business’ malpractice impacting user funds. While massive exploits and exchange hacks are becoming less frequent, they are still a risk that all investors must consider. As the blockchain world is still in its relative infancy, it’s a bit of a “wild west” that is unfortunately still dealing with plenty of crime. This leaves some of the industry’s major players – particularly high-profile exchanges – the target of hackers.

Although most exchange wallets are a mix of cold and hot wallets, the small percentage of assets stored in hot wallets can be worth tens of millions. If such a hack occurs, reclaiming funds comes entirely down to the business’s individual policies – which may have several caveats for reimbursement, or even worse, no repayment plan whatsoever.

Although cryptocurrency is often thought of as a long-term investment or a gateway to the Web3 world, one of its biggest uses is as a store of value. Bitcoin’s original vision was as a global payments solution that operates outside the sovereignty of central authorities like banks and governments. In simple terms, Satoshi Nakamoto intended the blockchain to give control of finances back to the consumer.

Leaving crypto on an exchange goes against one of cryptocurrency’s core philosophies. Although this may not be a big deal for every investor, there will be just as many who value maintaining complete control over their own funds. The only way to do this is by storing crypto in a self-custodial wallet – leaving assets on an exchange gives the business complete access to their customer’s finances.

Counterparty risk might be the most relevant risk of leaving crypto on a centralized exchange. This basically includes acts of fraud, bankruptcies, and companies otherwise not fulfilling their promised role as a custodian.

While there haven’t been too many major security breaches since 2020, there have been quite a few bankruptcies. Several exchanges pop up during crypto bull runs (like in 2021) and overplay their hand by leveraging their assets. When the market turns (as it did in 2022), these businesses suddenly lack the financial security to continue operating. Some will have even used customer funds to make shady investments (like FTX). In such instances, they will likely declare bankruptcy – meaning customers have a long road ahead of them to reclaim even a fraction of the assets they stored on the exchange.

The crypto industry is barely a decade old and is still encountering serious regulatory growing pains, with the risk of some Governments choosing to ban Bitcoin. Such issues are particularly prominent in governments that have adopted a “black and white” stance to regulation, such as China and the United States. It’s possible the constantly shifting regulations could result in powerful businesses and exchanges being forced to change their services, or even worse, shut down crypto exchanges completely. If such an event occurred, it is unclear how the regulatory bodies would address customer funds stored on the compromised exchange.

It is becoming more and more important for major cryptocurrency exchanges to implement insurance coverage. As the crypto industry matures, investors are becoming more security-conscious – so trading platforms have had to adapt and create insurance funds in the event of a hack.

However, there are still a lot of well-known digital currency exchanges that have no insurance coverage whatsoever. Additionally, the most popular form of insurance fund only covers theft caused on the exchange’s end – losing access to the account, or someone stealing passwords via a keylogger/malware aren’t usually covered. It’s also quite rare for an insurance policy to cover counterparty risks like bankruptcy.

Crypto investors that store their assets on an exchange are at the mercy of server issues or downtime. Although most major platforms don’t experience downtime all that much, it can still occur from time to time – lasting anywhere from minutes to days. During such periods, investors will be unable to access their portfolios.

While this may not be a huge issue for long-term investors, it can wreak havoc on the trading strategy of swing or day traders. The crypto market is notoriously volatile and constantly evolving, meaning that even being a few minutes late to a market trend can result in substantial opportunity costs. Even more passive investors may miss out on an up-and-coming altcoin they want to swap for due to exchange downtime.

Except in some rare circumstances, leaving crypto on an exchange means that investors do not have access to their private keys. Rather, the company operating the exchange will “own” all of its customer’s private keys. There’s a common saying in crypto – “not your keys, not your money”. By handing private key control to an exchange, the assets the company is holding are considered theirs (at least under most current regulations).

Withdrawal restrictions often come hand-in-hand with counterparty risks. What can happen is an exchange will overleverage itself and no longer have enough liquidity to pay out customer funds stored on the platform. To prevent a “bank run” the company cannot accommodate, they will freeze withdrawals until they can either pay out creditors or file for bankruptcy.

Less damaging instances of withdrawal restrictions can occur too – for example, high network traffic may result in fiat/crypto withdrawals being delayed. Some platforms may only allow users to withdraw a certain amount of funds within 24h, 30d, or another timeframe. Other risks include the exchange pausing withdrawals or delisting coins. Such limitations can incur substantial opportunity costs. This boils down to the lack of control when leaving crypto on an exchange – self-custodial wallets will usually have very few restrictions.

What To Look For If You Decide To Store Crypto On An Exchange

Storing crypto on an exchange can be risky, but there are several measures investors can take to mitigate the danger.

• Overall reputation and track record. Double-checking a platform’s reputation in the industry can be a good way to gauge its trustworthiness. Long-standing crypto exchanges like Binance and Kraken are likely to be safer storage solutions than lesser-known crypto brokerages with fewer customers. Additionally, platforms with a history of being hacked should be avoided due to mediocre security measures.
• Regulation, compliance, and insurance. Sticking to exchanges that are registered with local regulatory bodies is a good policy for investors leaving their crypto in the custody of another. Many governments have strict requirements that each platform must pass before it can offer financial services in that jurisdiction. Additionally, picking a platform that has an insurance fund – especially if it covers more than just hacking – is a great way to reduce the risk of storing crypto on an exchange.
• Two-Factor Authentication (2FA). As the crypto industry has matured, a pretty basic rule has cropped up among investors – if a platform doesn’t have 2FA, don’t use it. 2FA is one of the best safeguards against hackers, especially if they get access to account passwords (this is more common than exchange-wide exploits).
• Withdrawal procedures. Reading a business’s T&Cs is an important step to take for investors leaving their crypto on an exchange. These documents will likely highlight the withdrawal procedures of the exchange and the actions it will take in case of bankruptcy or financial instability. For example, Coinbase reserves the right to halt withdrawals and deposits in the case of insolvency.
• Offline cold storage. Most modern exchanges use a storage method combining both hot (online) and cold (offline, hardware) wallets. Try to stick to exchanges that have over 90% of their assets stored on cold wallets, and avoid those that only use hot wallets entirely. Most platforms will disclose their storage methods under the “Security” section of their websites.

How Much Crypto Should You Store On An Exchange?

As a rule, you should never store more on an exchange than you are comfortable losing. For newcomers to the scene, fractions of a Bitcoin or another crypto can be stored on an exchange to avoid the occasionally confusing process of sending digital currencies to a self-custodial wallet. However, this should only be a temporary solution while the investor is learning how to navigate the blockchain world.

More experienced investors – particularly active traders – may want to keep a certain amount of their portfolio on an exchange so they can easily sell or swap it. A small-time trader may only keep a few hundred dollars in a stablecoin handy, while professionals might be storing tens of thousands on the exchange. This allows them to quickly react to changing market conditions. Either way, anything intended for long-term holding should be stored in a hot, or preferably cold, wallet.

How Long Should You Leave Crypto On An Exchange?

There is no set timeframe for leaving crypto on an exchange. A general rule of thumb is – the shorter the better. The detailed answer once again depends on the goals of the individual investor. A professional day trader may use their stored crypto within a day or week, and then repeat the process with new funds.

For a novice trying to learn the ropes, a month or two is likely enough time to understand creating a wallet and sending/receiving crypto. Keeping crypto on an exchange for longer than six months can start to amplify the risks outlined earlier in this article.

With that said, keeping crypto on an exchange is more risky than other, alternative storage methods. That doesn’t mean it’s an overwhelmingly dangerous option. Lots of people do store significant portfolios on an exchange for years without an incident – it’s just not recommended to do so.

Tips For Keeping Crypto Safely Stored On An Exchange

• Use a strong and unique password. Lots of people fall into the trap of using the same password for all their accounts. If that password is compromised, suddenly hundreds of accounts are at stake. It’s always a good idea to use a randomly generated password – often a string of numbers, letters, and symbols – for each financial account. Using a trusted password manager application to help can improve personal security and simplify the login process.
• Regularly update the password. Google and other password managers will provide users with updates on whether their passwords have been compromised. If a security breach occurs, all passwords should be updated immediately. Beyond this, changing crypto exchange passwords every 6-12 months is a good way to keep hackers at bay.
• Enable 2FA. Enabling 2FA should be the first step for any new account on a crypto exchange. If the platform doesn’t support 2FA, it probably should be avoided.
• Only store a small amount of crypto. If storing crypto on an exchange, ensure it is a temporary option and there is a plan for moving it in the future. For example, a novice might give themselves a few weeks to learn the ins and outs of self-custodial wallets before choosing one. Or, an experienced investor might leave 1,000 USDT on an exchange for trading throughout the week.
• Monitor account history and be cautious with APIs. A lot of modern crypto exchanges have APIs that can be used to link useful third-party applications (such as tax software). However, the more parties that are introduced to the frame, the bigger the risk of passwords being compromised. Always keep an eye on account history, as some hackers may move really small amounts of crypto as a test, before stealing an entire portfolio.
• Whitelisting wallet address. The majority of high-end crypto exchanges will support wallet address whitelisting. This means users can only send crypto to pre-approved wallet addresses. Therefore even if a hacker got access to the exchange account, they can’t actually move the crypto.
• Turn on notifications. Keep an eye out for email notifications for any logins from strange devices or locations.

Alternatives To Storing Crypto On An Exchange

1. Hardware wallet. Widely considered the most secure method of storing cryptocurrency. This is recommended for serious investors willing to pay a few hundred dollars to ensure the safety of their digital portfolios. Trezor T and Ledger Nano are two examples of the best hardware wallets to use.
2. Browser wallet. Browser wallets are extensions that can easily connect to DeFi services like UniSwap or Decentraland. MetaMask is a very popular example.
3. Desktop wallet. Desktop wallets are software applications that can be downloaded and installed on a personal computer. Examples include Atomic Wallet and Exodus.
4. Paper wallet. Paper wallets are a set of randomly generated private/public keys that can be written down/printed onto a piece of paper. These keys can then send or receive crypto. Two paper wallet address generators are BitAddress and WalletGenerator.
5. Mobile app. There are lots of excellent mobile apps that store crypto while the investor maintains custody of their assets. A prominent example is ZenGo.
6. Multisig wallets. These wallets are like others on this list, except they require two sets of keys (rather than just one) to be accessed. These keys are often shared among different users. Examples include Electrum and BitGo.
7. Custodial services. There are businesses designed exclusively to provide a storage solution for crypto investors. These companies maintain custody over assets but will focus on storing them securely in exchange for a management fee. Gemini Custody, Anchorage, and Coinbase Custody all offer insurance coverage and cold storage.

Conclusion

It can be easy for investors to just leave their cryptocurrency on an exchange after purchase. In many cases, there will be no ramifications for this – hacks and insolvencies are rare for reputable, top-end crypto exchanges. However, as the community saw with the FTX contagion, such catastrophes are still a very real possibility. The only way to ensure the safety of an investor’s crypto portfolio is to take custody and store it in a hot – or even better – cold wallet.

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