Why is it Unsafe to Keep Your Cryptocurrency on Exchange Wallets?

This is likely the first advice that anyone will give you when it comes to cryptocurrencies. However, it’s also the most ignored advice, unfortunately. Since the exchange already has all of the wallets you need for all of your purchases, it just seems to be more convenient to store your assets there.

While most exchanges will, of course, tell their customers that they offer superior security, that is not always the case, and in the event that something does happen, investors will find they have little recourse here to regain their capital. In this article, we’re going to go over why you should not keep any assets on an exchange.

Cryptocurrency exchanges are not banks

Many who are new to the space are likely used to traditional financial agencies which often insure their assets, and in the event of a theft, users have their money returned to them in almost every case. Cryptocurrency does not work this way, and exchanges are not banks. They are not insured, and they will not return any assets to you in the event of a theft or loss.

While they do come with the convenience of being able to retrieve your account information for you, this is also part of what makes them less secure. If someone steals your assets from an exchange, the staff will most likely tell you that you’re out of luck. Cryptocurrency exchanges are not banks, and they will not return stolen or lost coins to you.

It’s your responsibility as in investors to secure your funds, and part of that security includes utilizing a safe, private wallet to which only you own the key. Holding assets on an exchange account is done at your own risk, and you could get burned very quickly with no one to help you recover your money.

Websites offer poor account security

Almost all exchanges function through websites, and this offers very poor account security. There are a number of ways someone can gain access to your information through a web-based account, but phishing is likely the most common one.

Scammers will often imitate an exchange through various methods such as fraudulent emails or even by placing ads in search results in order to gain your passwords. Once they do, they will quickly transfer your assets away, never to be seen again.

Due to the high profile nature of most of these exchanges, they quickly become prime targets for these phishing attempts, and scammers succeed in stealing from thousands of users this way. While you can, of course, secure your accounts with 2FA, this is no guarantee, and these security protocols can also be compromised.

Your assets are essentially stored in a hot wallet in most cases, with easily accessible login information, and if a thief gains access to your email address as well, then they may be able to change your 2FA security too.

For these reasons, trading platforms are prime targets for DDOS attacks and phishing attempts. The risk is low, and the potential for substantial rewards is high for these attackers. Even experienced traders have fallen prey to these incidents, and many have reported losses to the tune of thousands of dollars from cryptocurrency which they kept on exchanges for day trading.

It’s often difficult to even know your account has been compromised until it’s too late, and the transfer of funds to the thief's wallet has already begun. After which there are no means of retrieval.

Exchanges do not offer you backups or private keys

When using a privately owned cryptocurrency wallet you’ll be able to create a backup, and you can also access your private key. These will give you access to your funds should the wallet that you are using stops working, or your host machine become inoperative. Even if the organization which develops the wallet vanishes, in almost every case you’ll be able to restore access to your funds on an alternative option.

When storing your assets on an exchange, you do not have this option available to you. That’s because you do not own these wallets, the exchange does, and if the website goes down for an extended period of time or even shuts down completely, they can take all of your funds with them, and you’ll have no way to get them back.

Unfortunately, many cryptocurrency investors have already experienced this, when the company that was holding their funds either vanished without a trace or was shut down by a government raid on the facility and its founders. Even if they are taken down officially, it’s unsure when or if investors will have their assets returned to them. For this reason, storing assets in a wallet where you have access to the private key is the safest method in every situation.

Exchanges own your funds, not you

Not only does the exchange own the wallets that your funds are stored in, but they also have complete control over them. By leaving assets in an exchange wallet, you are trusting them to a centralized entity who can really choose to do whatever they want with your money. That means that they can hold or freeze your assets if they find something that they don’t like about your trading activity.

They can force you to submit more documentation, and they can even hold your money hostage until these specifications are met, or even indefinitely with little you can do about it. If you don’t have the ability to provide these documents, or if they suddenly stop servicing your country for legal reasons, it could prove very difficult to regain your investments.

Some of these outfits have made it particularly difficult to get your assets returned to you, and customer service could be virtually non-existent. It’s not uncommon for some investors to have their deposits or withdrawals stuck in limbo for weeks at a time with no response from the website’s staff.

Mt Gox, which at the time was the largest cryptocurrency exchange in existence, handling a whopping 70% of transactions filed for bankruptcy in 2014, and many investors have given up hope of ever seeing their money again.

Regulations could change quickly

Regulations regarding cryptocurrencies are still developing, and world governments have not entirely made up their minds about how they feel about these new currencies. This puts many exchanges in a legal grey area that could be prone to more regulation, or in the case of some countries, outright bans on their service. What will happen to your funds if this happens?

Nobody really knows, and it would be in your best interest to keep your funds in a private wallet safe from these difficulties, or even confiscation should your country enact some type of regulation that causes the exchange to cease all operations in their home country.

This concern may sound extreme, but nothing is set in stone yet for cryptocurrency, and investors should be extremely cautious. While this will likely not be a worldwide event, in some countries such as Pakistan, the central bank deemed cryptocurrencies illegal, leaving investors there in a precarious situation. Most of these investors will likely need to utilize decentralized options to continue trading, and any exchanges in their country would need to move or cease all activities.

Alternative options for coin or token storage

While it can be convenient to keep your funds in these places, it’s also a horrible idea. If you’re looking for a multi-asset wallet option, then you could try utilizing Coinomi, Jaxx or Exodus. These are multi-currency wallets that give you the option of storing multiple currencies in one place, but they also will allow you to own your private keys, and to give you backup and recovery options.

They don’t have the same risks associated with them as an exchange account does, because you’ll be able to restore access to your funds, even if the wallet provider vanishes, and they have no access to your money.

If you need to have funds available for day trading, then you could try looking into a decentralized option such as CryptoBridge or BitShares. These options work differently than traditional setups, because you gain the private keys to your wallets.

Unfortunately, decentralized platforms don’t have anywhere near the same trading volume as more centralized providers such as Binance or Bittrex, which leads many investors to continue to use centralized platforms, even if they aren’t really happy with them. If you do need to use a provider that does not offer you any methods to obtain your keys, but you still need to leave funds there for quickly executing trades, then be cautious with how much you leave there.

If you are day trading, it would be wise to only leave a very small amount of your funds as easily accessible collateral here. Once you’ve taken some profits, move them to a safer privately owned wallet to limit your exposure to this environment. While this method is not perfect, and it could still result in a loss, it’s infinitely better than leaving all of your assets on such a platform unshielded.