Crypto storage has always been a topic of debate. While some individuals stand by online custodial wallets, others are more comfortable using offline storage. At the end of the day, the choice is subjective and depends on one’s needs. However, recent happenings in the crypto market have cast a shadow of doubt over web-based crypto wallets, where a crypto firm holds your login keys and is tasked with securely storing your funds. Let’s understand why:

What happened?

Over the last couple of months, a spree of insolvencies and bankruptcies has rocked the cryptosphere. Reeling from the severe bear market and the aftermath of the Terra meltdown, several crypto exchanges, investment firms and lending platforms have decided to stop withdrawals and freeze accounts.

Eventually, some of these firms turned insolvent and declared bankruptcy. For instance, Voyager Digital, a crypto investing app for iOS and Android, declared bankruptcy on July 6 after freezing withdrawals in June. A few days later, crypto lender, Celsius followed suit, declaring bankruptcy on July 14. More recently, crypto lender Vauld applied to Singapore Courts seeking a moratorium order, which is like an American Chapter 11 bankruptcy filing.

What will happen to investor funds?

In the case of paused withdrawals, investor funds are simply frozen. These funds will be made available once the firm resumes withdrawals; this is more of a temporary obstacle. The real issue is when these firms go bankrupt.

In such cases, the fate of customer funds will depend on the company’s user agreement. For instance, in the case of Celsius, the company’s terms of use state that funds deposited “may not be recoverable” in the event of bankruptcy. It can seem quite cynical, especially considering that Celsius claims to have $167 million in cash on hand. Yet, it continues to hold customer funds and has not offered clarity on when it will reopen withdrawals.

In March 2022, popular crypto exchange Coinbase issued a similar statement after suffering a quarterly loss of $430 million and a 19 percent drop in monthly users. In its earnings report, the company stated that in the event of bankruptcy, “the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings.” Users would be labelled as “general unsecured creditors,” and their funds would become inaccessible.

Why is this so?

One of the biggest reasons for this is because cryptocurrencies are not fully regulated. As such, they do not offer the same protections as one would expect with fiat currency held in a bank or shares in a brokerage firm.

Also Read: A look at 3 generations of blockchains and what is next

“Users may be surprised to learn that, in a bankruptcy scenario, the crypto and funds held in their accounts may not be considered their own property,” said Daniel Saval, a lawyer with Kobre & Kim, in an interview with CNBC. These firms now control the funds and use them as per the court proceedings.

This is because, when users create an account on such crypto firms, they often store their holdings in a wallet controlled by the company. This means that the firm has partial control over the user’s holdings. This is because a private key governs access to a crypto wallet. Without this key, the wallet and the crypto stored within it cannot be accessed.

On crypto exchanges such as Coinbase or investment firms such as Celsius, these firms hold the private key, while users access the funds using a more conventional password. This makes it easier for users to access their accounts instead of remembering and entering a string of alphanumeric characters that is the private key.

However, this convenience can become a major cause of concern when the firms are battling insolvency and have the user funds under lock and key. And hence the saying, not your keys, not your coins.

It has happened before

In 2014, the Japanese crypto exchange Mt. Gox was hit by hackers. They made away with more than 740,000 BTC from Mt. Gox customers and 100,000 BTC from the company itself. The exchange eventually declared bankruptcy, and customers are still waiting to be repaid billions of dollars’ worth of cryptocurrency.

However, this isn’t to say that all custodial wallets are unsafe. Several crypto exchanges offer this service to their customers and seldom have any issues. Once in a while, there may be temporary pauses on withdrawal to solve some technical glitches, which are soon ironed out. But the fear remains that if something were to happen, you could lose your funds!

The safer alternative

Offline, non-custodial wallet are viable alternative. The prime advantage of a non-custodial wallet is that it is the most secure way to store your digital assets. Only you have access to the private key, allowing you to be your own bank.

These wallets often come in the form of a thumb drive; just plug it into your PC, enter the private key, and you will have access to your holdings. Most experts suggest tucking away your holdings in such wallets during bear runs to ensure you are not exposed to the volatility of crypto firms. It also ensures you are safe from hacks and attacks.

The downsides of hardware wallets

The main disadvantage of holding a non-custodial wallet is the age-old problem of forgetting passwords. When you forget your seed phrase, you lose access to your wallet. Further, if someone gets hold of your seed phrase, they can access and control your assets.

Also Read: Understanding store of value and why crypto is considered as one?