Exchange wallets – an opportunity or a risk for the user?

Exchange wallets – an opportunity or a risk for the user?
How is money really being laundered?
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Every beginner in the crypto world faces the dilemma of choosing the right wallet for their cryptocurrencies. Which wallet is safe? Which is easy to use? One element often excludes the other. That is why it is worth taking some time to analyze and make a deliberate decision. After all it is our money that is at stake!

How does a crypto wallet work?

The purpose of a cryptocurrency wallets is to store funds and access the blockchain on which all transactions made in the network are saved. By setting up a crypto wallet we are granted access to it through a private key that is used for transferring funds. Remember! Do not give your private key to a third party since, following the rule ‘Not your keys, not your coins,‘ you can lose access to your cryptocurrencies!

With the creation of your wallet, you also get a public key which is used for receiving payments. You can use this key in a safe manner because it does not give access to your wallet in any way.

Types of crypto wallets

We can distinguish a few basic types of wallets: paper wallets, hardware wallets, software wallets and exchange wallets.

Paper wallets

With regard to security, paper wallets or brain wallets appear to be the best option. Simply speaking, they require creating a wallet with the use of a program by generating a private key to be printed out or saved in the form of special key words. Such a wallet can be created via a Github repository, where you can obtain a wallet-generating script. Electrum, Armory, or Mycelium are also examples of paper wallets. Apart from security, the advantages of such wallets include seamless receipt of payments and the fact that the fees are network dependent (i.e. they are dependent on network load, not on the exchange). However, the element that could cause frustration is the difficulty in transferring funds and operating the wallet itself. Besides, there is no possibility to get your money back in case you lose your private key and there is no option to change the transmission network.

Hardware wallets

The next type of wallets, much more convenient in use, is the hardware wallet. Ledger and Trezor, which outrun each other in making their wallets easier for their users to operate, are the most popular ones in this category. It is worth noting that the private key stays in the hands of its owner. Such a wallet is saved on a device that resembles a bigger pendrive and is usually connected to the computer through a USB slot. Equipped with a special chip, it gives you access to the blockchain and protects your private key against being accessed. You connect it to your computer only for the time it takes to confirm the transaction, thanks to which your funds are not available to hackers. A stolen or lost wallet is retrievable thanks to key words, which can be stored on pieces of paper kept in different parts of your house or which can be memorized. Apart from security and retrievability when lost, the advantages of such wallets also include easier use and the fact that the fees are network dependent. There are, however, some drawbacks. You need to have the wallet with you to confirm any transaction and if you lose the device and the key words, there is no option to get your funds back. Moreover, by using such a wallet you partially entrust the safety of your cryptocurrencies to its creators and you also do not have the option to change the transmission network.

Software wallets

The above types of wallets are called ‘cold wallets’, which means such wallets which store the user’s funds offline. Their counterparts are called ‘hot wallets’, so such types of wallets which have access to the network, e.g. Metamask, MyEtherWallet, Exodus. Private keys are secured by the device the wallet was installed on (e.g. a laptop, a smart phone), hence there is a greater risk that your cryptocurrencies will be accessed by hackers. Nonetheless, the user-friendliness of these types of wallets is much higher when compared to the ones mentioned before. Moreover, you can secure your money with hardware wallets (in the form of a pendrive), e.g. integrate Ledger with Metamask. It will make using and viewing your wallet easier and you would only need to use the hardware wallet to confirm the transaction when you wish to send some money. Similarly to the other ones, an additional advantage of software wallets is the fact that the fees are network dependent. However, the dangers are also worth mentioning. Their safety depends among other things on you as the user. If you lose the device or the key words, you will not get your money back. There is no option to change the transmission network.

Exchange wallets

Exchange wallets have a bad reputation and are considered to be the least secure. The irony is that up till now all banking institutions are such types of central hubs managing wallets of fiat money of all citizens and yet we continue entrusting them with our money. Of course, it is the question of regulations and trust. Nonetheless, as far as centralized solutions are concerned, it is not much different. Apart from their centralized nature, the reluctance towards exchange wallets may also result from some past events – hacker attacks, bankruptcy of some exchanges, frauds, thefts, unlawful management of user capital.  The fees, which are usually higher in exchanges than in case of transmission between wallets are an additional disadvantage (this results from the mechanism of charging fees by a given network, as on average the exchange has to pay the same amount it would pay for three transactions in the network). 

Apart from a number of risks related to keeping funds in the exchange there are also many advantages. An exchange wallet is generated when you set up an account in the exchange. Thanks to this, you can deposit and withdraw funds between accounts quickly and without any problems.  Such wallets are easy to use thanks to a user-friendly interface. You do not need to have any device near you to be able to deposit or withdraw cryptocurrencies. You can protect your funds by setting a complicated password to your account and additionally enable two-factor authentication.

Unfortunately, the private keys will not be yours, which means that the funds deposited in such wallets somewhat do not belong to you. Technically speaking, it has its benefits. The responsibility for the security of our private keys rests on someone more experienced (as we assume), we have the option to get our account back if we lose our password and some exchanges (including Kanga Exchange) allow for internal transfers that are free or bear a microscopic charge. Transmitting cryptocurrencies between networks is an additional benefit. What does it mean? Ethereum that is transmitted via the ERC20 network is not the same Ethereum that is transmitted via BSC. When you have an ETH in your hardware wallet in the ERC20 network, you will not be able to transfer it to BSC. It is, however, possible to do it in an exchange (if the exchange supports the given networks).

The biggest advantage of keeping your cryptocurrencies in the exchange is the possibility to multiply your capital. For example, thanks to the Proof of Stake mechanism Kanga Exchange offers a 7-18% profit per annum! The KNG, oPLN, or oUSD tokens, are subject to this mechanism and each of them represents a different kind of capital multiplication. To make it easier to understand, let us look at the oPLN (omega PLN) stablecoin. In order to make profit on Polish zlotys, the purchasing power of which decreases while they are kept in the form of bank deposits, you should transfer it the exchange and deposit to a special ‘PoS liquidity oPLN’ account. The current profit increases to about 11% per annum, while the bonus is paid out on daily basis. Where does the bonus come from? Kanga Exchange has the widest network of partner cryptocurrency exchange offices in Poland. To enable such a big network to have liquidity in operating cash, it uses the PLN funds ‘frozen’ by the users in their PoS accounts, multiplying their capital in return. What about security? Sławek Zawadzki, Kanga’s CEO, declared that they do not use the Kanga users’ money. He believes such practices to be highly immoral. He ensures that the funds will stay untouched by Kanga team thanks to the application of adequate internal procedures, which guarantee that no individual can decide about it on their own.  Hackers? Imagine combining the first of the above-mentioned wallets, which would be used as part of the security measures in managing the exchange. It is a successful way to secure against breaking into the users’ online accounts and accessing the money deposited therein. In view of the above, we could safely assume that in the case of some exchanges the security measures are at such a high level that there are no reasons to be worrying about losing the funds deposited in the exchange.

The choice of the type of wallet is not an easy task, especially for those cryptocurrency holders who are still beginners. On the one hand, we care about the security of the cryptocurrencies that will be kept there and the friendliness of using the system. On the other hand, we wish not to be thinking about the passwords or private keys. We do not like the fact that a centralized entity (a cryptocurrency exchange) keeps our funds, but simultaneously we are happy when it helps us get the access to our account back after we lose it. How can we find the golden mean? Analyze the nature of each type of wallets and decide on using a few options, diversifying the risks in the same way.

Roman Majewski for Kanga Exchange

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