Cryptocurrency losses from scams, theft and fraud totaled $1.2 billion during the first quarter of 2019, according to CipherTrace, which is on track to surpass the $1.7 billion stolen last year. While nobody has hacked the actual blockchain protocol, there have been plenty of high profile thefts from exchanges and scams targeting individuals.
Let's take a look at five tips to keep your cryptocurrency safe from scams, theft and fraud, as well as losses stemming from fines and penalties from the IRS.
#1. Cold Storage for Investments
Cryptocurrencies are built upon public-key cryptography: A private key generates a public key using a highly-secure one-way hash function, while the public key generates an address using a similar one-way hash function. That way, you can send a transaction using a private key and someone can easily verify it using a public key; but, you can't reverse engineer the private key to send transactions out of another person’s account.
Most cryptocurrency thefts occur from exchanges that hold private and public keys on behalf of their customers. If private keys are stolen, hackers can easily transfer cryptocurrency out of customer accounts and into their own accounts. These stolen funds are impossible to recover without physically altering the blockchain, which only happens when large thefts occur due to inherent flaws in a cryptocurrency’s blockchain.
The best way to prevent theft is to use so-called cold storage, which means storing your own private key offline. You can accomplish this with anything from a printed QR code on a sheet of paper representing the private key to an encrypted hardware wallet containing your private key — just don't lose the private key or the crypto is lost forever!
#2. Ensure Your Devices Are Secure
Cryptocurrency held in exchanges or online wallets may be susceptible to theft, but at least these service providers take extensive precautions to protect client assets. For example, Coinbase stores 98% of customer funds offline in redundant split storage that's encrypted with AES-256 and distributed geographically in safe deposit boxes and vaults. These deposits are also ensured in the event of an attack to prevent customer losses.
If you plan to store cryptocurrencies on your own devices, you should ensure that they're highly secure to avoid theft. The Anti-Phishing Working Group estimated that nearly one-third of computers around the world were infected with malware, which suggests that most computers may not have an appropriate level of security. Unlike stolen credit cards, there's no way for cryptocurrency users to get their funds back if they're stolen.
There are a few ways to ensure your devices are secure:
- Install anti-virus and anti-malware software and update and run them on a regular basis to ensure that your device is never infected.
- Encrypt all data stored on your devices. If the device is stolen, criminals won’t be able to access the cryptocurrency, and hopefully, you have a backup.
- Use a secure wallet application to store cryptocurrencies in a way that protects them from device-level threats via encryption.
- Consider secure operating systems, such as Linux or MacOS, that are less susceptible to attack than Microsoft Windows.
#3. Use Secure Hardware Wallets
Hardware wallets are the most secure cold storage option for cryptocurrencies. It's impossible for a hacker to steal the cryptocurrency without physically stealing the device since it's not connected to the internet. If the device is stolen, hackers would still need to guess a four to six digit PIN code to decrypt and access the wallet. Modern hardware wallets are nearly impenetrable and extremely intuitive for consumers.
The three most popular hardware wallets are:
- Ledger Nano is one of the most popular hardware wallets with a tamper-resistant chip and proprietary operating system designed specifically to protect crypto assets.
- Trezor is another popular hardware wallet that's audited by security researchers and provides an easy-to-use interface for those new to cryptocurrencies.
- KeepKey is a newer hardware wallet that provides PIN protection, passphrase protection and customizable transaction speeds to maintain optimum security.
If a hardware wallet is lost, it's possible to securely recover the cryptocurrency using a predetermined 12, 18 or 24 word recovery seed. These recovery seeds should be kept in a secure location. You can simply purchase a replacement hardware wallet and input the recovery seed to regain access to the cryptocurrency in the original wallet.
#4. Avoid Common Crypto Scams
There are countless varieties of cryptocurrency scams — and new ones come out every day — but some have been more effective than others. By being aware of these scams, you can avoid becoming a victim and protect your cryptocurrency holdings.
Three of the most effective scams include:
- Initial Coin Offerings (ICOs): Many ICOs are legitimate attempts to start a viable business, but others have no viable business plans in place. New alt coins often make unsubstantiated claims about their products, prompting the SEC to crack down.
- Trading Systems: Many trading firms offer to invest your capital in "proven" trading systems that generate predictable profits. These trading systems are often pyramid schemes where new contributions are used to pay off prior investors.
- Free Giveaways: Fake social media accounts designed to mimic celebrities may offer free cryptocurrency giveaways — the only catch is that you need to deposit a small amount to receive the giveaway. Of course, criminals simply keep the deposit.
Common sense is the simplest way to avoid these types of scams — if a crypto offer seems too good to be true, then it probably is! Stick to long-term buy-and-hold investment strategies or short-term strategies that you develop and understand.
#5. Keep the IRS Happy
The IRS treats cryptocurrencies as property, which means that you must report capital gains and losses upon sale or conversion. If you're not up-to-date and the IRS discovers it, you could be responsible for paying back taxes with interest, as well as any fines and penalties. And, you might have to sell off crypto assets to afford these fines.
ZenLedger makes it easy to ensure that you're accurately reporting crypto gains and losses on your tax returns. By automatically aggregating transactions across exchanges and wallets, the platform calculates the gain or loss from each transaction and auto-populates important IRS forms, such as Form 1040 Schedule D and Form 8949.
The Bottom Line
Cryptocurrency losses from theft and scams total well over a billion dollars per year. You can minimize the odds of becoming a victim by following basic precautions, such as using cold storage, securing your devices, avoiding common scams and keeping the IRS happy.