The crypto industry has grown into a $1.3 trillion industry since Bitcoin’s inception back in 2008. However, the decentralized and digital nature of cryptocurrencies presents both a novel allure and a potential risk. As transactions move across blockchain networks, their privacy and security depend on individual traders, networks, protocols, and the developers behind them.
In this article, you’ll learn why crypto isn’t inherently private or secure, and we’ll show you how to enhance privacy and security.
Why Crypto Isn’t Really Private
The term “crypto” may lead you to believe that your transactions are private – but that’s a common misconception. Every cryptocurrency transaction actually appears on a giant public ledger, making it easy for anyone to trace them back to their origins.
For example, if you download and set up a MetaMask wallet. Unless you receive your initial cryptocurrency by mining or selling something, you’ll probably purchase Ethereum or another cryptocurrency with fiat currency. As a result, someone could trace any transactions you make with that Ethereum back to the processor that saw your credit card or bank account.
Web3 applications further complicate matters. For instance, many Web3 developers use Infura and other API providers to transact with blockchains. But as MetaMask users discovered, these services may collect and store IP addresses and wallet information. Consequently, someone could access these logs to match your wallet to your identity.
Of course, privacy may not matter for most crypto users. Many people are willing to trade off privacy for utility and ease of use. In many ways, these trends mirror those of the broader Internet, where most users were happy to move from anonymous listservs and forums toward social media platforms using their real identity.
How to Keep Your Transactions Private
Crypto users interested in private transactions have some options. For instance, privacy coins and crypto mixers can help preserve privacy using various clever techniques. However, it’s critical to understand how they work and the risks involved before using them.
Privacy coins work by concealing transaction data:
- Monero uses one-time stealth addresses for each transaction, ring signatures that group genuine transactions with decoy ones, and hides the amount sent in each transaction.
- Zcash uses zero-knowledge proofs to validate transactions without publishing the address or transaction amount to the blockchain.
Crypto mixers mix coins from different sources after a transaction, making it challenging to trace the exact addresses of a specific transaction. For example, Tornado Cash lets you deposit coins into a shared pool where multiple transactions are mixed and processed. As a result, you cannot tell who the recipient was of who’s coins using the public blockchain.
For obvious reasons, regulators have expressed concerns about privacy coins and crypto mixers. The U.S. actually sanctioned Tornado Cash, and the E.U. could ban privacy coins altogether. As a result, those using privacy coins or mixers should prepare for increased scrutiny – and most would be wise to avoid using them unless necessary.
Crypto Security Isn’t Perfect Either
The term “crypto” may also inspire confidence in security – but that’s also not necessarily true. Open-source code, immutable ledgers, digital transactions, and pseudo-anonymity have made the industry hot for hackers and criminals looking to steal or launder money. According to Chainalysis, illicit crypto volume reached an all-time high of $20.1 billion last year.
In addition, the crypto industry isn’t heavily regulated compared to banks and other financial institutions. While these lighter regulations open new possibilities, they also increase the risk of bad actors stealing money from unsuspecting customers. Consumers can’t rely on regulators to protect them or credit card companies to refund fraudulent transactions.
There are countless examples of these security risks:
- FTX, once one of the most popular crypto exchanges, lost billions of dollars worth of customer deposits after secretly moving them to its trading firm, Alameda.
- Euler Finance, a decentralized finance (DeFi) protocol, lost $196 million in customer deposits to hackers after a flash loan attack using a multi-chain bridge.
- Hackers stole $600 million from Axie Infinity, a popular crypto game, by exploiting the Ethereum-linked sidechain supporting the game’s non-fungible tokens (NFTs).
And, of course, it doesn’t always take a hack to lose money. By some estimates, Bitcoin users have misplaced about 20% of all existing tokens. The immutable nature of the blockchain means that these tokens are forever lost – unlike a missing credit card.
In addition, countless investors fall victim to Ponzi schemes and other crypto scams. These aren’t exactly security vulnerabilities arising from the blockchain, but they are instances where it’s much easier to lose money in crypto than conventional financial assets.
Tips for Keeping Your Crypto Safe
The good news is many of these security risks are avoidable. For instance, you can use strong passwords to keep your online accounts safe and choose reputable and secure platforms that shield you from potential threats.
Here are some tips to help keep you safe:
- Use Reputable Exchanges. You can minimize risk by using reputable exchanges with insurance policies to make customers whole. For example, Coinbase is a publicly traded company in the U.S. and offers insurance on all customer deposits.
- Be Careful with DeFi & dApps. The security of DeFi protocols and dApps depends on their developers. And unfortunately, even the most popular options have experienced devastating hacks. So, be sure to diversify exposure to any single point of failure.
- Use Cold Storage Solutions. The safest place to store cryptocurrencies is offline in “cold” storage. For example, you can use a Ledger hardware wallet to hold the bulk of your crypto assets and only keep some on an exchange for active trading.
- Protect Your Online Accounts. Consider using a password manager to generate strong passwords and integrate multi-factor authentication to secure your accounts further. In particular, hardware keys are among the most effective ways to protect your assets.
- Don’t Skimp on Due Diligence. The “fear of missing out” can lead many investors to purchase coins without adequate due diligence. By taking the time to research an opportunity, you can avoid many of the most common scams.
Despite these security measures, you don’t always have control over third-party platforms. The only way to completely protect against these losses is to purchase crypto insurance, which could help make you whole again if you experience unavoidable losses. In addition, you can diversify your assets across many platforms to mitigate any single loss.
The Bottom Line
The term “crypto” is often associated with “security” and “privacy,” but blockchain technologies are inherently neither. In fact, their transparent and open-source nature makes them anything but private, while their digital and pseudo-anonymous nature makes them a magnet for crime. Fortunately, you can take several steps to improve both privacy and security.
If you trade crypto assets, you should also ensure you properly record transactions for tax time. ZenLedger can help you automate the process by connecting with your wallets and exchanges, importing all your transactions, and automatically calculating your capital gain or loss. You can even generate the necessary tax forms in just a few clicks.
The above is for general info purposes only and should not be interpreted as professional advice. Please seek independent legal, financial, tax, or other advice specific to your particular situation.