Virtual Financial Assets (VFA) is all about cryptography and key pairs: random numbers that are associated, however, with real money. Your Public Key (or Address) is what you share with the world so that people can send you money, pretty much like your bank account. Your Private Key is what proves your ownership over that money. The bank analogy here would be that your Private Key is your debit card and your PIN and you with your ID in front of the teller asking to withdraw money. So, the Private Key is all that is needed to prove ownership over an address and the funds in it.
This makes abundantly clear the importance of keeping these Private Keys, well… private. In fact, it’s one of the major challenges that cryptocurrency users face. For that, several options are available that accomplishes a different balance between Security, Usability and Privacy.
Here we categorize the available options in two major categories based on Privacy: Custodial Services and Wallets. Custodial Services are usually exchanges, while Wallets are usually programs on your computer and phone or specialized devices known as hardware wallets. The basic difference between them pertains to Privacy and the ownership of Private Keys. With Wallets you have the control of your Private Keys, since they are stored locally on your device, and as such you have full ownership of your funds. With a Custodial Service they control the Private Keys for you and you interact with them through your account.
On the Privacy front, using a wallet certainly provides more privacy and anonymity than a custodial service. When using a wallet all that people can see is your address(es) which is very hard to associate with you, unless you publicly say that you own them. On the other hand, an exchange asks for personal information when you register with them, so your addresses and your transactions are easily linked to the information you have provided. Now whether that information can tell the world who you are depends on what KYC (Know Your Customer) policy the exchange applies and how much information it requires.
Wallets do score a clear win on Privacy, but exchanges have their advantages also and are mostly found on Usability and Security. As it was mentioned, keeping your Private Keys safe is of paramount importance. But it’s also not easy. It comes down to your security practices that most people aren’t that good with. If you have your money on a software wallet, like Exodus, you need to take great care that your private information isn’t somehow shared and that your computer is clean from malware. Same goes for your phone. It’s not an easy task to be properly fortified. On the other hand, if you have your money on an exchange you don’t have to worry about any of that. Caution is still required not to compromise your account, but it’s nowhere near to having to protect your keys yourself.
Of course, exchanges are prime targets for hackers, with all that money they hold, and many have been hacked in the past, in which cases customers have lost their money. Although, nowadays most major exchanges have their funds insured and keep the bulk of their assets in “cold” storage. An example of “cold” storage for everyday use are hardware wallets. These are considered the most secure way to store VFA, because the Private Keys are stored in a specialized secure chip and never come in contact with the outside world.
But what they provide in Security, hardware wallets usually lack in Usability. Software wallets used to be like that too, but they have recently taken a serious turn towards user-friendliness and providing exchange functionalities as well. Again, Exodus is a prime example. But exchanges are the best place to quickly trade between assets and their interface is usually straightforward and user-friendly, as one is accustomed to when dealing with online services. Also, exchanges are usually the easiest and cheapest way to exchange between VFA and fiat currency. Finally, exchanges usually make it simple to claim any forks or swaps of their supported assets, and based on their recent trend this is important to many people.
All in all, the selection of one method over the other needs research but will probably be based mostly on personal preference.
Edited by: Michalis Fragkiadakis