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A few months back The New Yorker profiled James Howells, a man from Wales who is famous in the crypto world for accidentally throwing away a hard drive with $500 million in Bitcoin (BTC-USD). The profile follows his saga to convince the city to let him excavate the landfill and unlock his millions. So far, he hasn’t had any luck. Howells isn’t alone. Stefan Thomas, a programmer from San Francisco, only has 2 more password attempts to get back into his locked account containing roughly $250 million, or his data will be wiped forever.
Losing Bitcoin is one thing, but getting it stolen is another. This past week, the U.S. Justice Department arrested a New York couple on charges of laundering billions in stolen Bitcoin. Also in the New York metro, “Baby Al Capone” Ellis Pinsky was sued by a Silicon Valley tech executive for using sim-swapping to steal about $25 million of cryptocurrency. Pinsky was a high school student at the time. The stories go on and on, and I personally know a few people as well who have lost crypto or had it stolen. Learning from your mistakes is good–but learning from other people’s mistakes is vastly preferable. As the crypto industry has matured, the risks of this sort of chicanery have gone down immensely if you take the right precautions, but it pays to understand the landscape so you can own crypto safely and without paying excessive fees.
If you’re completely new to crypto and you’re asking “How do you buy Bitcoin?” the simple answer is that you open an account at a crypto exchange, deposit cash, purchase Bitcoin, and you’re on your way. If you do this, it’s important you understand the fee structure and cybersecurity implications of what you’re getting into, so you don’t end up getting ripped off or getting your Bitcoin lost/stolen. More on this later.
Investors also have the option to buy the ProShares Bitcoin Strategy ETF (BITO) or the Grayscale Bitcoin Trust (OTC:GBTC), which has also filed an application to convert to become the first spot Bitcoin ETF. GBTC is especially interesting because of a one-time, event-driven trade that many people are interested in, which is the 24% discount to the net asset value of the fund. If the government approves the ETF conversion, I think it would be a good thing for investors who want an easy, low-stress, and safe way to own crypto, and it would benefit the holders of GBTC who have bought from impatient shareholders unloading shares below NAV.
I submitted public comments in favor of GBTC’s ETF conversion to the Federal government (I did so by email, not sure if they’ve been uploaded yet)–as I said, it’s open to the public so you also can feel free to submit your take.
More on GBTC from my latest coverage on it.
In the traditional banking system, bigger is almost always better from a depositor safety standpoint. In fact, the phrase “too big to fail,” came about because the largest banks in the world are too systematically important to allow depositors to lose money. This is generally true for crypto as well, you probably wouldn’t want to invest too much money with a small offshore crypto exchange. One key difference between traditional banks and crypto, however, is that most crypto exchanges make money from brokerage (i.e. customers buying and selling) rather than taking deposits and lending them out, so fees are just as important as a consideration. Still, to reduce the chances of fraud or chicanery, I would absolutely recommend sticking to the largest 10-15 exchanges or so by volume.
At present, these are the 5 largest cryptocurrency exchanges by volume.
Binance is the biggest crypto exchange in the world. Binance is big in Asia but got banned in the US and UK for money laundering and tax problems. Its recently reopened US-regulated exchange is pretty small. As far as customer funds are concerned, I think Binance can be trusted, but if you’re in the US, I’d pass on Binance given the controversy. Huobi also is Asia-facing and doesn’t take US customers.
Coinbase (COIN) was most American investors’ introduction to crypto. I made my first Bitcoin purchase on Coinbase in 2016 but sold far too early. Coinbase comes in two flavors, the main Coinbase platform which is user-friendly but expensive, and Coinbase Pro, which is a more sophisticated platform with lower fees and a steeper learning curve. Coinbase is a workable option.
FTX was also banned in the US but reopened a small US-facing platform. They’re best known for sponsoring the arena where the Miami Heat play (formerly the American Airlines Arena). Both Coinbase and FTX paid up for Super Bowl ads as well, increasing their public visibility.
In my opinion, Kraken is the best of the bunch here because they have lower fees (Super Bowl ads have to be paid for somehow) and I like their focus on cybersecurity. Like Coinbase, Kraken also comes in two flavors, Kraken and Kraken Pro. Kraken’s team didn’t buy a Super Bowl ad, but their CEO went on Bloomberg the following week to discuss the industry, which highlights some of the cultural differences between the companies. Coinbase had some widely publicized issues with hacks, where 6,000 customers got their cryptocurrency stolen from a single hack last year. They’ve since beefed up their security but it shouldn’t have happened in the first place. Kraken seems to be to the crypto world what Interactive Brokers (IBKR) is to the stock trading world. The typical fees for trading crypto are quite high (1%-1.5% commission per side seems to be about average), highlighting the need for a professional platform with low fees. Coinbase Pro and Kraken both have fees that are a fraction of this.
Lastly, another crypto exchange–the one I personally have used is BlockFi. BlockFi offered to pay interest on cryptocurrency, which is a novel idea. The problem was that they misrepresented the level of risk they were taking with offering crypto lending, which recently led to a $100 million civil settlement. No one lost money as a result of this, and BlockFi’s substantial equity capital would have been at risk before any depositor money, but caveat emptor. You can read the SEC portion of the settlement here. For what it’s worth, BlockFi actually is a pretty good exchange (remember that big banks get in trouble all the time too), but their yield program has now been shut down, which was the raison d’etre for putting money with them rather than one of their larger competitors.
Lastly, note that owning crypto does not inherently mean it will be stolen or lost. However, there’s a lot of volatility involved which you can deal with by taking small positions, and there are a lot of idiosyncratic risks with exchanges, cybersecurity, and such that need to be properly managed for you to have lasting success.
Of all the issues facing crypto investors, cybersecurity is probably the least understood and the most important.
If you set up an account on Coinbase for example, you’ll have a username and password, just like you would for any online account. But nowadays, millions of usernames and passwords are for sale on the dark web for a few dollars each. Even your identity can be bought and sold for a few bucks. Blake Hall, the founder of ID.me, famously claimed last year that $400 billion–nearly 50% of all the pandemic unemployment money the Federal government authorized was simply stolen by criminals. The number seems like it might be a bit high, but a White House report placed the number at a lower but still highly problematic 18.7%.
As a result of this, there have been huge investments made into cybersecurity in the past few years. The typical first line of defense against this is two-factor authentication (2FA). Typically, this means that when you log into your bank or brokerage account, you’ll get a text and you have to type in the code you’re given. Early crypto brokerages often made 2FA optional, which is highly dangerous. 2FA is not generally optional anymore due to the dramatic increases in the amount of hacking that occurs on a regular basis.
Not only should you have 2FA enabled for all of your bank and brokerages, but you should enable it as well on your email and social media accounts when logging in from a device other than your own. This will typically prevent your email from being taken over remotely, as well as your social media accounts. In the last year, I’ve seen a couple of dozen acquaintances get their social media hacked– and it generally is used to post crypto-related Ponzi schemes or other spam.
When money is involved, you will often want to take it a step further. The Silicon Valley tech executive from above was targeted by a sim-swapping scam. Often all the criminals have to do is bribe minimum wage employees at cellphone stores to give access to a target’s phone number, which they use to access their crypto accounts and drain the money. To hit back against this, many crypto exchanges have enabled authenticator apps like Google Authenticator, which deny would-be sim swappers. Google Authenticator caused me problems when I sold my phone and couldn’t access BlockFi, but I got access back to the account using that ID.me service. Of course, there are also other things to be vigilant about, like sophisticated phishing scams.
To be clear, most people will never be a victim of an unreimbursed cyber theft. I’ve had multiple rounds of fraud on my credit card accounts over the years, but I was able to get my bank to reimburse me. Crypto requires a little more caution due to the fact that charges can’t be reversed. This isn’t necessarily something to be paranoid about, but no matter who you are, you should review your banks, brokerages, email, and especially crypto accounts to take every commercially reasonable countermeasure against fraud and theft. Chances are if you’re reading this, your risk of being hacked is less than an outspoken tech CEO, but an ounce of prevention is worth a pound of cure. People who invested their money wisely and quietly buy beach homes and ski houses don’t make headlines, but fraudsters always do.
Owning Bitcoin directly has the distinct advantage of avoiding the recurring fees that ETFs charge. However, if you are lax about security, you’re far more likely to be a victim of cybercrime than you would be in the traditional financial system. At earlier crypto exchanges, sometimes the emphasis on security swung too far in the other direction and caused people to be forever locked out of accessing their crypto, effectively leading to the same result as having it stolen. Today, major crypto brokerages like Kraken Pro and Coinbase Pro offer a good balance of cybersecurity and accessibility.
This said, my favorite way to own crypto at the moment is to buy the Grayscale Bitcoin Trust, which offers a 24% discount to its net asset value in BTC and a clear catalyst to close it to 0% in the ongoing effort to convert to an ETF.
Do you have stories, ideas, or comments to share? Feel free to add your own thoughts below.
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Disclosure: I/we have a beneficial long position in the shares of GBTC either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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