Top 5 questions you should ask yourself when considering digital currency as an investment.
Updated: Jul 6, 2021
Question 4: What are the pros and cons of non-segregated and segregated digital currency storage?
Non-segregated storage of digital currency means that a self-directed custodian utilizes one specific wallet address for each type of digital currency. For example, if the self-directed custodian allows the custody of Bitcoin, Ethereum, and Ripple, the custodian will have three wallet address. All clients that purchase Bitcoin will share the one wallet address to store their digital currency. Although the self-directed custodian may represent the information to the client through an online portal or app to be unique, it is in fact not. The way you can determine if the self-directed custodian has non-segregated storage is to request the self-directed custodian to send you your “unique” wallet address. If they are unwilling, unable to, claim it is a breach of security or redirect you back to an online portal or app, chances are it is non-segregated storage. If they provide you a wallet address, put the wallet address into any blockchain explorer to discover the results. You will either see that the wallet address provided holds more digital currency than the balance you purchased, making it non-segregated, or you may determine that it is in fact segregated storage of your digital currency.
The pros of non-segregated digital currency storage are the annual storage fees are typically less than that of segregated storage fees, whether charged directly by the custodian or as a passthrough fee from a third-party. If a third-party company is storing the digital currency, you may receive higher levels of storage security standards due to the specialized service.
The cons of non-segregated digital currency storage are your digital currency is comingled in one wallet representing a larger amount of digital currency, which can draw the attention to potential theft internally (employees) and/or externally (cyber hackers). There are storage security standards due to the potential of the one wallet address being compromised and effecting all digital currency investments within the one wallet. Due to the limitations of all types of liability insurance being per occurrence and the fluctuating value of digital currency, you may not have the necessary liability insurance coverage to account for a total loss due to a one-time theft occurrence. If the custodian uses a third-party vendor for digital currency storage, then the liability insurance of the custodian does not cover the loss of the investment due to theft by an individual working for the third-party. The third-party employee(s) is not associated with the custodian responsible for the custody of the investment unless the custodian is endorsed as a loss payee on the third-parties insurance policy. Internal theft of a person(s) with access to the non-segregated wallet may be more tempted to commit theft as the value of digital currency increases. And finally, is tracking of assets in a non-segregated wallet becomes more challenging as the balance and the number of transactions fluctuate frequently.
The list of cons for non-segregated is a lot longer, but there are risks in any investment and digital currency is no different. The takeaway here is that the theft, computer failure, loss of access keys and a company going belly up affects the masses.
The pros of segregated storage are that the digital currency is unique to the wallet addresses assigned to the hardware, making it the most secure way to storage digital currency. Cyber hacking has minimal exposure if the pin numbers and unique phrases are maintained under a high degree of security. The digital assets can also be distributed to the account owner through the means of transporting the hardware to the client with the pin number and unique phrases to follow without the need for transmittal of the digital currency through the blockchain thus removing human error.
The cons of segregated digital currency storage are the manual labor of a custodian to set up digital currency hardware wallets and the maintenance of firmware updates on the device. Also, each time a client sells digital currency the hardware must be retrieved from the secure location to complete the transaction, which requires processing time and a window of opportunity for the digital currency price to fluctuate up or down.
Next week we'll answer the next question- Is self-dealing of digital currency investments in a Self-Directed IRA allowed?