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If you’re considering a crypto account, make sure you understand the risks.
Disruptive technology can change the way we see and do things.
Take blockchain and banking. The clever thing about blockchain — the tech behind the world’s first digital currency, Bitcoin (BTC) — is that it can cut the middleman out of all kinds of transactions.
For example, you no longer need to use a bank or financial institution to move money, or even borrow money.
That has given rise to something called decentralized finance (DeFi). DeFi encompasses a host of applications that may reshape traditional financial services, such as the currency we use, as well as the way we lend and save.
You might have seen advertisements for DeFi savings accounts with high interest rates and low fees. You’ll usually find them with top cryptocurrency exchanges, even though you don’t need to buy crypto to take advantage of the great rates.
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If you’re considering moving your money out of your bank account and into a crypto account, it’s important to understand the differences. Crypto accounts often have less consumer protection and put more responsibility on your shoulders.
Here are five things to watch out for.
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1. Interest rates
Interest rates are where DeFi applications really stand out. The best savings accounts may pay APYs of around 0.5%, but you could earn more than 8% with a DeFi account. It depends on several factors, such as:
- What currency you use
- How long you’re willing to tie your money up for
- Which DeFi application you pick
It’s a good idea to find out how the company is able to offer you those rates. It could be that they will lend your money to other people, in which case you need to be comfortable with their lending strategy.
As a borrower, you may be able to get lower interest rates than you would find with normal personal loans. However, you may have to secure your loan with crypto as collateral.
2. FDIC insurance
Most banks are FDIC insured. That means that if your bank fails, you’ll be covered for up to $250,000 per person, per bank. In contrast, if your crypto exchange or hot wallet provider fails, you could be left with nothing.
This is one reason many cryptocurrency enthusiasts use cold wallets or hardware wallets. These are small devices you can store offline that give you total control over your digital assets. However, you won’t be able to earn interest on the money you keep in a cold wallet.
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If you want to earn interest, you’ll need to leave your money with the exchange or brokerage. That’s why it is important to find out what protections are in place. Some exchanges that keep your crypto extra safe take out private insurance to cover your assets. Others have FDIC insurance for U.S. dollars, but not for cryptocurrencies.
3. Protection against theft, hacking, and fraud
FDIC insurance does not cover theft and fraud, but your bank probably does. There are several ways banks work to protect customers against fraud. First, they monitor your account for suspicious activity. If a transaction is unusual, the bank may call you for confirmation or temporarily freeze your account.
Second, if you do lose money — especially on your credit card — there’s a good chance you can get it back, as long as you report the theft quickly.
Now, if your crypto account gets hacked or you fall victim to fraud, it’s a different matter.
Let’s say there is malware on your computer and $500 worth of Bitcoin is stolen from your wallet. One the money has been moved, it will be almost impossible to recover. Crypto accounts don’t have the same safety net that banks do.
There have been a number of high profile exchange hacks, the biggest of which was Mt. Gox in 2014. Around 850,000 Bitcoin were stolen and only about 200,000 were recovered. Many customers lost their money.
4. Customer service
The level of customer service you receive depends a lot on which company you use, whether it’s a bank or a crypto account. However, if you’re someone who likes to go into your local branch and speak to someone face to face, you may need to stick with a traditional bank.
On the other extreme, let’s say you opt to move your digital assets into an offline hardware wallet as discussed above. You’d be 100% responsible for the security of that wallet. You’d need to set up a password and something called seed words, which are used to recover the account. If you lost them, you could completely lose access to your wallet — there’s no handy “forgot your password” button.
Cryptocurrency data company Chainalysis estimates that between 2.3 million and 3.7 million Bitcoin have been lost. That’s roughly between $91 billion and $148 billion at today’s rates.
5. Available currencies
Unlike your bank account, which probably only stores U.S. dollars, your crypto account will let you keep a range of digital and fiat (traditional) currencies. You can keep — and potentially earn interest on — dollars, pounds, and euros, as well as many types of cryptocurrency, such as Bitcoin and Ethereum.
Weigh the risks
If you’ve had a bank account all your life, it’s easy to take the protection it offers for granted. When you open a crypto account, you need to understand that it’s not the same. That doesn’t mean you shouldn’t take advantage of the benefits of DeFi. It just means you need to work harder to protect your money.
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About the Author
Emma owns the English-language newspaper The Bogota Post. She began her editorial career at a financial website in the U.K. over 20 years ago and has been contributing to The Ascent since 2019.