The importance of asset segregation

The Importance of Asset Segregation. Opinion Piece

Written by XEROF CEO Nick Ntigrintakis

Asset segregation is a critical part of any investor's crypto management plan. Everyone knows that keeping their private keys offline is essential for cryptocurrency security. However, since many people rely on exchanges to hold their wallets, a large number of crypto holders need to remember the risks of failing to segregate their assets

What is Crypto Custody?

When it comes to traditional finance, the main focus of custody is bookkeeping. For example, with stock certificates, ownership is recorded, and the issuer or a custodian keeps a record of who owns the stock.

Crypto is different. Because there is no centralized ownership of cryptocurrencies, the blockchain instead tracks accounts, often called "wallets." A wallet's private key, which acts as a password, allows anyone to conduct transactions with the balance. Cryptocurrencies share some similarities to bearer bonds owned by the person physically holding them.

Currently, crypto traders can hand over their keys to a custodian, such as an exchange. This arrangement can make trading more convenient, but it can also make exchanges a target for hackers, leaving traders vulnerable to hacking losses and other problems with the exchange.

But what happens if a cryptocurrency exchange goes bankrupt? Can every investor get their money back? Not necessarily.

Some exchanges explicitly state in their terms that funds may be irretrievable. Furthermore, different exchanges have different policies about what happens to their customers' funds in the event of bankruptcy, so how can we mitigate this risk when choosing to hold funds on a crypto exchange? 

What is a Segregated Wallet?

In order to avoid the risk associated with crypto exchanges, prudent investors should keep their crypto in a separate wallet.

Customers can easily send and receive their cryptocurrencies through segregated on-chain wallets registered in their name. These wallets are separate from a company's balance sheet, ensuring that customers have full control over their digital assets and that cryptocurrency is held only for their benefit.

In the cryptocurrency world, centralized exchanges serve as both an exchange and custodian. Although leaving assets on exchanges gives traders some flexibility, it also gives users the least control due to the terms of use.

The FTX incident highlighted the dangers of this strategy and the need for greater transparency. Exchanges have a position in the ecosystem because of certain characteristics, but they are not always the ideal custodians of assets. The strategy of leaving a certain portion of assets on the exchange for immediate trading while keeping the bulk of the funds in a separate environment is commonly used by crypto investors.

Why the SEC is Calling for Segregation of Crypto Assets

In February 2023, the SEC proposed strengthening protections for client funds held by investment advisors and extending those protections to crypto assets. Ensuring that client funds are appropriately segregated would help protect assets in the event of a custodian bankruptcy.

By ensuring that client funds are appropriately segregated, assets can be protected in the event of bankruptcy of the advisor or custodian. This came in the wake of several major bankruptcies concerning a number of cryptocurrency platforms, which left users without access to their funds and in a precarious financial situation.

Investigations revealed that several now-defunct platforms and exchanges had mixed assets with their own cryptocurrencies and those of other investors instead of properly segregating investors' funds.

Why Does XEROF Ensure Asset Segregation?  

Asset segregation is not only part of XEROF's promise of transparency and our overall code of conduct and ethics, but it is also a legal requirement in Switzerland (where we are based). Therefore, all client funds must be managed separately from a company's balance sheet and placed in segregated accounts in accordance with Swiss regulations.

In order to prevent the misappropriation of client funds, we have implemented various safeguards. In the unlikely event that XEROF goes bankrupt, user assets would not be subject to claims by creditors. With XEROF, customers will always retain full ownership of their cryptocurrency assets.

If you want to learn more about segregated wallets or discover what other services XEROF offers, please do not hesitate to contact us. You can also get in touch via Telegram, Twitter,  LinkedIn, and Facebook.

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