In the cryptocurrency space, there's a saying that has gained quite some traction and that we've used many times. Does "not your keys, not your coins" ring a bell?
The idea is simple. Cryptocurrency investors and worldwide users of Bitcoin and other digital tokens prefer to take custody of their own crypto assets so that no third party can control their funds. Generally speaking, it is believed that if you control the private keys of your digital wallet, you are also in complete control and ownership of your crypto, like your Bitcoin tokens, stablecoins, altcoins, or the tokens from play-to-earn crypto games.
However, it is technically feasible to freeze assets held in external wallets, like a hardware wallet, for example, and there are certain situations where this could happen. The odds of this happening to you are relatively low unless you are involved in major criminal activity. Nonetheless, it's better to be informed about the possibility of freezing funds on blockchain.
Can crypto assets be frozen?
The short answer is yes; assets can be frozen. In order to understand how crypto assets can be frozen on a blockchain network, let's do a quick recap of how tokens work. If you remember from our previous article on token standards, they are a subset of any smart contract standard. Smart contracts would not be operational without these compliance rules.
ERC-20 tokens are merely a reference to a database that tracks which addresses hold how many units of a native asset. The token contract manages this database. The contract updates the number of tokens connected with each address when tokens are transferred from one person to another. To maintain a consistent supply, the contract subtracts the appropriate amount from one address and adds it to another.
How can someone freeze funds?
The token contract is usually the only smart contract that has the authority to modify the token holder database. As such, a token contract can be used to freeze assets by blocking access to the funds, confiscating the tokens, or even burning them in exceptional cases.
An address may not be able to transfer, purchase (or receive), or sell (or send) crypto assets if the smart contract blacklists it. Only an admin address will be able to use a blacklisted address to update the smart contracts.
Why does a funds freeze happen?
Usually, Bitcoin or other crypto assets are frozen in case of illicit activity. These characteristics can be abused if someone acquires admin authority over a smart contract, or used to fend off attacks and recover illegal payments.
Blacklisting events don't happen often, only if something suspicious is detected in the smart contract. For example, if a scammer uses an inflation bug to mint and transfer crypto tokens to an address under their control, or if there is a security breach and the police request to freeze funds pending investigation.
The Tether (USDT) token employs a smart contract that has the ability to freeze and reissue native assets. There are more than 700 contracts blacklisted by the Tether token contract. It's worth noting that last year in January, Tether froze more than $150 million spread across three accounts. The company merely stated that it took action in response to a request from law enforcement.
In another situation, a multi-collateral stablecoin pegged to the dollar called aUSD was recently frozen in 16 wallets by the Acala team. Following an issue that allowed aUSD liquidity providers to mint non-collateralized aUSD, the Acala team recovered and burned these illegally minted crypto tokens, but only after the attackers dumped a significant amount on Polkadot-based decentralized cryptocurrency exchanges.
Not only Ethereum-based token contracts have the ability to freeze, blacklist, and seize tokens. This functionality is a standard component of token contracts on the majority of layer-1 blockchains.
There are two methods of freezing funds, depending on different scenarios. The global freeze method, used by Ripple Labs, is used when the gateway's wallets are compromised, or when there is a need to migrate users to a new account. Stellar also allows this global function, freezing token transfers.
Individual account freeze
This method is more targeted, enabling the gateway to cease all trading of one person's account. The reason why assets issued on blockchains like Stellar or Ripple can be frozen is that any native asset of theirs uses a 'real world' deposit with what's known as an Anchor (Stellar) or a Gateway (Ripple) to be issued.
However, unless these native assets are held on a centralized platform, such as an exchange, or with a custodian, like BTC, ETH, BNB, or XRP, they cannot be frozen.
The entities behind these centralized companies typically will only freeze funds if a police or court order is submitted to them. However, the parent companies, issuer, or administrator may reserve the right to freeze the assets for any or no cause.
Who can freeze assets?
In case of suspicious transactions, withdrawals, and criminal activity linked to certain accounts, the project developers can freeze the assets from the affected digital wallet.
Another possibility is that if a centralized exchange goes bankrupt, all the crypto money gets frozen. For example, in July 2022, a well-known centralized exchange, or CEX, called Voyager Digital, went bankrupt due to the crypto market's plunge and had to freeze all customer withdrawals. Customers were unable to withdraw their funds, make deposits, or trade. Voyager also stopped offering any loyalty rewards.
How to avoid your crypto getting frozen
We can't stress enough the importance of doing your own research before you make a crypto investment in Bitcoin or any other digital cash. Always keep in mind that centralized exchanges act as an intermediary between the buyer and seller (similar to a bank), and you don't control your private key.
If you decide to use a CEX, don't leave your coins on the exchange, especially if you invest more than 5% of your total portfolio.
Instead of using a CEX, trade on a decentralized exchange (DEX), such as Uniswap, Pancakeswap, Curve, or SushiSwap. You will control your private key, thus controlling your crypto fund.
As we mentioned before, the chance of your crypto assets getting frozen on a decentralized exchange is very low. It's not impossible, but major criminal activity has to be involved.
Now that you know how a crypto or Bitcoin freeze works, you'll be better prepared to keep your crypto assets safe in your wallet. Generally speaking, the phrase "not your keys, noy your funds" still stands, and the best bet for crypto investors is to use a DEX for transactions, as well as a hardware wallet.
Freezing your crypto is possible even when you control the private key, but you shouldn't worry about it in normal circumstances. Project developers will never blacklist addresses for no reason. Freezing assets will occur only after an unlawful transfer, and it's done to protect you, your wallet, and your digital money.
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