The Case for Self-Custody - Protecting Your Cryptocurrencies

US dollars are typically used to purchase goods, meaning you are taking possession of the goods once you have purchased them. Cryptocurrencies might be presumed to be the same. Bitcoin you purchased with US fiat currency sits in your wallet (i.e., account) on the cryptocurrency exchange. It is possible to trade, buy, and sell cryptocurrencies in that account using the currency there. It's important to know that bitcoin isn't actually stored in your account on the exchange; rather, it's stored on the blockchain.

?A crypto exchange functions as an intermediary between you and the transaction you are making. Your currency's ownership is challenged by two factors: access to blockchain-based assets and the use of financial intermediaries. Access and control define true ownership in cryptocurrency.

?Coin management and trading are only possible through the combination of your private keys and your public wallet address. Private keys are the equivalent of passwords. In order to take advantage of the blockchain, your private keys may either be generated and stored on a device that is separate from the wallet provider's server system, or they may be stored on the provider's server. There are 2 types of storage wallets: non-custodial (also called self-custody) and custodial (also called hosted).

As long as you generate and store your private keys independently of the wallet provider's system, you will be the only one with access to them. In self-custody wallets, your private keys remain in your control without the need for institutional intermediaries. Control is in your hands. Keeping control of your private key and constant access to your funds is essential to true cryptocurrency ownership.

?Why Self-Custody is Important

It is not uncommon for users to be confused and perplexed by their first foray into crypto. It can be difficult to know where to begin, even for those who are knowledgeable about online banking and stock trading.

Unlike buying a product from an online retailer like Amazon, purchasing cryptocurrency involves a multitude of steps — each with increasing friction and a sense of nervousness, since each step often involves identifying an individual (Know Your Customer / KYC), and finally transferring fiat funds to exchanges that (to the newcomer) are not household names (and therefore potentially unreliable).

Cryptocurrencies are often acquired through centralized exchanges. By doing so, users must prove their real identity, and transfer fiat currencies into their new account, at the very least. Fiat can then be exchanged for crypto from there.

The majority of newcomers to the cryptocurrency space tend to treat cryptocurrencies as if they were stocks. Users are not incentivized to move funds off exchanges since moving funds is a cumbersome process and incurs transaction fees (from/to exchanges) since they buy and sell short term (sometimes within hours).

Due to the convenience of being able to refer to one's exchange account as a stock portfolio account, individuals may even start keeping their long-term holdings there. There is nothing ideal about this situation. Even if "nothing" has happened yet, the trust of a third party holding a user's cryptocurrency can be a dangerous thing, unlike storing funds with a bank or holding stock with a trading institution.

Third parties hold a user's funds in their custody, which is a major issue with trusting them. Thus, if a third party is breached (internally or externally), and crypto is stolen, it is very likely that users who did not remove their assets will be responsible. As opposed to traditional financial institutions, where banks and trading institutions guarantee depositors' funds, exchanges do not follow these same protocols, thereby making them subject to real risks.

Starting with Self Custody for Crypto

The clumsiness that comes with moving on-exchange assets off of the exchange is one of the major challenges newcomers (and even existing users) face. There are plenty of hiccups during the process, including determining the right wallet to use. The issue of whether a wallet will support all of the tokens purchased from the exchange still remains. Users need to learn the differences between hot and cold wallets (among others) and then sort through the options. The number of BTC that may be stuck in Neverland while being transferred to Metamask is impossible to predict.

Transactions sent from an exchange to an individual's wallet are not without anxiety, though. When users receive their funds, they must safeguard their wallets - storing seed phrases safely, locking hardware wallets, and more. These efforts are compounded by the diversity of exchanges and wallets that are available (e.g. Binance, Coinbase, Ledger, Metamask, Phantom, etc.).

As a result, individuals often encounter too much friction to withdraw their assets from the exchange due to the anxiety-ridden experience. It seems like exchanges are pretty secure - and users can save transaction fees by not moving their crypto, and they can reset forgotten passwords easily enough, right? This is where keeping your key secure comes into play.

Benefits of Self Custody

Apart from being one of the greatest advantages of crypto, self-custody is one of the most compelling aspects of Web2-based financial asset management. As learned from the previous section, self-custody is essentially being one's own bank and removing the need to depend on financial institutions for account funds that may be frozen or seized at any given time. In addition, as cryptocurrency becomes more mainstream and becomes more accepted, it becomes easier to use crypto to pay for goods through a wallet (or other app).

Transferring funds to a personal account before being able to deploy the capital would be more complicated when using an exchange account or other intermediary. Last but not least, limiting crypto funds to a few wallet addresses allows one to monitor one's own coins and tokens more effectively. Wallets can be monitored with blockchain or crypto monitors, so users can be notified when inbound or outbound transfers occur.

Considering the prevalence of crypto-related crimes, setting up a blockchain monitor to monitor crypto on certain addresses will provide users with an additional level of comfort and security. Individuals will feel more comfortable knowing that their crypto remains in their wallets if a crypto monitor is in place to monitor their funds.