Exploring self-custody

Exploring self-custody
January 2, 2024

Not your keys? Not your coins. You’ve probably heard that phrase a few times by now, it’s a common phrase in the world of all things crypto and Web3.

Self-custody refers to the practice of holding your own private keys without relying on a third-party or a custodian.  

Proponents of decentralisation will argue that self-custody is the only way to guarantee control over your digital assets and financial privacy. On the other side of the coin, it means that you will be entirely responsible for safeguarding your assets.

In this blog, we’ll dive into what self-custody entails, and the role it will play as we head into what will likely be a more regulated digital asset market in 2024.

Private keys and wallets

At the heart of every blockchain transaction lies an alphanumeric code called a private key, which essentially proves ownership of an underlying asset. While anyone can deposit crypto to a public blockchain address, only those with the private keys to that address can access and move these funds.

The good news is that most digital wallets automatically create these keys and store them, and convert them into 24, 18, or 12-word mnemonic seed phrases that are essentially an unencrypted version of these keys.

There are two main types of self-custody wallets in use today – hardware wallets and software wallets. While hardware wallets, like Ledger or Trezor, are physical devices that store private keys offline, software wallets like MetaMask and TrustWallet are digital wallets that store private keys on the user’s personal computer or mobile phone.

The pros

For those looking for greater control over their finances, non-custodial wallets will likely tick all the boxes. These wallets particularly appeal to those that feel strongly about decentralisation, and those that are concerned about the privacy of their transactions.

The self-custody option has the added benefit of censorship resistance, meaning there is a full-proof way to ensure these funds are not seized or frozen by a third party. Meanwhile, non-custodial wallets also offer increased security because they are not susceptible to hacks and other vulnerabilities that a custodian in charge of storage would be.

For those that swear by the ethos of decentralisation, self-custody is often the only way to go without relying on a centralised entity. These wallets often don’t require users to provide personal information, making them an easy choice for those particularly concerned about the misuse of their data.

The cons

However, self-custody also puts the responsibility of safeguarding assets entirely in the hands of the wallet holder.

Outside of how daunting that idea may be to some people, it also brings to light a different security issue – what if you misplace the seed phrase to access this wallet, or say for instance, if trojan malware targets your personal computer and steals your private keys?

Indeed, the threat of that is very real today, as blockchain researchers have found the majority of retail losses in the crypto space don’t involve smart contracts hacks or FTX-type collapses, but rather private key compromises from malware, phishing attacks and user error.

Self-custody also involves a fair amount of complexity when it comes to setting up a wallet, compared to a custodian that stores crypto on behalf of users. In their current state, these wallets offer limited functionality, which can be particularly challenging when looking to buy or sell crypto quickly.

The future of self-custody

There’s a lot of debate as to which the better option is for securing your cryptocurrency, but the reality is that depends on you and how you intend to participate in the crypto space.

If you’re a retail user who is looking to trade and store assets on an exchange, you might choose to store at least a small amount of your holdings on that platform itself, especially if you’ve trusted them enough to begin your trading journey there in the first place.

On the other hand, if you’re confident enough to store your private keys in self custody, then a software wallet might be better suited for you if you intend to regularly participate in DeFi and need easy access to liquidity. If you’ve got diamond hands and are just looking for a secure place to store your crypto, then a hardware wallet could be the way to go, and it would be worth doing your own research to make decisions that work best for your desired outcomes.

As the industry continues to evolve, we believe the technology around self-custody will evolve too. We’ve already seen the emergence of multi-party computation (MPC) wallets that do not rely on seed phrases to secure private keys.

MPC wallets enable multiple parties to evaluate a computation without revealing any of their own private data. The main benefit of this type of Web3 wallet is the lack of a single point of failure, which is the case with most other solutions in the space today. Major players in the space like Coinbase and Fireblocks have already started using this solution to service an institutional suite of customers.

We believe that the next era of digital assets will feature a mix of institutional and retail investors, and the self-custody solutions will have to cater to different needs. A one size fits all approach won’t work in this scenario, and we’re likely to see more technology emerge that addresses this.

At the end of the day, self-custody offers control, security, private and decentralisation, without counterparty risk and will be an important part of how users in the crypto space secure their assets and stay connected.

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