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What is Self-Custody in Crypto?

Validated Individual Expert

The ongoing crisis of cryptocurrency lending and the associated crypto market decline once again confirms the importance of self-custody or the “true ownership” of crypto by its holder, according to several industry experts. It remains to be seen whether crypto lending would survive the current crypto winter. Still, several industry executives agree that investors can protect their assets forever by simply moving them to self-custodial or noncustodial wallets.

Crypto self-custody is about letting consumers fully control their keys and the fate of their crypto, and that is what we will be discussing in this article.

Defining Self-Custody in Crypto

Self-custody is a means of holding your digital assets by which only you have access to them. This means that you choose not to use a third party, and instead will manage your private key personally. There are different kinds of self-custody solutions that vary in their security and ease of use, so it is recommended that you spend some time learning about the various options that are available before making a decision about how you wish to proceed. You can learn more about cold storage and other key concepts by checking out the associated links in this document, but we highly recommend that you research these subjects yourself thoroughly before proceeding.

Issues with Crypto Custodians

Centralized exchanges are generally trusted intermediaries with one job: facilitating trades as directed by their customers. Following the collapse of FTX, many are left wondering how such a highly regarded exchange can manage to lose all of its users’ deposits overnight. The unfortunate truth is that FTX users were handing over custody of their assets the second they deposited them, and, despite the balance displayed on their accounts, the funds were likely being mishandled for quite some time.

Centralized exchanges, like FTX, act as custodians on behalf of their clients. As custodians, CEXs handle all of the crypto users purchase and deposit on their exchanges. While this helps simplify the trading experience for new users, it requires a significant amount of trust from users.

Anyone can log into their CEX of choice and view their crypto balance at will, but that doesn’t necessarily make it real. Since crypto is simply digital units of account on a blockchain and crypto cannot ever be removed from a blockchain, the balance users see on a CEX reflects the amount of crypto the CEX holds (or claims to hold) on their behalf. Therefore any crypto a user “holds” on a centralized exchange should be thought of as an IOU issued by the CEX rather than actual crypto assets. There are several instances in which the crypto users store on centralized exchanges may be lost.

While crypto-natives have long preached the phrase “not your keys not your coins” and encouraged crypto investors to withdraw their crypto from exchanges, their claims are often interpreted as fear mongering and ignored by newer market participants. The importance of self-custody in crypto is often learned the hard way when the assets users store with a custodian are confiscated and they’re left empty-handed.

Similarly to how an email account can be accessed by anyone with the appropriate login credentials, the crypto associated with a wallet address can be transferred by anyone with the corresponding private keys. Unlike the credentials to an email account, private keys cannot be recovered or altered if lost or compromised.

How to take self-custody of crypto assets?

If you are ready to take on the responsibility of managing your own crypto, literally being your own bank for digital assets, you can take self-custody of your assets by following the steps below:

  • Make sure you understand the basics of self-custody. Most importantly, understand the importance of seed phrases and how to handle them.
  • Get a hardware wallet. You can buy it with Ledger Nano X, Trezor, or BitBox. Make sure you order the wallet directly from the respective website and not through Amazon or other resellers as it could be compromised at this stage.
  • Connect the hardware wallet to your computer and follow the guide that is provided by the hardware wallet manufacturing company. You will also be asked to download a desktop application that lets you interact with the hardware wallet.
  • Make sure you download the correct firmware indicated by the hardware wallet manufacturer.
  • Set a pin for your hardware wallet. This pin is for accessing the very hardware wallet at hand.
  • Safely secure your seed phrase. Do not store it in the digital world. Also, do not share it with anyone. If another person gets your seed phrase, your coins are at severe risk. Your seed phrase is different from your pin. As long as you have your seed phrase you can retrieve your crypto assets using another hardware wallet.
  • With most hardware wallets, you have to download the respective crypto asset integration, so you can actually store bitcoin, ether, etc. on your wallet. You can do this using the hardware wallet’s desktop application.
  • Use your hardware wallet when you are connecting to DeFi.

Two important caveats when using any hardware wallet are:

  • Be cautious when you are sending crypto to another address. Countercheck addresses involved.
  • Do not connect to a website unless you have a specific reason, and when you are done disconnect your wallet.

Why is self-custody important?

Owning your private keys allows you the power to enjoy the full benefits of your crypto assets. You do not need any permission to store, send, and receive crypto. With self-custody, there are no know-your-customer (KYC) requirements, and you can transact your assets anonymously.

If you decide to keep your cryptos on an exchange, you run the risk of being held hostage by the government or the exchange. In addition, the exchange could be selling you paper Bitcoin and pushing the price down.

Some exchanges can freeze your crypto transactions, set limits on the amount you can transact, and even use your deposits to back up their exposures.

If you want to send a large amount of crypto, the rule of thumb is to start with a small amount. Once you’ve confirmed that the transaction was successful, send the larger amount. It is important to note that if you send your crypto to the wrong address, there is no way to recover it and there is no customer service.

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