This and last week have been marked by the current crisis that exploded due to the implosion of the FTX cryptocurrency exchange and its native token FTT. This nefarious situation in the cryptocurrency market brings us to our main topic today: self-custody. In the next few paragraphs, we will tell you why self-custody is important and why we should work together to build a more decentralized market.
What Happened with FTX?
FTX was one of the largest exchanges in the crypto market just two weeks ago. It handled a substantial trading volume compared to other platforms and it was among the most popular trading sites after Binance.
Due to the bear market that affected digital assets since November 2021, rumours about Alameda’s balance sheet, and a deleveraging of the FTT token, the native currency of FTX plummeted. Indeed, Binance revealed that they were also selling their FTT tokens.
BlockFi Plans Worker Layoffs After Disclosing Exposure to FTX, Sources Say –WSJ
BlockFi Suspended Customer Withdrawals Last Week, Citing FTX Turmoil –WSJ
BlockFi Had at Least $14 Billion of Customer Deposits as of Last Year, Sources Say –WSJ https://t.co/i5cpmB2bYa
— *Walter Bloomberg (@DeItaone) November 15, 2022
This pushed the price of FTT below $2 per coin from $25 in just a few days. Moreover, due to other issues such as claims of attacks and hacks, FTX blocked withdrawals from its platform.
This created a situation in which thousands of users were not able to sell their coins and withdraw their funds, taking us to our main topic: the importance of self-custody in crypto.
What is Self-Custody?
Bitcoin (BTC) was created with the goal of decentralizing the financial system, taking the power from centralized financial institutions and bringing it to people. This was possible thanks to Bitcoin’s permissionless protocol and a large network of miners and nodes.
With the expansion of the crypto market, companies such as centralized exchanges (CEX) were developed and gained traction. Most users relied on crypto exchange services due to their reliability, solutions, and integration with other financial tools such as banks or third-party apps.
We cannot negate the importance of crypto exchanges. Thanks to them, it was possible to onboard a larger number of users to crypto and offer unique solutions that before didn’t exist. However, easy access to crypto trading and financial services came at the expense of self-custody.
When users deposit funds in crypto trading platforms, these companies behave like banks. You give control of your crypto to a third-party company, and therefore, you lose the benefits of decentralization. Moreover, you share private information with them and risk your whole funds.
It is clear that crypto exchanges and other platforms offer interest on your crypto and passive income on your holdings, but the rate that you are receiving is due to the risk that there is involved in holding your funds in a platform to which you don’t hold your private keys. Remember, not your keys, not your coins.
If an exchange experiences an attack, similar to what happened to Mt. Gox nine years ago, then your funds could be at risk. In the worst-case scenario, users might lose all their funds, as happened in the past in traditional finance and banks. And there’s nothing that you can do unless you self-custody.
How to Self-Custody?
Self-custody is one of the best practices in the crypto market for users to keep control of their coins. When investors hold their coins at centralized exchanges such as FTX, they give control of their private keys to a centralized institution. Instead, when you self-custody your coins, you keep your private keys secure.
If you hold your private keys, you must know that you are responsible for your own funds. Any mistake could end up with your funds getting lost forever. This is why it is very important to understand how self-custody works and why private keys are important.
The best way to hold your coins, especially if you are a long-term holder, is by using a hardware wallet. These are devices that keep your funds secure at all times and keep your private keys outside the reach of malicious parties such as hackers.
When you hold your funds in a hardware wallet or another wallet that let you hold your private keys, you will avoid issues such as blocked withdrawals or hacks at exchanges. Nonetheless, you should never share these private keys with anybody else. Otherwise, you risk your funds.
Additionally, if you lose your hardware wallet, then you could recover your funds using your private keys, something that is not possible by using an exchange. If you want to withdraw your funds and the exchange is blocking withdrawals, then the exchange is deciding for you.
There are advantages and disadvantages of self-custody. You take the responsibility of properly handling your wallet, funds and private keys. The best thing to do is to always start with simple wallets and things and then move to more complex and secure solutions. This is a process that requires time.
That being said, it is important to always withdraw our funds from exchanges (those funds that we are not using to trade), and keep them secured in one of our hardware wallets or devices for which we hold our private keys.