What is Self-Custody and Why Does it Matter?
Following the collapse of SVB, the concept of self-custody is becoming more important than ever as more investors begin moving their assets to bitcoin and out of cryptocurrencies and platforms that offer to hold them.
While the collapse of FTX was an obvious sign to many in crypto that non-custodial wallets are bad for investors, SVB’s collapse is proving to drive that same point home much more strongly than before because of its status as a bank.
Self-Custody: What is it?
To start, self-custody is the concept of having total ownership over something; and, in this case, money. It stems from the issue that banks have too much control over customer assets and was initially sparked by the 2008 financial crisis that saw banks lose trillions of dollars after being inappropriately invested in subprime mortgages.
With the rise of bitcoin and blockchain, self-custody became a major focal point for investors who wanted to experience total ownership of their funds without any major entity being in the way.
Why Self-Custody Matters
To provide total custody to an investor, blockchain technology relies on one important concept - decentralization. This allows investors to partake in an asset that is not managed by anyone and is only created through advanced mining algorithms.
Due to this, self-custody provides three highly important benefits to investors:
Security - Users are given total control over their on-chain assets through their private keys which only they have access to.
Control - Without third-party involvement users are allowed to use their funds in any way they choose so long as they are legal.
Privacy - On-chain assets disconnect the user’s wallets from their personal information which provides protection against data breaches and identity theft.
How to Achieve Self-Custody in Blockchain Technology
Before investing in blockchain assets, users first need to create their private keys which are essential to self-custody. These keys are how users can interact with the blockchain and must never be shown to someone else because there is no recovery system.
While this may seem drastic, it is the only way that investor assets and wealth can be detached from any third-party system. Without asymmetric encryption, assets would require centralization and defeat the purpose of cryptocurrency.
In order to create a private key, users need to obtain a wallet that will allow them to do so. There are a few types of wallets - hot, cold, and warm - that all essentially do the same thing by storing private keys in a secure place.
Risk of using non-custodial wallets
While self-custody is highly important for decentralized finance, interacting with exchanges and other platforms is still necessary for users that want to convert their cryptocurrency into fiat. However, in order to do so, centralized exchanges need users to place funds into non-custodial wallets that are operated by the exchange.
In the short term, these non-custodial wallets are fine because they allow users to onboard and offboard their assets. However, over long periods, non-custodial wallets can create a lot of risk for users if the exchange they are using collapses, such as FTX did in 2022, which caused investors on the platform to lose everything.
Now that SVB has fallen too, investors are worried that their fiat is no longer safe either, causing the price of bitcoin to balloon as more investors look at bitcoin as the only safe storage of wealth available as both banks and centralized exchanges continue to crumble.
