What is custody in crypto?
Introduction
An individual’s ability to retain control over their financial assets is known as custodianship. Financial custody has become extremely important in recent years as more consumers have become educated on the TradFi industry practice of fractional reserve banking where banks lend out upwards of 95% of customer holdings. Central banks are predatory in how they try to assert control over their client's finances.
For example, many institutional banks must give authorization for their clients to withdraw or deposit their own funds. Banks encourage consumers to trust them as secure custodians but in reality, function as greedy bureaucratic intermediaries.
Perpetuating the Need for Self-Custody
Bank services like portfolio management and mortgage brokering are all designed to discourage people from doing things themselves. Disguised as a convenience, financial intermediaries encourage people to relinquish control of their assets because it's easier and safer for them to be managed by “trusted professionals.”
Additionally, the fear of lender insolvency—the inability to pay back debt—as demonstrated by the collapse of Silicon Valley Bank and Credit Suisse in 2023, has also brought to light the importance of self-financial custody.
With almost every global regulated financial system or institution requiring proof of identity—referred to as Know Your Customer (KYC) protocols—just for a customer to hold their funds there, it is almost impossible to self-custody in TradFi.
These protocols require individuals to provide personal information such as name, address, date of birth, and government-issued identification documents. The aim is to prevent fraud, money laundering, and other illicit activities by ensuring that businesses have accurate information about their customers.
However, KYC protocols can limit privacy because they involve the collection and storage of sensitive personal data. This information can be vulnerable to breaches or misuse, posing risks to individuals' privacy and security.
Additionally, KYC requirements may lead to the aggregation of personal data across various service providers, creating a comprehensive profile of an individual's financial activities. This level of surveillance can erode privacy rights and raise concerns about potential misuse or unauthorized access to personal information.
No bank or credit union enables individual access to funds; at any point, customer assets can be frozen, withheld, or confiscated by the institution that secures them. Custodianship or control over assets, in TradFi is shared between the owner and the institution that stores them.
The Rise of De-Banking
The debanking movement, characterized by individuals and communities deliberately distancing themselves from traditional banking institutions and financial services, has gained momentum in recent years.
This phenomenon encompasses various strategies and alternative financial systems aimed at reducing reliance on centralized banking entities. Debanking entails embracing decentralized financial technologies, such as cryptocurrencies and peer-to-peer lending platforms, to facilitate financial transactions and services outside the traditional banking framework.
One significant driver of the debanking movement is dissatisfaction with conventional banking practices, including high fees, inadequate customer service, and perceived lack of transparency. Individuals seeking greater control over their financial affairs are drawn to debanking as a means to assert autonomy and transparency in their financial dealings.
Moreover, debanking is seen as a tool for promoting financial inclusion, particularly for underserved or marginalized communities lacking access to traditional banking services. By leveraging decentralized technologies, individuals can participate in financial activities without relying on the infrastructure of traditional banks, thus reducing barriers to entry and expanding financial access.
The Solution of Crypto
In light of very invasive TradFi banking practices, cryptocurrency and blockchain have become a haven for investors as these technologies are the only spaces where true financial custodianship can exist. Cryptocurrency, based on its principle of decentralization, truly enables privacy and anonymity for people who simply want to be the sole entity controlling their assets.
Self-custody in crypto refers to the practice of users exercising complete ownership and control over their assets in web3 by becoming their own banks. This involves storing cryptocurrencies in non-custodial wallets and safeguarding their private keys. It's a decentralized approach to asset management that eliminates the need to trust centralized exchanges or third parties.
Private keys are like secret passwords for digital assets, and they should never be shared with anyone. They are the key to unlocking a digital lock, and whoever has access to private keys can control and access the relevant digital assets.
Differences from Traditional Custody Methods
Traditional custodianship, such as that seen in banks or financial institutions, involves a third-party entity that holds and safeguards an individual's assets. This custodian has the authority to manage these assets on behalf of the individual under specified conditions.
On the other hand, self-custody in crypto empowers the individual to become their own custodian. Instead of transferring control to a third party, individuals retain complete control over their own assets. This includes the ability to access, transfer, and manage their digital assets at their discretion, which is facilitated through the use of private keys.
While self-custody in the crypto world offers numerous advantages regarding control and ownership, it also carries increased responsibility. This includes the need for enhanced digital security measures and the responsibility of safeguarding one's private keys.
How Self-Custody Works
In the realm of cryptocurrencies, self-custody is a vital aspect that grants users complete control over their digital assets. With self-custody, individuals serve as their own banks, eliminating the need for third-party intermediaries like centralized exchanges. In this section, we will delve into the workings of self-custody, focusing on private keys and security measures.
Private Keys and Ownership
At the heart of self-custody in crypto is the private key, a secret password that grants you access to your digital assets on the blockchain. It's akin to the key to a digital lock, and anyone who holds your private keys has the ability to control and access your cryptocurrencies. Thus, safeguarding these keys is of utmost importance.
With self-custody, the private keys are stored in a non-custodial wallet, a decentralized tool that lets you be in charge of your own financial holdings. This setup allows for end-to-end control of your assets, reinforcing the principles of decentralization that underpin cryptocurrencies.
It's crucial to note that private keys should never be shared with anyone. Their security is paramount to maintaining control over your assets and preventing unauthorized access.
Security Measures in Self-Custody
Given the importance of private keys, robust security measures are integral to self-custody in crypto. These measures aim to protect your digital assets from potential threats such as hacking or theft.
One of the fundamental security measures is the choice of wallet for storing your cryptocurrencies. Self-custody wallets can either be software wallets or hardware wallets.
Software wallets are applications installed on your computer or smartphone, providing ease of access but are vulnerable to digital threats. Conversely, hardware wallets are physical devices that store your cryptocurrencies offline, offering more secure, albeit less convenient, storage.
Regardless of the choice of wallet, it's essential to maintain stringent security practices. These include using strong, unique passwords, enabling two-factor authentication (2FA), and keeping your wallet software updated. Regularly backing up your wallet can also help to safeguard your assets if your device gets lost or compromised.
Remember, self-custody in crypto comes with considerable responsibility. While it offers greater control over your assets, it also necessitates a proactive approach to security. Being your own bank means ensuring that your 'bank' is as secure as possible.
Financial Freedom Opportunities
One of the main advantages of integrating self-custody with DeFi is the extensive financial freedom it offers. Self-custody wallets, a form of hot wallets connected to the Internet, allow users to connect with decentralized apps and explore the vast offerings of Web3.
These include decentralized finance, gaming, and social media. In contrast, centralized exchange (CEX)-hosted crypto addresses are limited in their connectivity, resembling watered-down versions of self-custody wallets.
Furthermore, self-custody in DeFi enables users to participate in decentralized lending and borrowing protocols, yield farming, liquidity provision, and other innovative financial products and services without relying on intermediaries.
This offers users the ability to access a wide range of decentralized financial applications, such as decentralized exchanges (DEXs), lending platforms, and yield aggregators.
Smart Contract Interactions
Integrating self-custody with DeFi also allows for direct interaction with smart contracts on various blockchains. These smart contracts are self-executing contracts with the terms of the agreement directly written into the code. This means that once the predetermined conditions are met, the smart contract will automatically execute the transaction.
With self-custody, users can directly interact with these smart contracts, allowing them to participate in a variety of DeFi activities. This includes investing in yield farming, providing liquidity for pools, and participating in lending and borrowing protocols.
By integrating self-custody with DeFi, users can avoid the risks associated with centralized exchanges, such as hacks, exit scams, and regulatory actions. This allows users to still benefit from the opportunities and potential returns offered by the decentralized finance ecosystem while maintaining control over their assets.
Conclusion
The concept of self-custody emerges as a compelling solution to address the limitations and vulnerabilities associated with traditional financial custodianship. As individuals become increasingly aware of the pitfalls of entrusting their assets to centralized institutions, the appeal of self-custody gains prominence.
With the rise of debanking movements and growing concerns over privacy and financial autonomy, self-custody offers a pathway to reclaiming control over one's financial affairs.
By leveraging decentralized technologies and adhering to the principles of ownership and privacy inherent in cryptocurrencies, individuals can assume full custodianship of their digital assets.
Through practices such as storing assets in non-custodial wallets and safeguarding private keys, individuals can assert autonomy and protect against potential risks such as hacking or unauthorized access.
