How to Take Self-Custody of Crypto Assets
“Not your keys, not your crypto.” With the start of the 2022 bear market, this truism has regained relevance as several crypto firms halted withdrawals out of the blue. In pursuit of protecting their assets, many crypto investors have been asking this question: What is self-custody?
The self-custody of crypto assets refers to the fact that users can take complete control of their digital asset(s). In other words: Ownership over one’s crypto assets gives a user full control to send, receive, and store one’s cryptocurrency without relying on any third party.
At the same time, owning one’s cryptocurrency in self-custody means that users carry the sole responsibility for their private keys. Consequently, a user has to carefully store and guard the private keys of crypto assets they hold — or else they might be at risk of being lost or stolen.
However, there are real risks to storing one’s digital assets on centralized exchanges too. This includes the risk of theft of one’s crypto assets by hackers when held on an exchange. If the crypto exchange is my counterparty, there is also the risk that the company holding the crypto assets could face troubles of illiquidity. As a matter of fact, crypto lenders or exchanges might very well engage in rehypothecation, lending out the crypto assets of a user into a chain of leverage. This poses risks because the crypto assets might not be readily available when needed. Such risks became evident in June 2022 when the crypto lender Celsius halted crypto withdrawals, transfers, and transactions for customers.
To prevent these risks related to holding one’s crypto assets on centralized exchanges, it is advisable to choose self-custody of all or part of one’s digital asset portfolio.
Crypto assets are bearer assets
On the other hand, a crypto asset is one of the few asset classes that can be held and traded directly with others peer to peer, meaning there is no centralized third party involved. Moreover, crypto assets like bitcoin or ether are sufficiently liquid and fungible, meaning that these crypto assets are not only digital bearer assets but assets that can most likely be traded at competitive prices when needed.
Using financial jargon, we can describe traditional assets like stocks, bonds, or bank deposits as “credit assets” and crypto assets as “bearer assets.” A “bearer asset” allows you to have self-custody of the asset, whereas a “credit asset” is held by a third party. The difference in the two asset types can be explained by using cash that you physically possess. As such, physical cash is held directly, making it a bearer instrument. On the contrary, using a credit card implies that the “cash” is being held with third parties, and one is using a debt instrument to buy an item.
Crypto assets like bitcoin can be considered digital bearer assets because they allow anyone to hold the private keys, making it possible that the assets can actually be owned. Holding a digital bearer asset comes with several benefits like the fact that they can be used at one’s own discretion. Digital bearer assets can be shielded from arbitrary seizure or freezing by banks and other financial intermediaries. Such assets can also be used for cross-border digital transactions, while a public blockchain infrastructure of nodes instead of a bank is making sure the assets are properly sent across borders and protected from theft in the process.
The basics of holding crypto assets
For you to take self-custody of your crypto assets, you need to understand some basic crypto concepts like a blockchain address, public key, private key, seed phrase, and crypto wallet.
A blockchain address is a unique sequence of numbers and letters that operate similarly to an email address. A blockchain address can receive crypto assets. While such an address can be used more than once, you are advised to always use new blockchain addresses for privacy reasons. Conveniently enough, with most wallets, blockchain addresses can be created without limit. The purpose of this address is to assign a unique address to a user every time he/she receives crypto. A blockchain address is created by hashing a public key.
Your “public key” is sort of like a bank account, while the blockchain address is your bank account number. You can send and receive cryptocurrency using either your blockchain address or your public key. For privacy reasons though, it makes more sense to use the blockchain address.
By contrast, a “private key” is like an ATM password to a bank account. It proves you own the account or in the case of crypto, you own the coin(s) associated with the private key. Your private key allows you to spend your crypto. This also means that if somebody else gets access to your private key they can spend the coins in your wallet.
A seed phrase is generated when you create a wallet for the first time. As such, a seed phrase is just another form to illustrate a private key. You are supposed to save it and never share it. In the event someone obtains your seed phrase, you will lose your coins. So, for all intents and purposes, the seed phrase is like your crypto assets, even though technically, this is not correct.
A crypto wallet is a device, mobile or web app, or physical medium that stores your private keys for crypto transactions. This means that the coins are not in your wallet, they reside on the blockchain itself. It is the private keys that are stored within your wallet.
Self-custody and non-custodial wallets
We have observed that crypto assets are digital bearer assets that allow for self-custody of digital assets. Lately, more and more people are starting to see how important it is to take self-control of their assets rather than entrust banks and third-party services with them.
When it comes to crypto wallets, it is important to distinguish between two important categories:
- Custodial wallet — With this wallet, your private keys are held by another party. The counterparty secures your wallet and returns your coins whenever you need them.
- Self-custodial wallet — This wallet allows you to hold your private keys and have full control of your crypto.
In order to become a self-custodian of your crypto assets it is essential to use a non-custodial crypto wallet.
For a small amount of crypto, you can use a web or mobile wallet to store your crypto. For example, for less than $100 worth of BTC, you can download the Trust Wallet mobile app and store your coins there. Other non-custodial wallets include:
However, for larger amounts you want to use a hardware wallet. A hardware wallet is a physical device that stores your crypto and is not connected to the internet. Hardware wallets are considered safe because your private keys are stored offline and no transactions can happen unless you physically confirm them through your hardware wallet. The most popular hardware wallets are Ledger Nano X, Trezor, or BitBox.
How to take self-custody of crypto 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.