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What Is Self-Custody in Crypto?

Read 8 min
Beginner
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KEY TAKEAWAYS:
—  While custodial wallets offer users convenience, their third-party providers own your wallet’s private keys, meaning they control your assets.

—  Self-custody is when you control your private keys yourself, taking full responsibility for the security of your wallet.

—  Ledger’s devices and software ecosystem make it easy to practice secure self-custody.

Bitcoin was designed as an electronic, peer-to-peer payment system, allowing two willing parties to transact directly without middlemen. This was an attractive proposition for early adopters following the 2008 financial crisis when banking malpractice led to a wide loss of trust in the traditional financial system. As such, Bitcoin offered an alternative with some serious potential. 

Primarily, Bitcoin was created to take intermediaries out of finance; returning control to the people. This was the premise the whole crypto ecosystem was built on. Many chains, protocols, and crypto solutions embraced the ethos of blockchain, striving for a more decentralized transfer of value. But, that’s not strictly true for every crypto platform and service in existence, and that also extends as far as storage solutions.

To reiterate: not all solutions for storing crypto offer self-custody. While some wallet providers put you in control, others reserve the right to do whatever they like with your crypto. But before we get there, let’s explore the basics. In fact, what is self-custody in crypto in the first place?

What Is Self-Custody in Crypto? 

Self-custody in crypto is all about ownership. Unlike centralized financial institutions such as banks, self-custodial solutions allow you true ownership of your assets. 

You see, when someone says they store crypto in their crypto wallet, that isn’t strictly accurate. 

Your crypto is stored on the blockchain network, by every single node. Each node in the network stores a copy of the entire blockchain’s history—every single transaction ever made. So, instead of storing cryptocurrency, your crypto wallet stores the secret information that allows you to manage a specific account called a private key

Every address on a blockchain network is tied to a key pair. There’s a public key, which your blockchain address is derived from, that acts as a unique identifier for that account. Then there’s a private key, which allows anyone the power to manage the assets at the associated blockchain address. 

That private key is what your crypto wallet must store, and it must do so securely since anybody with the private key of an address can access its funds. But what do private keys have to do with custody of your assets exactly? 

Who Owns Your Private Keys?

When you hear about custody in crypto, it’s essentially about who controls the private keys of a crypto wallet.  To explain, there are two approaches a wallet provider can take to custody: custodial or non-custodial solutions. A custodial crypto wallet is one whose private keys are held by a third party; typically a centralized exchange. Conversely, a non-custodial wallet requires its owner to manage their own private keys.

The difference may seem minimal, but these two wallet types have vastly different approaches to security. 

Using a custodial wallet is much like securing your funds in the bank. With this method, you are protected from thieves. However, you depend on the bank to access your funds, meaning they have access to your accounts. If the bank fails, or mismanages your funds, there’s nothing you can do about it. This is exactly how custodial wallets work: the provider reserves the right to access your funds when they like. That’s not exactly ideal!

On the other hand, using a non-custodial wallet is much like storing cash physically; such as in a safe or under your floorboards. With this method, only you control how and when you spend your funds. However, you’re also responsible for storing it in a safe place. If anyone were to get a hold of your cash, they could spend it. Similarly, anyone with access to your private keys can manage the assets at that address. This is why it’s often said that “with self-custody comes responsibility”.

The Benefits of Self-Custody

So now you know what self-custody in crypto means, but let’s dive a little deeper. There are a range of benefits of managing your assets yourself—and not all of them are as obvious as the first.

Ownership

If there’s one famous phrase in crypto it’s Not your keys, not your coins”. The truth is that without a non-custodial wallet, you don’t truly own your assets. 

At best this can mean inconveniences such as spending limits and transaction fees, but the consequences can get much more severe than that. For example, if a centralized wallet provider goes bankrupt or otherwise fails, you could lose access to your funds—through no fault of your own! 

Then, consider counterparty risk stemming from a centralized entity that uses bank reserves. Even in crypto, some projects rely on bank reserves: fiat-backed stablecoins are a good example. To put it simply, using a non-custodial wallet for a coin doesn’t help if the centralized issuer relies on banks and traditional financial institutions.

More Wallet Options 

When you use a custodial wallet, you will likely be limited to a wallet interface on a browser or mobile app. Conversely, when you self-custody your crypto you have countless wallet options from which to choose.

To clarify, almost all non-custodial wallets today benefit from BIP-32 and BIP-39 compatibility. Thanks to this standardization, a single 12-24-word seed phrase can recover a near-infinite number of blockchain addresses. What’s more, you can actually switch between non-custodial wallet providers by importing your wallet using those 12-24 words. Unlike with custodial wallets, you’re free to move from provider to provider as you’d like. Even if the wallet provider you use goes out of business, you can easily import your accounts into another non-custodial wallet’s interface. That’s true ownership!

Enhanced Privacy 

Privacy is a major topic of concern within crypto, given the nature of blockchains as public ledgers. Indeed, many crypto users prefer to keep their public wallet addresses completely anonymous to help maintain their privacy. The thing is, this is only fully possible with a self-custody wallet.

Custodial wallets require you to undergo a full Know Your Consumer (KYC) process, which involves volunteering personal information like your name and address, and even a form of photo identification. While this information might not necessarily be tied to any public wallet address, you are putting your faith in the wallet provider to keep it safe from any potential data leaks or attackers.

Access to the Decentralized Ecosystem

On smart contract-compatible chains, such as Ethereum and Solana, you’re likely to access blockchain apps and services. Blockchain apps and dApps, such as decentralized exchanges, DeFi protocols, NFT marketplaces, and governance platforms; are only compatible with a limited number of wallets, and usually, the accepted wallet providers will be non-custodial. While some platforms may be compatible with some of the larger custodial wallet providers, your access to the full blockchain ecosystem hinges on whether you use a non-custodial wallet or not.

Types of Self-Custody Wallet

So now you know about what self-custody entails, but what about the different types of non-custodial wallets? Let’s dive into the most common types of non-custodial crypto wallets you might encounter.

Software Wallet 

A software wallet, otherwise known as a hot wallet, is a crypto wallet you download on your computer or mobile phone. Software wallets store your private keys on their host device—the same device that connects to the internet. Although non-custodial, software wallets are vulnerable to online threats such as hacking. This makes them unsuitable for securing large amounts of cryptocurrencies.

Paper Wallet 

A paper wallet is simply a physical piece of paper with the private keys of an account printed on it, typically in the form of a QR code. A paper wallet is very secure, however, they aren’t very user-friendly. Sending and receiving funds in accounts controlled by paper wallets can be challenging, particularly for beginners.

Hardware Wallet 

A hardware wallet is a physical device that allows you to manage your assets while storing your private keys completely offline. Since they store private keys in a chip separate from your internet connection, hardware wallets are better protected from malware and spyware than software wallets. Plus, since they have a digital interface, they are much more user-friendly than paper wallets. It’s important to note that hardware wallet models differ greatly, with varying features and security measures to consider.

Self-Custody Best Practices

Self-custody comes with responsibility. If you don’t practice it correctly you could leave your assets at risk. Remember, blockchain transactions are irreversible: you only have one shot. If you lose your crypto because of a mistake or a scam, you’re unlikely to get it back. So, let’s explore how you can practice self-custody securely.

Protect Your Seed Phrase

Practicing self-custody properly means keeping your seed phrase safe. Your seed phrase allows you to restore access to the associated accounts —no matter the wallet provider or whether you have the physical device or not.

So from the very beginning, you must record your seed phrase correctly. Any mistakes with the spelling or word order of your seed phrase will prevent you from recovering any associated accounts later. 

Next, you should never record your seed phrase on a digital device. That includes all phones, tablets, and computers, as well as all cloud storage services. Digital devices and servers for cloud storage are hackable, which could lead to your wallet being compromised.

Instead, you should store your seed phrase on something physical. A piece of paper does it for most people, though some people choose to engrave their seed phrase onto metal for extra security. Of course, you’ll want to store that physical seed phrase somewhere safe from theft or damage. If you’re struggling to find somewhere secure to store your seed phrase, you can always consider using Ledger Recover. This paid optional service can help you create a backup for your wallet access, using your ID instead of your seed phrase.

Use a Hardware Wallet

Hackers and other malicious actors have many sophisticated ways of accessing the information on devices connected to the internet. That means that if your seed phrase is stored on a device that connects to the internet – like a software wallet stores its data on your phone or laptop – it is susceptible to being stolen by a hacker.

Using a hardware wallet is a must for anybody serious about self-custody. When you use a hardware wallet your private keys are generated and stored completely offline, protecting it from online threats.

Typically, hardware wallets also offer additional security measures against physical hacking. For example, Ledger devices use a Secure Element chip to store private keys and drive their secure screens. These pieces guarantee that what you see is what you sign.

Segregate Your Crypto Assets

Even if you follow the above practices, there’s still one major vulnerability when it comes to the security of your assets: you. User error, typically in the form of signing a malicious transaction, is a major factor in users losing their crypto. Sometimes the danger is impossible to avoid, especially when blind signing. This is why Ledger recommends that you segregate your crypto assets.

Each Ledger device can generate a near-infinite number of crypto accounts. Its custom operating system BOLOS will guarantee your accounts work in siloes, meaning the security of one account can’t affect the security of another, as long as you’ve secured your seed phrase effectively.

By generating multiple accounts for different purposes, you can manage a cold account, a burner account, and more, all from the same interface. If you sign a malicious transaction with one account, your assets in other accounts remain safe.

Secure Self-Custody: At The Core Of Ledger’s Security Model

In the end, it’s important to understand that self-custody is a tradeoff, though one with obvious benefits that also align with the foundational ethos of crypto. When you choose self-custody you lose some convenience by taking on complete responsibility for your assets, and it’s more than worth it for the agency and security you get in return.

Ledger believes in the ethos that started with the Bitcoin whitepaper and sees self-custody as an irremovable part of crypto. The world-class security of Ledger devices makes self-custody a seamless process, and with Ledger Live, buying, swapping, and managing your crypto couldn’t be easier.

After all, if not self-custody then why crypto?


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