The cryptosphere is reassessing the value of self-custodial services versus custodial services. In basic terms, the debate boils down to whether or not crypto investors should safeguard their own private keys — as roughly 83 million users had as of April 2022 — or trust institutions like crypto exchanges to hold their keys.
Keep in mind that crypto transactions require two sets of keys – one public and one private. Both keys are required to authenticate a transaction and record it on the blockchain. Institutional services, i.e. exchanges, will hold onto those keys for investors, but they frequently charge fees for withdrawing crypto and, in rare cases, may even limit an investor’s ability to withdraw funds from the exchange. The popular refrain in the crypto space goes, “not your keys, not your crypto.”
This is where the terms “self-custodial” and “custodial” come into play: Custodial services hold the private keys needed to transfer crypto assets from one crypto wallet to another, while self-custodial services, like Olliv, place the trust squarely on the investor to guard their own keys and finalize both sides of each transaction.
Are self-custodial wallets & services preferable for crypto investors?
Holding your own private keys means you’re solely responsible for maintaining the keys’ privacy. Using self-custodial wallets and services also requires you to take care to ensure that private keys are entered correctly during each transaction. Even with (or perhaps because of) this increased level of personal liability, many investors may find themselves more at ease with the idea of holding their own keys, thus holding direct access to their own crypto.
Anyone getting into crypto for the first time should assess their comfort level when it comes to risk and responsibility. In a nutshell, the personal responsibility for self-custodial services or self-custodial wallets is high; unless you share your private keys, no one else will have access to your digital assets.
Investors who opt for the self-custodial approach should consider how they'll secure their keys. One popular strategy is to write them down, laminate the piece of paper, and store it in a fire safe or other secure location. With the right strategy, it's easy to keep your keys available to you but safe from others.
What are the advantages and disadvantages of custodial wallets?
On the other side, exchanges that hold crypto investors’ keys are centralized, making it less like a “wallet” and more like an “account.” They can offer expediency and convenience, typically asking a user to remember only their username and password in order to sign in and then facilitating simplified purchases or transfers.
Handing all the ownership and security to a third party does carry significant risks, though. Despite the convenience, investors may still be vulnerable to bankruptcy, hacks, and other disruptions to a centralized crypto exchange’s operation. In a recent bulletin to staff, the U.S. Securities and Exchange Commission (SEC) laid out its stance on the risks faced by exchanges as they attempt to manage and safeguard crypto key information belonging to investors, saying “the methods create significant increased risks to [exchanges], including an increased risk of financial loss.”
What are the risks of custodial wallets?
The risks of using custodial crypto services can be analogous to holding your money at a bank or using a payment app like PayPal. The risks stem from the fact that, ultimately, you're not in full control of your funds.
Control of your traditional money is closely regulated by lawmakers, insurers, and bank employees. Same goes for full control of your crypto assets, as crypto markets will likely be subject to increasing oversight and regulation. But the terrain is shifting — in some cases rapidly — and crypto regulation varies from one locale to another. It may stun investors to wake up one day and realize they’re not able to access any of their digital assets. Is this scenario likely? Perhaps not. Is it impossible? No.
Lastly, the elephant in the room: What if a crypto exchange goes bankrupt?
Or if the exchange gets hacked, what then? If something drastic happens and an exchange dissolves overnight, investors who keep their crypto on those exchanges may find they have little-to-no recourse in getting back stolen funds. And they may find themselves last in line for payouts from bankruptcy settlements. Some exchanges have disclosed they could designate investors as “unsecured creditors” and this means that, in the event of bankruptcy, those investors will be the last to receive settlements from the bankruptcy estate.
Final thoughts
Self-custodial crypto wallets and self-custodial-based crypto services provide investors with direct access to the blockchain. Thinking of blockchains along the lines of a public utility, using self-custodial crypto services is like being able to tap directly into the power supply when you want electricity for your home. And it carries the added bonus of not having to pay a third party whenever you want that power. There’s also minimized risk of a data breach when crypto investors hold their own private keys.
As long as investors remain diligent in protecting their private keys, then the advantages of self-custodial wallets and services easily outweigh the drawbacks.
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