As cryptocurrencies garner increased attention, keeping them safe and secure becomes more crucial than ever. In this week’s edition of ‘The Cortex Connection’, we’ll cover the basics of self-custody, and provide some ideas you can review and incorporate for yourself.
Self-Custody v Custody
Self-custody, sometimes referred to as non-custodial, refers to the practice of an individual or entity holding, managing, and securing cryptocurrency assets. When you self-custody your assets, you have complete control over your private keys and are responsible for keeping them secure; you are therefore solely responsible for the consequences of any loss or theft. Self-custody is achieved through the use of a hardware wallet or a software wallet installed on a personal device.
On the other hand, when you use a custody service, you are entrusting a third party to hold and manage your assets on your behalf. This is often done for convenience but can also be used for those requiring additional security or regulatory compliance. Examples of custody services include exchanges, brokerages, and institutional custodians with companies like Coinbase, Fidelity, and Gemini.
While it’s not a perfect comparison, for the purposes of this article you can think of custody as cash in your bank account and self-custody as cash in your wallet.
The Risks
The cash v bank account comparison is a rough take because crypto assets stored in a custody account will have a varying degree of coverage for loss, including no coverage at all whereas traditional bank accounts come with insurances like FDIC and NCUA on their cash deposits. Despite this, there are risks associated with both custodial and non-custodial options.
Risks of Self-Custody
If your private keys are lost or stolen, there is no way to recover your assets, making this a potentially significant risk.
Self-custody requires a certain level of technical knowledge, and mistakes can be costly. Accidentally deleting or losing access to private keys, for example, can result in permanent loss of assets.
If you encounter any issues with your software or hardware wallet, you’re typically limited to forums and FAQs to help resolve your issues.
Risks of Custody
When you entrust a third party with your assets, there is always a risk of loss due to hacking or fraud.
Custody services are not currently regulated in the same way as traditional banking institutions, which means there is a risk that your custodian may fail or go bankrupt like Voyager, Celsius, and FTX
When using a custody service, you may have limited control over your assets, including restrictions on when and how you can access or transfer them.
It’s clear that both self-custody and custody have their own inherent benefits and associated risks, and the choice between the two will depend on your specific needs and circumstances.
Hardware v Software Wallets
There are two types of crypto wallets: hardware and software. While both serve the same purpose of securely storing and managing your digital assets, they differ significantly in their features, security, and ease of use. Choosing between these two depends on your specific needs and risk tolerance.
Hardware Wallet
A hardware wallet is a physical device that is designed to securely store your private keys and manage your crypto assets. They are usually small, portable devices, typically with a small screen and a few buttons for navigation, which allow you to confirm transactions and manage your holdings.
Hardware wallets are considered to be one of the most secure methods for storing your assets as they are not connected to the internet so your private keys and other sensitive information are kept offline. Most hardware wallets require you to physically confirm any transactions, which provides an extra layer of security against unauthorized access.
Pros
Enhanced security: Less vulnerable to common hacks and malware.
Portable: Easy to carry, store, and use on the go.
Ease of use: Comes with clear instructions and tailored support.
Cons
Cost: More expensive than software wallets.
Risk of Damage or Loss: Physical devices can be misplaced or stolen.
Limited Functionality: Hardware wallets are designed primarily for the storage of crypto assets and may not have the same functionality as a software wallet.
Hardware wallets come at a cost, and have less functionality than some software wallets however their high level of security makes them ideal for those who are looking to secure their long-term hold portfolios. Some popular hardware wallet providers include Ledger, Trezor, and KeepKey.
Software Wallet
A software wallet is a digital wallet that allows users to store, send, and receive crypto assets using a software application installed on a computer or mobile device, typically for free. Software wallets are also known as hot wallets, as they are connected to the internet and accessible through various applications.
Software wallets usually store private keys on a user’s device, making it easier for them to access their assets. However, this also makes them more vulnerable to hacking and other malicious attacks.
Pros
Accessibility: Often free and readily available for download on a variety of devices.
Flexibility: Can support multiple cryptocurrencies and offer a wide range of features including transaction history and address book functionality. While hardware wallets provide increasing support in this category (by using software wallet connectivity), software wallets will typically support the latest developments first.
Convenience: Allows for easy access to your assets and can be used for everyday transactions without much friction.
Cons
Security Risks: Private keys are stored on an internet-connected device.
User Error: Software wallets are reliant on users keeping their private keys secure and can be susceptible to human error, such as forgetting passwords or downloading malware.
Dependence on Third-Party Providers: Some software wallets rely on third-party providers for additional features, which can pose risks to privacy and security.
Software wallets have increased exposure to security risks as they are used on internet connected devices that can be compromised, and are more susceptible to human error however their high level of convenience for day to day transactions make them ideal for those who are looking to frequently buy and sell their digital assets and more easily interact with the latest blockchain and smart contract developments. Some popular software wallet providers include MetaMask, TrustWallet, Atomic Wallet, and a special mention to the newly released Uniswap Wallet.
Which Will You Choose?
So whether you choose self-custody or not, we encourage you to review where your crypto assets are held and consider whether your current storage methods are meeting your security and accessibility needs. If your assets are sitting idle on an exchange or other custodial platform, maybe it’s time to consider the benefits of moving them to a software or hardware wallet you control.
Feedback!
As always, we hope you find the information in these issues valuable and welcome any feedback and suggestions you may have. If there are any topics related to DeFi that you would like us to cover in future issues, please feel free to visit our Discord channel to let us know! We want to make sure we’re providing content that you care about.
Thank you for reading!