We often overlook the importance of security — until there is a crisis.
When Sam Bankman-Fried announced his now-defunct crypto exchange FTX was filing for bankruptcy, Web3 enthusiasts around the world likely shared a similar thought: What about my money? And as the story unfolds — painting Bankman-Fried as a pathological liar, media briber and vegan snowflake — perhaps one silver lining is that the FTX solvency crisis lit a fire under the Web3 community, motivating people to prioritize crypto security in a new way.
If you’ve tuned into Web3 Twitter or any financial news outlet over the last few weeks, the phrase, “not your keys, not your crypto'' may sound familiar. This commonly used phrase references the decision to use a self-custodial crypto wallet versus storing one’s crypto on a centralized exchange (CEX) like FTX.
Known as Web3’s sexiest security blanket, self-custody is the buzzword nearly everyone in Web3 is talking about: “Self-custody is a huge, top-of-mind topic for everyone,” says Maika Isogawa, founder and CEO of the crypto protection company Webacy. “People are literally losing life savings because of issues with this.”
In the wake of FTX’s recent crash, more of us need to shift to self-custody. Let’s explore why self-custody is the new “it” thing right now — and why that should probably never change.
Read More: BFF’s Guide to Crypto Self-Custody
Early crypto adopters usually argue in favor of self-custody as much as possible. Why?
Centralized exchanges (CEXs) such as Coinbase, Kraken, Gemini and formally FTX hold custody, or control, over their customer’s digital assets. Akin to a traditional bank, CEXs store your assets and can lend out, leverage or borrow against them. In exchange, CEXs promise to keep your assets protected, practice compliance checks (called KYC, or “know your customer”) and provide customer service to remind you of your password in the case you forget it or lock yourself out.
The concept of custodial institutions is not new, according to Shailee Adinolfi, director of business development and partnerships at crypto wallet company MetaMask. “Historically, financial systems have forced people to leave assets in the custody of others,” she says.
In fact, that's why crypto was invented: The earliest adopters saw blockchain as a way to dis-intermediate money by removing the need for a third-party custodian altogether. Crypto was designed to be a self-custodial asset, sort of like a digital bar of gold that you keep in a physical safe, except your crypto wallet is serving as a digital safe instead. Of course, that’s a departure from how we’re used to operating. We’re used to giving banks the key to our money and simply making a username and password to log in to their system when accessing our cash.
“Cryptocurrency was created via the blockchain to give us the opportunity to control our own digital assets and remove some of these custodial entities or intermediaries from the system of financial services,” says Adinolfi. .
What happens however, when a CEX mismanages its holdings at the expense of your assets? Enter stage left: FTX and its alleged backdoor hedge fund, Alameda Research.
Over the last year, FTX employed highly irresponsible risk-management strategies and commingled assets between the exchange and its sister company, Alameda. The pair held approximately $11 billion worth of liabilities consisting mainly of their own FTT governance token, leaving the exchange in an asset deficiency. What’s a trusting consumer to do?
After CoinDesk leaked documents elucidating FTX’s financial straits, and FTX’s chief competitor Binance announced it would sell off a large chunk of its FTT governance tokens, customer withdrawal requests followed, totaling an estimated $6 billion. Facing tremendous capital strains worth over $8 billion, FTX had insufficient liquidity to supply customers who were trying to extract their funds. This resulted in over 1 million people losing investments held in FTX. On November 11, FTX’s CEO and founder, Samuel Bankman Fried — known as SBF among Crypto Twitter users — declared bankruptcy.
Thanks to SBF's actions — which some argue set the entire crypto industry back years — decentralized exchanges (DEXs) like Uniswap and AAVE have embraced the PR nightmare as an opportunity to market themselves. Crypto evangelists continue to argue that self-custody is the path forward, and that decentralization should be our number-one focus right now.
Decentralized platforms are peer-to-peer, meaning that they impart the roles and responsibilities usually managed by an entity onto users. They remove the KYC process, meaning anybody can access them no matter their identity, location or financial history. On DEXs, users connect non-custodial wallets and maintain their own seed phrases and keys. This allows them to maintain and own assets, even in the event that a DEX fails.
Read More: Centralized Exchanges Vs. Decentralized Exchanges
Self-custody empowers users to control their own assets and maintain the private keys that safeguard them. In practice however, this will require that consumers get up to speed on a rapidly evolving industry. Proper wallet and private key management are among the main barriers to crypto adoption, says Adolfino.
“Simply the concept of keeping your own keys and the seed phrase, remembering them, and storing them safely is something that needs education,” she says. There’s also cost: The most secure crypto wallet solutions Ledger and Trezor can range between $50 to $200 in price.
However, new companies and solutions are always arising. One group looking to tackle the aforementioned challenges is Webacy, a security layer for self-custody that pairs safety tools and services with users’ non-custodial wallets. Webacy allows users to manage their wallets without having to remember seed phrases or private keys, and be notified upon any suspicious wallet activity.
“The products that we're building upon are supposed to emulate things that we're comfortable with, but in blockchain fashion”, explains Isogawa.
MetaMask and other self-custodial wallet providers are also developing new tools and services aimed at streamlining the user experience. Many innovations center around transaction monitoring and “know-your-transaction” data integrated directly into users’ wallets. These types of tools can help customers discern and evade suspicious transactions and protect themselves from potential bad actors.
Of course, tooling across the board in Web3 is still new and emergent. In the meantime, consumers should never buy or invest more than they can afford to lose and learn with the right-sized steps for their financial and educational goals.
Isabel Doonan is the CEO and Cofounder of Girls Gotta Eth and Sacreage, a Web3 startup working to expand tooling for crypto philanthropy. With a background in Fintech and ESG, she is deeply passionate about the intersection of blockchain and climate funding, as she works to build a better, more equitable future in which everyone can participate in philanthropy.
This article and all the information in it does not constitute financial advice. If you don’t want to invest money or time in Web3, you don’t have to. As always: Do your own research.
