Deep Dive: Crypto Self-Custody
If you have been paying attention to crypto news recently, you have probably heard of various insolvencies across the industry. Whether it’s Celsius, 3 Arrows Capital, BlockFi or Voyager, a concerning trend has once again reared its ugly head in our space: counterparty risk. Yes, for some reason, decision makers at various multibillion dollar crypto companies decided that offering unsecured lending to highly leveraged counterparties with 100-vol assets on their balance sheets was a good idea; after all, what could possibly go wrong? A phrase that has often been joked about as being the rallying cry for out-of-touch Bitcoiners — “not your keys, not your coins” — has become extremely pertinent in a macroeconomic landscape of shrinking liquidity, crypto lenders limiting withdrawals and other firms experiencing outright insolvency. In this piece, we will touch on ways that you can start to take self-custody seriously, without losing access to some of the key services that you may have grown accustomed to with Centralised Finance (CeFi) providers and centralised exchanges.
If you have been around the block in the cryptosphere, you have heard of a hardware wallet. Whether it is a Ledger, Trezor, Grid+ Lattice, or any number of other physical hardware crypto wallets, this is where your self custody journey likely begins. Hardware wallets are undoubtedly the most secure way to store a variety of different cryptocurrencies, so long as security best practices are followed. First and foremost, never purchase a hardware wallet from a reseller — only from the original manufacturer. This ensures that it has not been tampered with in any way. Secondarily, heed the warnings that come in the box — primarily around storage of your seed phrase. Your seed phrase is no joke! It needs to be stored in a secure, offline location — not stored digitally in the cloud, and not stored physically next to an open flame or a source of water but rather in something like a fireproof safe, lockbox, or safety deposit box. This might seem like a big headache, as who wants to take time to ensure their operational security has been properly implemented — much less click buttons every time they’d like to broadcast a transaction, right? We’ll tell you who: CeFi depositors whose assets have been frozen against their will. It would have been a lot more convenient for them to click a few buttons, rather than rely on the good faith and opaque processes of private businesses.
Okay, great. So you’ve got your Ledger all set up, but what about the yield!? Indeed, CeFi lenders offered what turned out to be unsustainable interest rates on customer deposits, with some of them even dipping their toes into Decentralised Finance (DeFi) in order to bolster their returns. So, if the CeFi lenders are using DeFi to pay out yields, why can’t you do that, too? Well, you can! We will avoid the topic of lending, as there is heightened illiquidity risk in the market right now for lenders (the risk that your deposits get fully lent out, earning a very high interest rate, but putting us right back to square one in terms of trustless access to our assets). You can, however, greatly benefit from the untimely exit of many market participants from the DeFi market and earn some tremendous yields by providing liquidity to a decentralised exchange, such as Uniswap or Curve. While centralised intermediaries with unsecured loan obligations make a frantic exit for the doors in order to meet other obligations, on-chain liquidity providers will earn relatively more fees from relatively increased swap volumes. Just be careful of which pool you choose, lest there be any impermanent loss, a topic too broad to be covered here.
Okay, great. You’ve withdrawn your assets from centralised exchanges and maybe provided a little bit of liquidity to a decentralised exchange to earn yield. What about swapping your coins, something which centralised exchanges are uniquely good at? Thankfully, blockchains are uniquely good at this as well. While the difference in fees between centralised exchanges and decentralised exchanges has often been difficult to justify, with decentralised exchange aggregators such as 1inch and KyberSwap, you can always ensure that you get the best price for the lowest amount of fees when you are trading. Often times, these fees will even rival, or be lower than centralised exchange competitors, such as *cough* Coinbase *cough* just to name one. What’s more, many of the woes around transaction fees have not necessarily been solved, but have certainly become less of an issue as competition for blockspace has dropped along with cryptocurrency prices at large.
The truth is, relationships with centralised intermediaries are sticky. They provide services that users grow to appreciate or maybe even depend upon over time. As much as we all want to use self-custody for our crypto — its original, intended purpose — most of us are not miners and must therefore use a centralised exchange in order to exchange our fiat for cryptocurrencies. This is a necessary evil for most but it doesn’t mean you have to stop at the purchasing phase; go out and use your crypto! While the initial transition to custody of crypto assets on-chain might be difficult at first, go and talk to any crypto native and ask whether their experience has been better when their assets were stored on a centralised exchange or when they were stored in their own custody. Between airdrops, high yields, abitrage and the ability to access your funds whenever you choose, regardless of what anybody else says — the time to move your crypto assets to self-custody is now.
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