Self-custody wallets have become more relevant than ever as users explore ways to safeguard their digital assets. The failure of several centralized crypto companies where users lost billions of dollars, has compelled users to explore different ways to store their crypto.
Starting with Mt. Gox, a cryptocurrency exchange, that was compromised several times due to security breaches over the years, which resulted in over $460 million worth of user funds being stolen in 2014, to the most recent being Crypto.com and FTX, which were hacked in 2022 where over $35 million and $1 billion worth of user assets respectively went missing.
Within a self-custody wallet, unlike a custodial wallet, users maintain complete control of their assets. In the case of a centralized crypto company, the private keys of the users are held by centralized entities and as a result, the users risk losing their funds in the case of hacks and bankruptcy threats. On the contrary, the user controls the private keys to their wallet and retains complete ownership at all times. No third party can access your assets within a self-custody wallet and you are the guardian of your private keys.
Owning your keys allows you to enjoy the complete power of being a crypto holder. You do not require any permission to send, store and receive your crypto as no central entity can prevent you from conducting transactions using self-custody wallets.
Some central entities can freeze your crypto holdings, set limits on the amount you can transact and even use your assets for their personal gain as we witnessed in the FTX failure where the company used users’ assets to fund its subsidiary companies without the user’s consent.
Self-custody is important as it protects you from counterparty risks and gives users complete control of their digital assets. This means that the private keys to their wallets (that is like a password to a user’s wallet) are stored directly on their mobile device, web browser or somewhere offline. These keys are not stored on any centralized platform that can seize your assets overnight.
Also with self-custody, there is no single point of failure, and thus provides multiple layers of security to your funds. Self-custody also protects powerful actors from corrupting the network and its participants.
To understand private keys, we must first understand what are public keys:
Self-custody wallets are of two types: Hot and Cold wallets.
Also known as software wallets, hot wallets are available in the form of mobile, desktop and online wallets. Hot wallets are connected to the internet and you can use them on your mobile phone or your laptop. Holding your assets on an exchange is also a form of a hot wallet. Self-custody wallets are the ones where you manage your private keys and thus remain in complete ownership of your funds.
These wallets come in the form of an app on your iOS or Android device and are handy as you carry them always with you. Different apps give you different options to secure your private keys. Mostly, the key is kept on your smartphone with backup and recovery options. Okto, for example, is a self-custody mobile app that stores your private key on your smartphone and you remain in control of your funds at all times. Even if you lose access to your funds, you can easily recover your crypto with assisted recovery available within the app. It should be noted that at no point can Okto access your funds.
Cold wallets are offline wallets that store your private keys in a physical device or hardware. Cold wallets are not connected to the internet and the chances of hacks reduce drastically. There are no central entities involved in managing cold hardware and thus, you are solely responsible for safeguarding your private keys.
A hardware wallet is like a USB drive that you can carry with you and your private keys are stored in them. They are self-custody and no one can access your assets as they are stored offline, and managed solely by you.
When you set up a self-custody wallet, it generates a random string of 12 simple words called the recovery phrase or a seed phrase. It is like the master password to your wallet and you need to keep it safe and secure. As long as you have the recovery phrase, your digital assets are secure. But if you lose it or if someone gets access to your recovery phrase, you will end up losing your funds. Hence, it could be a good practice to keep several copies of your recovery phrase in a safe location.
However, writing down seed phrases and keeping them secure sounds like an ancient way of safekeeping. As the tech is evolving, solutions such as Okto are emerging that provide self-custody solutions without having to manage your seed phrases. With Okto, there are no seed phrases and the private key share of the user is stored on their mobile devices. The mobile key share is stored in an embedded encrypted database. The mobile app is protected by biometric verification to prevent anyone but the user from gaining access. In the event of key share misplacement from the user’s side such as when a phone is lost or replaced, they have a reliable, simple process to back up and recover their key share.
In a nutshell, as crypto is evolving and gaining prominence, the safest option to keep your assets safe is by using self-custody solutions that provide complete ownership and control of your assets. Taking a step further, solutions such as Okto are more advanced that deploy MPC technology to safeguard your funds without having to manage seed phrases. Hence, choose your options wisely as the responsibility to safeguard your private keys lie solely with you.