The recent series of failures in the crypto industry have made users lose millions of dollars to centralised crypto companies. With the continuous bankruptcies and insolvencies over the past year, starting from the Terra meltdown, to the most recent FTX failure, users have started questioning the safety and security provided by custodial wallets of the centralised exchanges.
A custodial wallet is one where a third party owns the private key to your crypto and is in charge of your assets. A recent example is that of the FTX exchange that held users’ keys and controlled their funds. With a self-custody or a non-custodial wallet, you have complete control over your private keys, and remain the sole owner of your crypto funds.
In the past decade, the downfall of over 14 centralized crypto companies has wiped out 1.2 million BTC, almost 6% of the current 19.2 million BTC supply out of circulation. In the past year alone, millions of people have suffered irrecoverable losses to centralized entities like FTX, Celsius, BlockFi, and more. Approximately $1 billion of customer funds have been lost from the FTX exchange. Moreover, exchanges have witnessed a historic outflow of 106,000 BTC per month after the recent FTX debacle. Binance, the largest crypto exchange experienced users withdrawing $1.35B of Bitcoin in Days following FTX Collapse.
As a result of the FTX collapse, users started pulling out from crypto exchanges and turned to non-custodial platforms to trade and store their assets. For example, Uniswap, witnessed a large increase in trading volume on Nov 11, the day of the FTX filing for bankruptcy.
There are several factors that make centralized exchanges like FTX extremely risky and why people end up losing money:
Misuse of Funds: With a custodial wallet, users never have control of their crypto assets and rely entirely on a third-party custodian to store their keys & funds. As they say, “Not your keys, not your crypto.”
Single Point of Failure: A custodial wallet that is linked to a centralised exchange is vulnerable to a single point of failure, as the funds are at risk if a rogue CEO or a bad actor decides to flee with the funds or dissolve the company. In 2021, the founder of Thodex (a Turkish crypto exchange) disappeared with $2 billion of investors’ funds.
Lack of transparency and proof of reserves: Centralised exchanges should maintain a certain amount of reserves at all times in order to honor withdrawal requests from all their customers. As we saw in the case of FTX and a few other instances, firms ended up using customer funds for other purposes.
Weak security & fund safety measures: If the third party lacks robust security measures, the user risks losing all their funds. A liquidity problem, such as the one at Celsius, BlockFi, and Genesis might threaten investor capital and lead to bankruptcy risks.
Liquidity & Bankruptcy Risks: A centralised crypto company has the power to freeze users’ accounts overnight, misuse their funds, create liquidity crises, and file for bankruptcy as seen in the recent FTX case.
If the above risks of custodial wallets are not addressed, people might lose trust in the industry and may not realize its true potential and the strong value it adds to the world of finance, which empowers the users at the core level.
The importance of self-custody wallets has grown tremendously as users explore ways to safeguard their digital assets. The recent fallout of FTX, the world’s second-largest crypto exchange has made self-custody wallets more relevant than ever before.
Self-custody wallets are the ones where the user maintains full control of their assets. You control the private keys to your wallet and retain complete ownership at all times. No third party can access your assets and you are the guardian of your private keys while decentralised platforms are just an interface to manage your digital assets and engage in DeFi activities.
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.
Self-custody platforms such as Okto put control back in the hands of the users by giving them complete custody of their funds. Okto allows users to become their own banks by safeguarding their accounts. With Okto, there is no need to remember your key or worry about losing them or the recovery process unlike wallets such as Metamask or Trust Wallet, where you need to ensure that you remember your private key and safeguard them at all times.
In a nutshell, when using a centralised exchange, one must always do their research and trade with trusted industry players who have no history of hacks, or misuse of funds and are transparent enough to declare their reserves. CoinDCX recently published its Proof of Reserve report to provide transparency to its users. Hence, one must carry out their due diligence before choosing a wallet and should be aware of the risks of custodial wallets.