Introduction: custodial and non-custodial wallets
Remember: Not your keys, not your crypto. “Custodial” means someone else keeps custody of your keys. Impossible is nothing.
We have already seen what public and private keys are. Custodial means someone else keeps your private keys for you, non-custodial means nobody else does, i.e. you must keep them yourself, and nobody can help you if you fail at that.
Non-custodial is therefore better suited for the decentralized aspect of crypto. Custodial is on the contrary the default approach for centralized exchanges, which is a very different approach from the “plain crypto in the blockchain” we have seen so far. In the case of decentralized exchanges:
- They have the crypto and may use it, e.g. lend it, market making,… and give you interest in exchange.1
- The crypto you have may not be accounted for in the blockchain but in the private database of the centralized exchange, which may be hacked2.
- Even your public key may be shared with other customers, hence writing a “memo” is necessary to receive the transfers to you.
- They probably need to implement KYC. The worse scenario is not an exchange needing KYC to create an account, but not needing it until you try to withdraw from it, potentially locking you out of that crypto that was never yours.
The cypherpunk spirit is against both centralization and KYC. The former is easy to avoid, using the centralized exchanges as on and off ramps, without permanently storing any crypto in them. The latter is harder, as the FATF, and authorities would have issues with that, e.g. taxes.3
Something that is less often mentioned when discussing crypto wallets is what would happen if the owner of the wallet passes away. For non-custodial, the instructions may be stored in a safe yet accessible place. For custodial wallets, you may need to ask (and possibly agree) with the organization keeping custody of your crypto. Each one will be different.4
I know many people do not like making plans for their heirs, especially young people without children, who may not have accumulated as much wealth as who would be their heirs. But most people do not choose when to die. Stay safe, have a happy and long live, hope for the best, and prepare for the worst.
Note: In addition to potential technical problems with a blockchain, they may incur liquidity problems, preventing withdrawals.
In this case, the security they have is probably much higher than what you would have at home. However, they are also a more visible and interesting target for hackers, while your wallet with $69.42 may not gather so much attention.
On a side note, there is not and there will be not any financial advice in this newsletter, and certainly neither advice for tax evasion or any other illegal activities.
At some point most of them may be just like banks (or be banks). This is one aspect where regulation may be beneficial. My best wishes for your survival until then.
Cross-posted from the Sigmoid newsletter