9 Min Read 
Many users around the world onboard into crypto for the first time through exchanges. These users end up leaving their crypto holdings on various exchanges who act as custodians. A custodian is an institution responsible for storing and securing investors’ private keys.. This is common for users who are used to utilizing traditional financial institutions, such as banks, who have strong regulatory oversight, and mature insurance schemes that have evolved over time.
However, the crypto industry is still young. Many of the protections consumers have in their country’s legacy financial system are non-existent or are much less mature in the web3 space. In addition, many of the attributes that attract people to crypto are reduced when holding these assets on an exchange.
For example, privacy, censorship resistance, inflation resistance, and usability are all affected negatively by custodians. Taking custody, or full responsibility of your assets, is not only possible, but it helps to ensure these qualities are preserved.
Privacy
Traditional finance systems are subject to extensive surveillance, with transactions visible to multiple parties including banks, financial institutions, and government agencies. This surveillance is facilitated through centralized databases and information-sharing networks, allowing for broad monitoring of financial activities. Federal law enforcement agencies often collaborate closely with financial institutions, gaining access to customer data and transaction records without requiring individual warrants (U.S. House Committee on the Judiciary, 2024). This level of surveillance can negatively impact privacy-conscious individuals or those engaged in legal but sensitive transactions.
For example, a person making legal purchases related to healthcare or personal matters may find their private financial decisions scrutinized by multiple entities, potentially leading to unwarranted suspicion or discrimination. Many in crypto want to reclaim their financial privacy. However, when leaving crypto-assets on an exchange users are giving up any chance of financial privacy.
Self-custody doesn’t automatically grant privacy, it depends on the product you choose, but you have a better chance of reclaiming financial privacy by taking custody of your crypto-assets. Many self custody solutions don’t collect personal information and have no ability to track transactions made by the users they support.
To determine if a product offers privacy, research the company’s privacy policy and data handling practices. If a product doesn’t mention privacy features prominently or lacks options to enhance transaction privacy, it likely doesn’t prioritize user anonymity. Remember, true privacy in the crypto space often requires a combination of tools and practices, so consider using privacy-focused wallets, VPNs, and non-KYC solutions for enhanced protection.
Censorship Resistance
In the traditional financial system, banks, payment processors, and governments can limit a user’s ability to transact. For example, users can encounter daily withdrawal limits, restrictions on savings account transactions, caps on 401(k) loans, delays in international transfers, and limited banking hours. Within crypto networks it’s nearly impossible to stop a user from transacting freely unless the user gives up their crypto-assets to a third party or custodian.
Custodians come under the purview of national and international regulators. Government agencies often make determinations on what transactions can and cannot be made. The custodians might not want to censor or freeze the assets of its customers but they have to comply with court orders or international sanctions if they want to continue operating in the countries they do business in.
Self custody solutions help preserve this quality because the provider of the solution typically has no ability to limit a user’s ability to transact. Even if regulators wanted to go after businesses that offer self custody solutions their energies would be wasted. These businesses wouldn’t be able to comply for technical reasons. This is because self custody solutions are designed to give users full control over their private keys and transactions, effectively removing any intermediary’s ability to intervene or impose restrictions on the user’s funds or activities.
Usability & Accessibility
When leaving assets with a third party, users are much more vulnerable to that entity’s infrastructure working properly as well as them being able to manage their supply of assets. When using a custodian you’re usually logging into their servers and they are sending and receiving assets on your behalf.
Custodians also tend to secure assets in a mix of hot and cold storage. Hot storage refers to wallets connected to the internet, whereas cold storage involves offline methods, such as hardware and paper wallets. Assets in hot storage are inherently more vulnerable, but easier to access quickly for the custodian to perform transactions on your behalf. Cold storage assets are less vulnerable, but are hard to access and transact with. Custodians are motivated to keep the majority of the assets they take possession of in cold storage. As a result a common ratio of assets custodians hold in cold storage relative to hot storage is 49:1.
For example, if 100 exchange customers each gave a custodian one Bitcoin, the exchange would collect 100 BTC, keep 98 BTC in cold storage and 2 BTC in hot storage. If only 3 or more customers elect to move more than 2 BTC out of the custodian’s possession simultaneously, the custodian will have to access their cold storage to honor the wishes of these customers. Moving assets out of cold storage is a slow, manual process that can take some time. Too many customers moving too many assets out of the custodian’s possession in too short of a time period could negatively impact the customer’s ability to transact in a timely manner.
This isn’t the case when using a self-custody solution. There is much less infrastructure that has to be relied upon and users have near instant access to their assets to transact as they please. The self-custody provider simply provides the tools and platform to manage these assets, but it does not have access to or control over the funds.
Sound Money and Inflation Resistance
Many are attracted to Bitcoin because of the promise of sound money. Sound money refers to a form of currency that maintains its value over time and serves as a reliable medium of exchange, characterized by stability, scarcity, durability, portability, and divisibility. In the case of Bitcoin, it is considered sound money due to its programmable scarcity, limited supply of 21 million coins, resistance to manipulation, and its ability to serve as a reliable store of value and medium of exchange over time. This is in contrast to fiat currencies that can be subject to confiscation and inflation with arbitrary supply creation. What many fail to understand is these values of BTC are put at risk when custodians take possession of large sums of crypto assets.
When custodians hold assets it becomes close to impossible to know the true supply of what they hold until customers take possession.
The GameStop short squeeze of January 2021 stands as one of the most significant and recent examples of market manipulation and custodial risk. This event, which shook the financial world, highlights the vulnerabilities in traditional financial systems and centralized exchanges, underscoring the importance of sound money principles. The GameStop/Robinhood incident and the FTX collapse highlight the vulnerabilities in traditional financial systems and centralized exchanges, underscoring the importance of sound money principles. While these events were not directly related to inflation, they exposed how easily centralized entities can manipulate markets and mishandle user funds. The GameStop saga revealed how brokers like Robinhood could restrict trading to protect institutional interests, while FTX’s bankruptcy uncovered the misuse of customer assets and the creation of tokens “from thin air.” These incidents contrast sharply with the concept of sound money, which maintains value over time and resists manipulation.
It’s been well documented how gold markets are strong-armed by Central Banks and Bullion Banks to suppress the price of gold. According to Chris Powell of the Gold Anti-Trust Action Committee (GATA) international financial institutions are able to do this through gold futures contracts which are settled in cash not gold. Participants in these markets never actually take delivery of the underlying gold held by custodians. By never taking possession a massive supply of imaginary gold can be produced in the form of financial contracts. According to GATA the amount of claims on gold are far greater than the actual supply held by custodians. The difference between actual supply and the claims on that supply is unknown because hardly anyone actually takes possession.
US Equities have also come under similar scrutiny. Former CEO of Overstock, Patrick Byrne, has alleged for years that the number of claims on corporate shares far exceeds the actual number of shares. His investigations into the inner workings of Wall St as the CEO of a public company led him to the obscure Depository Trust & Clearing Corporation (DTCC) and its legal subsidiaries.
The DTCC is responsible for clearance, settlement, and custody of almost all of the publicly traded securities in the United States. The DTCC represents a large central point of failure for public financial markets. In addition, there is a long chain of middle men between the DTCC and the actual owners of these securities. Hardly anyone actually takes possession of their securities. Transfers of these securities are just accounting entries that are eventually settled by the DTCC. Byrne’s investigations were a big influence on his attraction to Bitcoin and the promise of public blockchains.
Although crypto custodians cannot actually affect the issuance schedule of a crypto asset, they can engage in behaviors that create artificial supply in the market like lending their customer’s deposits out without their knowledge or having more claims on deposits than they can actually redeem. This behavior creates a gap between expectations and reality concerning the actual supply of assets in the market. Only by taking possession can we be sure that our expectations about supply are in line with reality.
Edge Self-Custody
At Edge, we’re proud to offer a secure, easy, and private self-custody solution that helps keep the key attributes of crypto alive. Third party custody has its place, but large custodians can represent a threat to some of the very qualities that drew many to crypto-assets in the first place.
Edge doesn’t collect any personal information from our users. No name, no phone number, no ID, and no email is required to use our solution. We connect you directly to public blockchains so you can freely transact as you wish as soon as you need to.
Privacy, censorship resistance, accessibility, and access to sound money are preserved all in one application.
