The most significant choice an investor interested in digital assets must make may be whether to purchase cryptocurrencies as a long-term holding, but the most important choice may be where to keep cryptocurrency like bitcoin.
After California’s wildfires earlier this year, social media posts claiming bitcoin losses started to surface. Some users described the difficulty of recovering crypto keys from a safety deposit box in a bank affected by the fires, or they showed metal plates meant to protect seed phrases that were burned up and unreadable. Although it is impossible to confirm specific reports of fires destroying hard drives, laptops, and other storage devices that contain seed phrases and crypto wallets for so-called hard and cold storage, it is undeniable that bitcoin self-custody poses a distinct set of security risks. Moreover, such dangers are increasing.
Cryptocurrency holders usually utilize some sort of “wallet,” which has two primary features: whether or not it is integrated with the internet, and the degree of control it has over trades and transfers. The question of whether a cryptocurrency investor retains complete custody and trading control over their assets or if they use a third party for custody at all is another fundamental concern.
Think of a Coinbase or Blockchain.com service as an example of a typical third-party platform “hot wallet” that is always online. Cold storage and “cold wallets,” on the other hand, include hardware (such as a USB stick) that stores private keys offline or even just a seed phrase (a master recovery code, which is a set of 12 to 24 words necessary to regain access to a crypto wallet) on paper or metal. Crypto can be accessed via hardware wallets or offline seed phrase backups when a device is linked to the internet.
When it comes to third-party custodial solutions, owners should take precautions like using two-factor authentication and creating strong passwords to assist them stay alert against the threat posed by fraudsters who can access an internet-connected platform. The Department of Justice’s U.S. Marshals Service, which handles asset forfeiture from U.S. law enforcement, uses Coinbase Prime to hold its seized digital assets.
Many cryptocurrency bulls want to keep digital assets like bitcoin in their own custody for the same reasons they are first drawn to cryptocurrencies: a lack of trust in certain institutional oversight mechanisms. The ease of custodial wallets from cryptocurrency brokers is exchanged for the possibility of fraud, exchange shutdowns, or hacking, as was the case with FTX’s well-publicized collapse. Furthermore, a recent series of worldwide occurrences, such the wildfires, generate additional concerns regarding changes in the crypto custody discussion. Due to the ongoing Middle East turmoil and the Russia-Ukraine war, foreign crypto bulls have had to reconsider how they handle self-custody.
“Physical risks in the world, such as a natural disaster, are an opportunity to revisit how bitcoin security works and the common security lapses folded into most people’s practices,” said Nick Neuman, co-founder and CEO of self-custody business Casa. The majority of users use a single private key to secure their bitcoin. That key is a single point of failure if it is stored on a single device or is written down as a seed phrase on paper. “Your bitcoin is gone if you misplace that key,” he stated.
It should be clear that the least amount of fire protection is provided by keeping seed phrases on paper, although this is a typical practice, according to Neuman. A little protection can be obtained by slipping these pieces of paper into safes or fireproof bags, but not much, and even taking the extreme precaution of placing the seed words on “indestructible” metal storage plates creates some chances of failure. Firstly, they might not be as indestructible as they seem, and secondly, they might be hard to find among the debris.
Based on the stories being shared on X and the location of the flames in California, it makes sense that bitcoin was probably lost, according to Neuman. “There are some that are quite convincing,” he remarked.
Multi-signature configurations are provided by certain self-custody systems, such as Casa, which lower the possibility of single-point failure. A multi-key crypto “vault” may have several hardware keys, mobile phone keys, and a recovery key that is kept on behalf of an owner by a business such as Casa.
With the multi-sig custody technique, a trusted partner can hold a minority of the keys while the owner can keep the majority. According to Swan Bitcoin managing director John Haar, in such a scenario, the owner would have to simultaneously lose all copies of the seed phrases and all physical devices. Bitcoin can be recovered by the owner as long as they have access to at least one device or one seed phrase. In the event of a natural disaster, for example, this strategy should greatly reduce the likelihood that all of the devices will be lost, according to Haar.
Regarding Casa’s five-key method, Neuman stated that you can distribute these keys around different areas or even nations and that you require any three of the five keys to authorize a bitcoin transaction.
Best standards that we use to other aspects of our personal lives should also be applied to cryptocurrencies, according to Jordan Baltazor, chief administrative officer at regulated crypto custodian Fortress Trust. First, risk assessment and storage strategy diversity. He claims that digital assets are no different when it comes to cloud backups of private and sensitive information to prevent loss or corruption.
Businesses like Coinbase and Jack Dorsey’s Block provide products that attempt to combine some of these concepts, producing a more secure yet user-friendly cryptocurrency wallet. Before a user can access their cryptocurrency assets for trading, they must first go through the Coinbase Vault, which has additional security measures. Coinbase Wallet and Block’s Bitkey are mobile apps that function similarly to a standard wallet, making it simple to move bitcoin around. However, they also have the capability to pair with hardware wallets and offer additional security that is typically associated with cold storage.
To increase security, bitkey hardware necessitates several authorizations for transactions, much as “multi-sig wallets.” Additionally, Bitkey provides recovery methods to mitigate the risk of losing codes or phrases required to retrieve a cold wallet, which is one of the largest risks associated with self-custody.
Solutions like Dorsey’s could assist resolve the conflict between security and convenience; at the very least, they highlight the existence of this conflict and the likelihood that it will act as a barrier to the wider adoption of cryptocurrencies. Aside from the dangers posed by wars, wildfires, and other natural calamities, the largest human risk facing bitcoin self-custody is the untimely death of the bitcoin owner. Unlocking the crypto chain of custody is arguably no more complicated than inheritance.
Before releasing funds from custody, Coinbase requires certain will designations and probate court paperwork. Physical wallets provide little to no assistance, which might leave all of that digital value locked on a private key. The Bitkey executive described the company’s inheritance solution as “kind of a multibillion-dollar problem waiting to happen.” The solution was released in February.
According to Neuman, everyone with a significant bitcoin investment needs to reconsider how they safeguard their money. “The industry does see more cryptocurrency holders taking action to move to more secure storage setups after disasters like the California wildfires or when exchanges go bust like FTX.” “I suppose it’s human nature to wait until ‘bad things happen’ before taking action to improve your own personal situation,” he observed. But he believes that if people were more proactive, they would do better. “If they don’t, they run the risk of experiencing that ‘bad thing’ then it’s too late,” he stated.
