Not Your Keys, Not Your Coins?

What a week.

The crypto industry is in total panic.

Trust in centralised exchanges is at an all-time low. Centralised exchanges are seeing a huge outflow of capital. Some to other exchanges. Others to non-custodial wallets.

Many see the FTX collapse as proof that the only secure way to hold funds is to hold the keys yourself. But reality is far more complicated.

Advocates of people holding their own keys don't seem to realise how dangerous it is for one to hold their own funds. An estimated four million bitcoin are lost forever. That's roughly $80b!

In the NFT space over $100m of assets have been stolen from users' self-custodial wallets. And that's a low estimate.

Risks of holding your own keys

Despite it being popular to yell "Not your keys, not your coins" each time an exchange goes down, there are real risks to holding your own keys.

Two of the main risks are theft and account recovery.

Theft can happen in many ways. Someone might steal your unlocked device, steal your private key, or have you sign a malicious transaction.

If you're unable to recover your account you will also lose money. An estimated 20% of all Bitcoin has been lost this way forever. If someone passes away they may not have inheritance procedures set up. If a flood or fire happens destroying the wallet device and seed phrase the funds are also lost.

The challenge is that anything you do to make account recovery easier will make your account less secure. If you've written down your seed phrase someone can now steal it. They can now "recover" the account and drain it. If you've given your seed phrase to your partner, they may steal your funds. If you've stored your seed phrase on the cloud, anyone with access can now steal it.

There are some complicated mechanisms people use to get around these issues but I hope it's clear there are some real risks to holding your funds in non-custodial wallets.

There are workarounds that might work for you but they likely don't work for your parents or your friend who is buying crypto for the first time. For mass adoption hacky workarounds won’t cut it.

The UX of holding your own keys is horrendous. The average person does not want to be responsible for the security of their own bank account.

All these risks apply whether you have a browser wallet like MetaMask, a mobile wallet like Rainbow, or a hardware wallet from Ledger or Trezor.

If you're a trader then a non-custodial wallet can also be a huge headache. There are decentralised exchanges to trade on but the experience is better on centralised alternatives.

MPC to the rescue?

Multi-party computation, or MPC, is used by companies like Fireblocks for large institutions, and ZenGo for regular people.

MPC allows multiple parties to control your wallet. Each party holds what is known as a secret share. Multiple parties must approve a transaction for it to go through. No single party has control of the funds.

For example, when using ZenGo, their servers and your phone must approve a transaction for it to go through.

If ZenGo's servers are hacked the hacker cannot drain your wallet. And if your recovery file is stolen that isn’t enough to drain it either. The hacker needs access to the secret shares of both parties to gain access.

The advantage of ZenGo over a centralised exchange is that the CEX has full control of your funds, while ZenGo cannot move your funds without your approval.

The advantage of ZenGo over self-custody is that if your ZenGo recovery file is stolen, this isn't enough to move your funds either. ZenGo must still agree for the transaction to happen. And they will only do this if you've proven who you say you are by logging in via email and biometric scan (what they call 3FA). You can also add emails and biometric scans of family members to your account for recovery.

In short, ZenGo helps with the security and recovery of your account while keeping you in full control of your assets.

Of course there are trade-offs to every solution. There are levels of trust involved with any service you use. Whether it's trusting Coinbase, Ledger or ZenGo, you need to be sure the company is doing what they say they do. If Ledger kept a copy of your private key you'd be in trouble too. But hopefully the benefits of MPC are clear.

Despite the benefits of using a wallet like ZenGo, it’s still a mobile wallet. I wouldn’t recommend walking around with $50k or $1m in your pocket. A wallet like ZenGo in combination with other wallets can work great though.

There might be other MPC wallets out there worth a look but ZenGo is the only one I’ve used which is why I use it as the main example in this section.

What about multisig wallets?

Multisig (multi-signature) wallets such as Gnosis Safe are another way to hold your assets. The basic idea is that multiple owners control the wallet.

For example, the wallet can have three owners and every transaction needs at least two wallets to approve.

Multisigs can be used by both teams and individuals.

As a team of three people, each of the three people can hold be a key.

Or as an individual, you could have a Ledger, MetaMask and ZenGo wallet, be the owners of the multisig wallet.

What's nice about multisig wallets is you can add additional rules too. On Ethereum a multisig wallet is a smart contract. This means any rules can be coded in.

One helpful rule is Spending Limits. They allow any of the owners to make small transactions while still requiring multiple approvals for large transactions.

For example, you could give each owner an allowance of 3 ETH to spend per week. But if anyone wants to remove 100 ETH from the wallet they'd need multiple signature approvals first.

This removes the hassle of multiple signatures signing for small transactions but still protects the wallet from unauthorised larger withdrawals.

Spending limits are also a way to handle inheritance in the event of an individual passing away. The individual can set up the wallet so that their partner is able to withdraw a limited amount per week. For example, a Gnosis Safe with 500 ETH, could allow 10 ETH to be withdrawn per week without multiple signatures. Over the course of a year the inheritor will be able to claim all the funds.

This obviously isn't ideal but it means that the funds aren't lost and the person you've given access to these spending limits is only able to drain 2% of the wallet at any time. If they start spending without your approval you can remove their access to the funds.

Multisig wallets are a great step in the right direction. Any solution that splits control into multiple pieces has advantages to a solution with a single point of failure.

But multisig wallets are still a pain for most people to use. We won't reach mass adoption of crypto this way either. It's not easy to make a transaction using a multisig wallet as you need multiple approvals.

For more sophisticated users holding larger sums I highly recommend taking a look at Gnosis Safe. If you want to play around with it first before taking the leap they have a Goerli testnet site.

What does the future of crypto look like?

The future of crypto is a mix of all the above. Despite the risks of holding money on CEXs, for many it's riskier to hold the funds themselves.

MPC wallets will play a big part in the future of crypto. And all wallets need to have an extreme focus on user friendliness and security.

It's dangerous to hold large funds in mobile or browser wallets but for smaller sums these wallets work fine.

So where should you hold your funds?

It depends.

It depends how technical you are.

It depends how much money you have.

It depends how quickly you need access to your funds.

For many splitting the funds into multiple places will make the most sense. For example, you might have $2k on MetaMask, $3k on ZenGo, $50k on Coinbase, and $100k in a Gnosis Safe.

There are risks involved for each solution. None of the above should be taken as financial advice.

It's still far too easy to lose funds and this might be the greatest barrier to mass crypto adoption.

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Additional Resources

The cover photo was generated by Night Cafe using the prompt “not your keys not your coins”:

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