TLDR; Self-custody wallets

I grew up in an English-speaking community and there are certain associations (or prejudices) one makes when they hear certain words. Custody, for example, transports my mind to a court room in which recently divorced parents are vying for who retains custody over the children.

Similarly, in finance, there is a notion of custodial accounts, which Investopedia describes as “… a savings account set up and administered by an adult for a minor.” When the minor is old enough, depending on local laws, they can take control of the account.

But, once a child becomes an adult do they really have custody of their funds?

I don’t think so.

In the past, life savings and wages would be stashed at home for safe keeping. This was important in the early days of America because banks were opening and closing frequently. But keeping money under the mattress had its own risks too. Eventually, as faith grew in the banking industry, citizens grew more comfortable depositing their life savings and investments with financial institutions. They gave up custody in return for perceived security.

Other benefits of centralized custody? In many industrialized nations, a central bank insures losses up to a certain amount if your bank becomes insolvent. Insolvency periodically happens, and can happen for a variety of reasons, but suffice it to say this insurance reduces concerns that citizens may have about putting their life savings in banks. There are other intangible benefits too, like being protected by the “full faith and credit” of the U.S. Treasury.

All of this ignores an important primitive though – your savings account is custodied at a financial institution that may take actions without your permission. That means a number of things to various people:

1. A bank may grant loans in excess of their holdings, which is called fractional reserve banking. Prior to 2020, banks were required to keep at least 10% of deposits on hand as reserves. That means for every $100 you deposit, $1000 in loans are allowed to be issued according to the Federal Reserve Act. This effectively creates new money, or debt, in the system.

   In March of 2020, the Board of Governors of the Federal Reserve System announced that reserve requirement ratios would be 0%. In their own words, “This action eliminates reserve requirements for thousands of depository institutions and will help to support lending to households and businesses.” Instead, the Fed will now pay the banks interest to incentivize their holding of fractional reserves.

2. If you have broken laws or are considered a criminal by the Department of Justice, asset forfeiture is a tool that agencies can use. Based on probable cause, the government can compel custodians to freeze or seize your assets if they are suspected of being earned illegally. It may seem obvious that this only pertains to criminals, but in countries with shaky rules of law, asset forfeiture is a serious concern. If you don’t hold it, you don’t own it.

3. Domestic debt defaults by governments can directly impact access to custodied savings accounts. In Cyprus in 2013, for example, the banking sector was nationalized in order to save it from collapse. Unfortunately, that meant freezing accounts holding over $130,000 to help pay off the banking sectors debts with a 10% “bank tax”. [Reuters] This led to a panicked bank run by customers to withdraw their cash into self-custody (aka: under their mattresses).

Keeping money in banks is not without inherent risks.

Here is a list of countries that have experienced financial crises and debt restructuring events just in the last 10 years: [”List of sovereign debt crises” on wikipedia]

2022: Ghana, Sri Lanka, Russia

2020: Zambia, Lebanon, Argentina, Ecuador

2018: Barbados

2017: Venezuela

2015: Greece

2014: Argentina

2012: Greece

Readers in G7 countries might be thinking, phew, this isn’t happening in my country… but that’s not entirely true. Insolvencies and bank runs happen in these countries as well, albeit with muffled impact.

In 2008-2009, over 160 banks in the US failed due in large part to a mountain of irresponsible mortgages that were made in the years prior. Although deposit accounts were protected in the USA by the federal government, banks that were exposed to high-risk mortgage products were putting their depositors in jeopardy. The lack of risk control was negligent.

This happened more recently in the crypto markets with FTX and Alameda in 2022. Through fraud and self-dealing with its partner hedge fund, Alameda Research, this centralized custodian made reckless decisions with depositor funds.

This brings us to the main point – how much of your personal wealth is stored outside of your control? Who has the most control over your investment portfolio? If you needed to empty your bank account tomorrow, could you?

Centralized financial (CeFi) operators are a black box for depositor money depending on what the regulations allow. Celsius, Voyager, Blockfi, Gemini and others demonstrated in 2022 that crypto customers must take these risks even more seriously. That is why a modern diversification strategy must include self-custody.

Self-custody allows you to have the most control and responsibility over your assets. Only you can decide how the funds will be managed, leveraged, spent, staked, etc. If you want to send money to family across the world without paying an intermediary bank fee, just send a payment over the public blockchain network.

Decentralized financial (Defi) applications now provide many of the same functions brokerages provide but you can make transactions at any time, night or day. There’s no waiting until the next business day to process a trade, convert currency, or lend/borrow money. Defi is already enabling people to become their own bank.

Not only is self-custody a good form of diversification, but you’ll also need an approach to wallet security. Recently Kevin Rose’s self-custody wallet was hacked and he lost dozens of valuable NFTs from his self-custodied wallet. As part of his own learning, he tweeted about his new system of using multiple wallets addresses.

“GM 🌅. I've had a few questions about my updated approach to wallet security; for those curious, here is my new system: (feedback welcome)”

— KΞVIN R◎SE (🪹,🦉) (@kevinrose) February 1, 2023

Consider using at least 3 types of wallet: hot, social, and cold.

• Hot wallets are “throwaway” wallets where you do most financial transactions. They connect to more applications and allow more smart contract access than the others. Don’t keep valuable items here.

• Social wallets are where you interact with others in web3, keep inexpensive items, and limit financial activity. After all, wallet activity is pseudo-anonymous but public.

• Cold wallets provide vault-like protection. Keep the crown jewels here. Don’t connect this wallet to any applications or contracts if you can avoid it.

A diversified wallet strategy should be part of every investor’s plan. While this isn’t investment advice, making intentional decisions about who controls your assets is highly recommended.

<<Interested in learning more about DeFi and self-custody wallets?>>

Try the Intro to Defi lesson on Bankless Academy: https://app.banklessacademy.com/lessons/intro-to-defi

Benjiming is an advisor to Bankless Academy and can be reached on Twitter @BenjimingDefi and GM.xyz @Benjiming.

TLDR; Self-custody wallets

I grew up in an English-speaking community and there are certain associations (or prejudices) one makes when they hear certain words. Custody, for example, transports my mind to a court room in which recently divorced parents are vying for who retains custody over the children.

Similarly, in finance, there is a notion of custodial accounts, which Investopedia describes as “… a savings account set up and administered by an adult for a minor.” When the minor is old enough, depending on local laws, they can take control of the account.

But, once a child becomes an adult do they really have custody of their funds?

I don’t think so.

In the past, life savings and wages would be stashed at home for safe keeping. This was important in the early days of America because banks were opening and closing frequently. But keeping money under the mattress had its own risks too. Eventually, as faith grew in the banking industry, citizens grew more comfortable depositing their life savings and investments with financial institutions. They gave up custody in return for perceived security.

Other benefits of centralized custody? In many industrialized nations, a central bank insures losses up to a certain amount if your bank becomes insolvent. Insolvency periodically happens, and can happen for a variety of reasons, but suffice it to say this insurance reduces concerns that citizens may have about putting their life savings in banks. There are other intangible benefits too, like being protected by the “full faith and credit” of the U.S. Treasury.

All of this ignores an important primitive though – your savings account is custodied at a financial institution that may take actions without your permission. That means a number of things to various people:

1. A bank may grant loans in excess of their holdings, which is called fractional reserve banking. Prior to 2020, banks were required to keep at least 10% of deposits on hand as reserves. That means for every $100 you deposit, $1000 in loans are allowed to be issued according to the Federal Reserve Act. This effectively creates new money, or debt, in the system.

   In March of 2020, the Board of Governors of the Federal Reserve System announced that reserve requirement ratios would be 0%. In their own words, “This action eliminates reserve requirements for thousands of depository institutions and will help to support lending to households and businesses.” Instead, the Fed will now pay the banks interest to incentivize their holding of fractional reserves.

2. If you have broken laws or are considered a criminal by the Department of Justice, asset forfeiture is a tool that agencies can use. Based on probable cause, the government can compel custodians to freeze or seize your assets if they are suspected of being earned illegally. It may seem obvious that this only pertains to criminals, but in countries with shaky rules of law, asset forfeiture is a serious concern. If you don’t hold it, you don’t own it.

3. Domestic debt defaults by governments can directly impact access to custodied savings accounts. In Cyprus in 2013, for example, the banking sector was nationalized in order to save it from collapse. Unfortunately, that meant freezing accounts holding over $130,000 to help pay off the banking sectors debts with a 10% “bank tax”. [Reuters] This led to a panicked bank run by customers to withdraw their cash into self-custody (aka: under their mattresses).

Keeping money in banks is not without inherent risks.

Here is a list of countries that have experienced financial crises and debt restructuring events just in the last 10 years: [”List of sovereign debt crises” on wikipedia]

2022: Ghana, Sri Lanka, Russia

2020: Zambia, Lebanon, Argentina, Ecuador

2018: Barbados

2017: Venezuela

2015: Greece

2014: Argentina

2012: Greece

Readers in G7 countries might be thinking, phew, this isn’t happening in my country… but that’s not entirely true. Insolvencies and bank runs happen in these countries as well, albeit with muffled impact.

In 2008-2009, over 160 banks in the US failed due in large part to a mountain of irresponsible mortgages that were made in the years prior. Although deposit accounts were protected in the USA by the federal government, banks that were exposed to high-risk mortgage products were putting their depositors in jeopardy. The lack of risk control was negligent.

This happened more recently in the crypto markets with FTX and Alameda in 2022. Through fraud and self-dealing with its partner hedge fund, Alameda Research, this centralized custodian made reckless decisions with depositor funds.

This brings us to the main point – how much of your personal wealth is stored outside of your control? Who has the most control over your investment portfolio? If you needed to empty your bank account tomorrow, could you?

Centralized financial (CeFi) operators are a black box for depositor money depending on what the regulations allow. Celsius, Voyager, Blockfi, Gemini and others demonstrated in 2022 that crypto customers must take these risks even more seriously. That is why a modern diversification strategy must include self-custody.

Self-custody allows you to have the most control and responsibility over your assets. Only you can decide how the funds will be managed, leveraged, spent, staked, etc. If you want to send money to family across the world without paying an intermediary bank fee, just send a payment over the public blockchain network.

Decentralized financial (Defi) applications now provide many of the same functions brokerages provide but you can make transactions at any time, night or day. There’s no waiting until the next business day to process a trade, convert currency, or lend/borrow money. Defi is already enabling people to become their own bank.

Not only is self-custody a good form of diversification, but you’ll also need an approach to wallet security. Recently Kevin Rose’s self-custody wallet was hacked and he lost dozens of valuable NFTs from his self-custodied wallet. As part of his own learning, he tweeted about his new system of using multiple wallets addresses.

“GM 🌅. I've had a few questions about my updated approach to wallet security; for those curious, here is my new system: (feedback welcome)”

— KΞVIN R◎SE (🪹,🦉) (@kevinrose) February 1, 2023

Consider using at least 3 types of wallet: hot, social, and cold.

• Hot wallets are “throwaway” wallets where you do most financial transactions. They connect to more applications and allow more smart contract access than the others. Don’t keep valuable items here.

• Social wallets are where you interact with others in web3, keep inexpensive items, and limit financial activity. After all, wallet activity is pseudo-anonymous but public.

• Cold wallets provide vault-like protection. Keep the crown jewels here. Don’t connect this wallet to any applications or contracts if you can avoid it.

A diversified wallet strategy should be part of every investor’s plan. While this isn’t investment advice, making intentional decisions about who controls your assets is highly recommended.

<<Interested in learning more about DeFi and self-custody wallets?>>

Try the Intro to Defi lesson on Bankless Academy: https://app.banklessacademy.com/lessons/intro-to-defi

Benjiming is an advisor to Bankless Academy and can be reached on Twitter @BenjimingDefi and GM.xyz @Benjiming.