When I first acquired bitcoin, I actually had it sent right to a wallet I control. I bought it from a person I met online at a coffee shop in my neighbourhood. This is different from most people who’ve acquired bitcoin in the last 5 years. Right now, the most common way of obtaining bitcoin is through an exchange. Due to obvious security concerns, it is best practice to not keep 100% of your funds on an exchange.
This is one example of the “Don’t keep all of your eggs in one basket” principle. Taking your money off an exchange isn’t always that straightforward. Many coins have their own unique wallet that require a knowledge of how that particular cryptocurrency works. You are making tradeoffs when keeping money on an exchange vs. a wallet that you control. It is best to be aware of what those tradeoffs are, so that you can better balance where your assets are stored.
Non-Custodial Wallets
Non-Custodial wallets allow you to truly own the asset, as you are the only person on the planet with the key to unlock them. Learning about non-custodial wallets really opened my eyes to the nature of ownership in today’s world. We have been conditioned to believe that we own the money in our bank, and our data that sits on the servers at Facebook. Unless we control what is known as “a private key” for our money, data, or identity, we don’t have full ownership over it.
This is fine in and of itself, but it is best if you are given the discretion to decide which things you’d like to completely own. For me, bitcoin best allows me to own my money in a more direct way than anything else. For this reason I choose to hold a good portion of my total holdings in a variety of non-custodial ways.
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Benefits
100% Ownership. I personally enjoy the feeling of knowing that I have 100% ownership over something that other people value, that no one can take away from me. To me, this is one of the core value propositions of bitcoin, and of money itself. What good is money if my bank account can be seized or taxed at the discretion of a third party? What good is my money if I cannot transfer it to who I want, when I want? Bitcoin is my hedge against the unknown.
Rewards. When you’re using a particular cryptocurrency’s non-custodial wallet, and that coin is a “PoS coin” (Proof of Stake coin), then you can likely stake it on the wallet to earn yourself some rewards. So that would be Cardano, Crypto.org, Ethereum, Polkadot and many others. I recommend checking out our latest podcast where we talk in depth about staking and rewards.
Tradeoffs
You must remember your key. If you forget, lose, or otherwise destroy access to your funds, then you’ve lost them forever. There is no one on this planet that can help you recover them. The possibility of this is brought to nearly 0 by following some very simple rules about key management.
I managed to lose a little bit of bitcoin early on in my research (2014/2015) after getting some from a faucet. I had no idea what I was doing, or how much that bitcoin would later be worth. I later wiped my hard drive and will never be able to retrieve that bitcoin. I wasn’t even aware at the time that I needed to secure my wallet, by remembering my key. This is what led me to learn more about the importance of key management.
Mistakes are Permanent. There is no 1-800 number if you make a mistake while sending cryptocurrency from one wallet to another. Double/triple/quadruple check address destinations and amounts. Sometimes, if you’re sending to an exchange, they can recover your funds. Read about how I did that to myself once with ATOM.
Exchange Wallet (Custodial)
Exchange wallets are known as custodial wallets. There are now many different types of cryptocurrency apps and services that do not give you access to your keys. Not your keys, not your crypto. Anything dealing with cryptocurrencies that does not give you your keys is custodial! There are really fantastic custodial cryptocurrency companies such as Kraken, Binance, and Crypto.com. Then there are totally bogus companies that are not worth mentioning.
The problem with custodianship in the crypto space, is that it has been abused ferociously to take peoples funds. You have to know which services to trust, and which to stay away from.
I use exchanges all the time, but with a smaller chunk of my overall portfolio. I use 2 exchanges on a regular basis, with 3 more on backup depending on what I need to do. I am typically using exchanges to participate in one of their many offerings (such as syndicate, supercharger, or launchpad). The point is, when using exchanges, don’t rely on just one.
Why Use More than One Exchange?
During periods of high trading volume, like in the middle of April 2021, several exchanges went down, or were slow to respond. Crypto.com is my favourite place to buy bitcoin, but I was unable to log into their account in a timely manner during one of these periods of market excitement.
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Benefits
Faster. Cheaper. Diverse Options. You can do more, faster, for less by using custodians. Just take Crypto.com for example. All in one place you can get “safe” storage, lending, borrowing, trading, staking, contests, and supercharger. Most of these things are free for you to do, and will even make you money. If you were to set up similar services on a non-custodial wallets, they will inevitably be more complex to set up, and cost you more time and money.
Tradeoffs
Hacks. Scams. There are two really bad things that can happen when using an exchange. The exchange gets hacked or the exchange is a scam. In either case, you could be looking at a total loss of your funds. This is not as infrequent as you might think. Mt. Gox is the first notable case, with the other being QuadrigaCX. In both cases, victims of the attack have still not been reimbursed years later.
I did have this happen to me on a smaller scale. I invested in a cloud mining company that gave me hash power in exchange for bitcoin. Everyday I would get paid a ridiculous ROI. One day they shut the website off and the payments stopped coming. I had invested in a ponzi scheme without realizing it… Once you know how to spot them though, you’ll never make the same mistake again.
Accessibility. This might seem counterintuitive, but have quick and easy access to your funds might actually be a curse, rather than a blessing. I have been a victim to panic selling in the past. It makes a big difference to have to send your money to an exchange, before selling. If your funds are already on an exchange, then there is one less thing stopping you from making an irrational, impulsive decision in a time of volatility.
A Balance of Both
There are some that advocate for a staunch non-custodial approach with your assets. Others are happy to promote the many ways you can use your money on exchanges like Binance and Crypto.com. There is a happy medium in between, and that’s usually where I like to sit with things. Not 50/50. But whatever is right for you depending on how the tradeoffs play into your financial goals. If passive income is important for you, then you’re naturally going to have a different allocation than someone who is prioritizing security.
For example, my plan to achieve a balance is to establish long term security, practicality, and continuous uninterrupted growth. For this reason I have prioritized the following.
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Know what is possible, craft your own plan, then stick to it.
Regards,
Keegan