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Crypto Corner: What is crypto self-custody?

In this episode of Crypto Corner, a series that dives into cryptocurrency, Yahoo Finance Producer Joseph Santangelo explores what is crypto self-custody. Featuring Casa Co-Founder and CTO Jameson Lopp, MicroStrategy Executive Chairman Michael Saylor, BitBoy Crypto Founder Ben Armstrong, Crypto YouTube Host Matt Kohrs and Yahoo Finance Senior Reporter Jennifer Schonberger.

Video Transcript

JAMESON LOPP: When you're being your own bank, you're not asking any other third party to be updating your records. You're actually updating those records yourself. This is a new paradigm. The only thing you can relate it to is hiding cash under your mattress. That is self-custody of an asset.

MATT KOHRS: Light bulb aha moment-- do not keep your crypto on exchange. Clearly, self-custody is the way to go. The person you should trust in the world of crypto is yourself.

JAMESON LOPP: When you look at the modern financial system, a very, very small amount of assets are actually self-custodied by their owners. Even when we talk about gold, people who are basically using modern financial systems, they tend to invest in gold by investing in paper gold, where the gold is in a vault held by some institution and they just have an ownership record in the accounting ledger somewhere. So with Bitcoin, one of the unique aspects of it is that we can actually do self-custody at a level that you can't really do with any other asset.

JOSEPH SANTANGELO: Maybe you can define the term "self-custody" for someone who's new to this and is just watching, never heard the term "self-custody" before.

JAMESON LOPP: This is really what I have been doing at Casa and at previous companies, is to try to make it easier for people to understand that and to be able to self-custody at what I would argue is an even greater security level than a bank. And so what is self-custody? Well, what is ownership of Bitcoin? It basically means that you have this tiny amount of secret data, which we call a private key, which allows you to unlock that Bitcoin and spend it on the network.

And so this private key becomes very important for you to safeguard, make sure it doesn't get into the wrong hands, make sure that you don't lose it, because much like if you have physical gold or physical cash and you lose it or it gets destroyed, same thing with Bitcoin. It's gone. Nobody can get it back for you.

- Wait, so you can lose your Bitcoin?

JAMESON LOPP: So we have to be a lot more careful upfront to make sure that our self-custody systems are secure and robust against any of a million different things that can go wrong. And if you look throughout history, a lot of people have lost a lot of keys to their Bitcoin.

So this takes a bit more effort upfront to get right. But my belief, my argument of why it's worth the effort and why I've been working on this problem for so long is that it gives you a level of sovereignty that you can't really have with traditional accounts. And that basically means that as long as you have your keys, you can use your funds however you want. And there is no authority that can basically block the use of your funds or tell you how to use them.

- No authority can block my funds? How do I know that's not illegal?

JAMESON LOPP: Early use cases for this, I think as most people know, were things like Silk Road, various black and gray markets.

JENNIFER SCHONBERGER: The US Justice Department sees more than $3.3 billion in stolen Bitcoin from a previously announced raid on the residence James Zhong. The Justice Department reported today that Zhong pleaded guilty Friday to wire fraud when he stole more than $50,000 in Bitcoin from the illegal Silk Road marketplace. Now, Silk Road, of course, that was an online darknet black market used by drug dealers and other unlawful vendors from 2011 to 2013 to try to distribute illegal drugs through money laundering.

JAMESON LOPP: And that's because those types of markets tend to be highly censored by various authorities. But even beyond that and into more mundane things, when you're self-custodying, you don't have to worry about custodial risk, which is something that has also been coming up a lot recently, where there are various large institutions that are holding on to people's Bitcoin and other crypto assets. And it turns out they've been doing very risky things with them and may have lost some of them or otherwise traded them very poorly. So when you're the one holding your keys, you have full control and authority over exactly how your funds are being used or not being used.

JOSEPH SANTANGELO: What are some of the risks for retail investors who choose to keep their Bitcoin on exchanges? A lot of people do choose to keep it on a Coinbase or a Cash App. What are some of those risks that come with doing that as opposed to self-custodying?

JAMESON LOPP: The total set of risks is actually a lot higher than with self-custody. And it's understandable that people tend to be leery and afraid of self-custody because it is responsibility, where if you screw up, no one can get the keys and the money back for you. However, you have to realize that when someone else is custodying your keys, they can screw up in all of the same ways. There's no guarantee that something won't go wrong.

BRIAN SOZZI: Never a dull moment in investing. Let's take a look at crypto prices here. Just moments ago, FTX filed for bankruptcy and announced that Sam Bankman-Fried, the one-time billionaire leader of this company will resign as CEO of what has been a wild, wild week for crypto.

BEN ARMSTRONG: This shell game was set up so early on that it had the back end to where Alameda could go in and borrow customer funds whenever they wanted to.

MICHAEL SAYLOR: When you have actors that use corrupt, counterfeit, stolen money in order to undermine the industry, it's not good for anybody. Nobody in their right mind should be loaning money against an air token that you manipulated yourself.

But, of course, Sam happened to be the CEO of a bank that made loans. So he applied for a loan from his own bank and he granted it to himself. And then he took real assets, like Bitcoin, from his honest customers. And then he rehypothecated them, traded them, lost them. And so this is just an egregious ethical lapse. And it can't go on.

JAMESON LOPP: Look throughout history. A number of exchanges and other large custodians have been found to be insolvent due to any number of issues, whether it be technical issues, where the keys were stolen from them, sometimes insider attack issues, where employees or even C-level executives at companies have absconded with money and then either just disappeared or died or maybe died. You never know.

From a legal perspective, I think another thing that people don't understand is they're used to having their funds in financial institutions that have some sort of insurance or other regulatory protection around. And if you actually look at the terms of service of pretty much every custodian that I'm aware of when it comes to Bitcoin is that you're actually an unsecured creditor. And there is no deposit insurance.

Some companies will tell you that they have insurance policies. But when you really dig into it, you'll find that their insurance policy covers probably less than 1% of the total amount of assets that are being held on that platform. So suffice to say if you lose your funds or if your custodian loses your funds, you're probably going to be in a very similar position as if you yourself had lost them.

JOSEPH SANTANGELO: Do you think that in order to hit some kind of inflection point of mainstream adoption of Bitcoin that there does need to be a similar amount of trust in custodians as there would be in a self-custody? Because a lot of people are used to the traditional way. If you put your money in the bank, you trust someone else to have it. Does there need to be a similar level of trust like the old way?

JAMESON LOPP: Well, I think part of the problem is that people are implicitly trusting the custodians because they're assuming that the crypto custodians are the same as securities custodians or as regular banks and other financial custodians.

JOSEPH SANTANGELO: So, OK, if I'm someone who's looking to store my Bitcoin in the safest way possible, in your opinion, what do you think is the safest way for a person to store the Bitcoin?

JAMESON LOPP: I tend to divide it up into three or four different tiers because what we're really talking about is trade-offs between security and convenience. The more security you have around something, sort of by definition the more inconvenient it needs to be to access it because you're making it inconvenient for attackers to access it. If this is an amount of value that you would be comfortable walking around with with cash in your wallet, you don't need a ton of security because it's probably not the end of the world if it gets lost or stolen or whatever.

Moving beyond that, if you're talking more about like a checking account level of money where maybe this is like a month's income or several months' income, nontrivial amount of money, that's when you probably want to start to invest in, say, buying a hardware device to keep those keys on. So this all it needs to be commensurate with how much value you're actually trying to protect.