Why non-custodial crypto wallets matter to investors focused on risk management and control
While crypto markets have evolved significantly since their early days, one fundamental aspect has remained the same. The problem of custody.
Price volatility gets all the attention, but control over how your assets operate is what really matters when you talk about your real risk exposure.
Non-custodial wallets solve this problem by giving users control back from third-party providers. Users don’t rely on someone else to give them access to their own money. For investors, this isn’t a philosophical debate. It’s a very practical one that will affect how risk is distributed.
Custody risk as a layer of risk above and beyond market risk
Investors can make good decisions about the market, and still lose money due to a lack of access to their assets. Lack of access could be due to restrictions on withdrawals, delays in accessing assets, or compromise of access to assets through third-party providers.
Any failure in the infrastructure relied upon by custodial solutions can cause loss of access to funds – regardless of market conditions.
Non-custodial wallets eliminate dependence on outside infrastructure. Users retain control over their own private keys or recovery data. This means users don’t rely on the centralized accounts of third-party providers, but it also means there aren’t fallback options available (such as password reset or account recovery via customer service).
The benefit of control and associated responsibilities
The biggest advantage of using a non-custodial wallet for storing cryptocurrency is clear. The user retains direct control over access credentials. Users do not require permission from a third-party provider to execute transactions. Assets are available based solely on the user’s actions, not based on some external process.
However, this structure creates a new, direct responsibility. Security is now something that needs to be managed by the user. The user must store recovery phrases safely; maintain the security/availability/integrity of devices used to interact with the wallet; and avoid exposing themselves to environments known to be compromised.
One example of this type of model is found with tools such as jaxx-liberty.io. These tools are built using a non-custodial model for local key management and access to recovery phrases. Although this structure is nothing out of the ordinary, it does illustrate how control is transferred in this type of model.
Operational discipline determines success
It is often assumed that non-custodial systems are safer simply because they represent a different form of organization. However, this belief is misguided. Systems are only as safe as the practices being applied around those systems.
Most failures within self-custody systems are not failures related to technology. Most failures occur due to procedures that were poorly followed. Loss of recovery phrases, poor or missing backups, and/or devices being compromised are the leading causes of inability to gain access to funds. Unlike custodial systems, these errors cannot be resolved through support structures.
Therefore, the focus is shifted from technology to behaviors. Investors must apply the same degree of care to their access credentials as they would to any financial instrument. Methods for storing access credentials; backup strategies; and routine patterns for gaining access must be established prior to attempting to utilize a self-custody model.
Usability and scope influence risks
Another area of consideration is usability. How easily will a wallet be able to be utilized long-term? A system that is complicated will likely lead to errors during transactions or attempts to recover assets.
Non-custodial wallets vary greatly in terms of complexity. Some are designed for simple storage and transfers, while others offer advanced features such as tracking portfolios or trading assets. The best option will depend upon the intended use.
For example, investors managing small sets of assets may find that less complex systems help minimize operational difficulties. More complex investment strategies may demand more feature-rich systems.
Regardless of which type of system an investor chooses, a large difference exists between the capabilities offered by each system and the requirements placed upon the user. This mismatch between tool and usage provides an opportunity for error and therefore avoidable risks.
Why non-custodial models persist
Although custodial models for managing digital assets are becoming increasingly popular, non-custodial wallets continue to provide a valuable service. They allow owners to link ownership directly with control over those assets. This is especially useful in situations where counterparty risk presents an ongoing challenge.
The trade-off for utilizing a non-custodial model is always consistent. The greater ability users possess in controlling their own assets (and thus reducing reliance on third-parties), results in a commensurate increase in liability among users themselves.
There is no middle ground between utilizing third-party resources for asset management versus doing everything oneself. Both approaches move risk from one place to another.
For investors concerned with control and risk management, this dichotomy continues to be central. Non-custodial wallets are not a default choice for asset protection — instead they are a deliberately chosen method of structuring ownership and management of assets.