written by Tristan Amzallag, President OnWatt Inc., Crypto Asset Specialist
Satoshi Nakamoto is reputed to have invented and released Bitcoin in an effort to prevent the catastrophe of the 2008 Great Recession from happening again. The cause of that recession was deeply rooted in the riskier and riskier bets that institutions were making with their depositors' money and when the house of cards finally came down, billions in savings were wiped out. Large financial institutions went bankrupt, and the $64 Billion Bernie Madoff Ponzi scheme was revealed to the world. It was a catastrophe only averted by the Quantitative Easing measures put in place by governments around the world; and in the US alone, these measures cost $2.1 Trillion.
“Not your keys, not your coin," an early Bitcoin community saying, is at the philosophical heart of Bitcoin. Satoshi believed that you should be given the freedom to hold onto your money and not rely on the trust of a third party. Trust is inherent in the security of the Bitcoin network, not in people.
Unfortunately that message was lost in the bull run of 2021 and many people, again, lost a lot of money to the fallacy of third party trust. By now, most people have heard about Bitcoin. It’s a controversial topic that was in news a lot during the pandemic, but few understood it and how to best use it. Bitcoin, after all, is just a tool for managing wealth.
Between 2020 and 2022, Bitcoin went from under $10,000 to $69,000 at the peak and everyone wanted to get in on the action. How could you resist? The best and easiest way to get into Bitcoin and crypto was through an onramp such as Coinbase or Kraken. A third option emerged in 2020: FTX.
FTX presented a strong case to users with an easy to use app interface, the availability of advanced trading tools, and low trading fees. They also relied heavily on marketing and self-promotion, as a safe place to onramp into the crypto world. They offered wallets for many different kinds of cryptos and were the custodians of $34 Billion in client deposits. They were partnered with or endorsed by celebrities and famous entities like MLB, NFL star Tom Brady, famed businessman Kevin O’Leary, and basketball legend Shaquille O’Neal.
Clients could link their bank accounts to the FTX platform to buy and sell cryptos with ease. Since the market was experiencing a bull run, it was profitable to hold onto that crypto rather than trade it away. Users could easily track their investment growth through the ease of the FTX app, where many of them made their initial coin purchases.
Except clients didn’t have free access to those coins. They relied on the FTX platform to access their coins. FTX was the custodian of all its wallet private keys and therefore had full access to them. As a result, FTX’s CEO Sam Bankman Fried was able to move the crypto held in their corporate wallets without the clients’ knowledge; and FTX, and her sister company Alameda Research, did exactly that. Thus far they have been found to have purchased real estate in the Bahamas worth $300 million, The Miami-Dade Arena naming rights worth $175 Million (now the FTX arena), invested in or purchased crypto tech companies such as Robinhood and Blockfolio, and contributed more than $70 million to left leaning political campaigns.
In November 2021 the crypto market reached its peak, with Bitcoin hitting $69,000, but a precipitous drop soon followed. As a result, many FTX clients rushed to liquidate their crypto before they missed the peak and of course the company didn’t have the necessary funds to support such an exodus. The fraud was revealed and once again the house of cards came crumbling down. FTX halted all withdrawals in November 2022 and soon afterwards filed for chapter 11 bankruptcy protection. The CEO, Sam Bankman-Fried, has been arrested and a new management team has been put in place. The investigation has just begun, and there is approximately $34 billion to account for. It will take some time to reveal the full extent of the theft but it is unlikely clients will see many of their funds returned to them.
FTX isn’t the first example of people losing everything to centralized failures. In 2014, a crypto exchange called Mt. Gox, based in Japan, was hacked and thousands of private keys were stolen from a centralized database. This amounted to a theft of 600,000+ Bitcoin worth millions of dollars at the time; and worth billions today.
In 2018, Canadian exchange QuadrigaCX’s CEO Gerald Cotton died unexpectedly from Crohn’s disease. It was revealed shortly after that he was the only one who knew the password to his encrypted computer which held the private keys to the company’s wallets, and to the clients’ deposits. $215 million in crypto was locked away in a centralized computer and no one could access it at the time of his death. This story is marred in conspiracy, however, as Gerald Cotton lost $115 million in client assets on bad trading strategies and people have speculated that he faked his own death.
Even the largest exchanges with the highest levels of security are vulnerable. In October 2022, Binance, the world’s largest crypto exchange, suffered a hack and lost $570 million in crypto assets. Fortunately these weren’t client deposits, but still cost the company a lot of money and revealed vulnerabilities in their system.
Bitcoin is built on trust in the algorithmic consensus of the network, not trust in people or central entities. It allows its users the freedom to choose how they protect their wealth; and there are many different ways to do it today. Since all you need is the private key to retrieve your coins, which is represented as an alpha numeric string, you can store that key practically anywhere.
Originally the way to store your coin was with the Bitcoin Core wallet. This wallet is downloadable to any computer and is easy to use but has a major drawback— it doubles as a network node. This means that you have to download the entire blockchain along with the wallet in order to access your coins. The blockchain is currently 455GB and never stops growing. Many people still use the software today as Network nodes, but it isn’t used as a wallet much anymore.
Another way to store your Bitcoin is on paper. Since all you need is your private key, you can simply print it! If you want to see what that looks like, you can make yourself a paper wallet at bitaddress.org. Additionally, there are services that will engrave your private keys onto titanium for you. In order to send that Bitcoin, however, you’ll need to “sweep” your private key into an internet connected wallet such as Bitcoin Core.
In 2011 Mike Caldwell created Casascius Coins. These coins are about 30mm in diameter and 3mm thick and are minted in brass, silver, and gold. The front of each coin is stamped with a unique Bitcoin address, and the back is stamped with a hologram that shows a tamper-proof design. He also funded these coins with various amounts of Bitcoin. The Brass coins have 0.1btc and 1btc amounts on them. Silver coins have 10btc and he even minted and funded a 1 troy ounce gold coin with 1000btc on it, worth $23,000,000 today! The irony of these coins is that we went from metal coins, to digital money and back to metal coins again.
These analog storage methods are great for coins that you want to keep for longer term investment. They are known as cold wallets and their main advantage is that they can’t be hacked by some group online. They are completely disconnected from the internet and the bitcoin just resides there, untouchable.
A hot wallet, by contrast, is one that maintains an active connection to the Bitcoin Network. Bitcoin Core is one such wallet, but over the last 10 years modern alternatives have appeared. Exodus is both a desktop and mobile app wallet that allows you to store many types of crypto and gives you access to your private keys. Trust Wallet is another example of a hot wallet app with private key access. These modern standalone wallets even have a mnemonic phrase feature. With just 2 dozen words in a specific order you can gain access to all your crypto stored in the wallet. This means if you need to delete the app, or your phone is destroyed, all you need is the seed phrase to restore all your crypto.
Lastly, I want to mention hardware wallets. These are similar to USB drives but with some additional software installed that allows the owner to use mnemonic phrases for recovery as well as interfacing with blockchains to allow users to send and receive their coin. These are good methods of storage because they can act as both a cold and hot wallet. Cold when you keep it in your safe, hot when you plug it into a computer connected to the internet. The Ledger Nano and Trezor Model T are the industry leaders in hardware wallets.
As you can see, there are many ways to maintain custody of your own crypto and it may seem tempting to leave coins on an exchange where you bought them for good reasons: firstly, you don’t pay the transfer fee to send them to a private wallet, and secondly, it gives you access to a market for liquidation when Bitcoin spikes. History has shown, however, that there is risk in trusting centralized systems that “hold” your crypto as a convenience. Central exchanges should be used for what they are good for— a medium of exchange, not storage. Users should get comfortable with moving coin to and from these exchanges when they want to trade it; and as for the fees incurred, consider it insurance for the safety of your wealth.
Remember, reader: not your keys, not your coin.