Token Advice

At 401 Financial, we’re fully aware that the world of crypto can be complex. We’ve been navigating the space for many years now and have had the opportunity to develop a thorough understanding of the technology, the assets, and the terms that make up this budding ecosystem. As we begin our Onchain Series, our goal is to pass some of that knowledge on to you to help you navigate this new “onchain” world. A world that we believe will be incredibly important in the future. In case you missed it, we wrote a short intro here to give you an idea of where this series is heading. Now let’s dive into our first 101 topic, self-custodial wallets.

Digital Self-Custody

When you hold cash in your physical wallet, you have “custody” of that cash. The same goes for other physical assets, such as gold, art, etc. This tale is as old as time and has existed for thousands of years. Very recently in our collective human history, we invented the digital world. When we sit and think about it, the internet hasn’t been around that long! If we charted the entire course of human history, we’d guess that the period of the digital world would be less than one second on a 24 hour clock. As new inventions happen, sometimes they bring about new frameworks for how we think about the world. They also sometimes require new tools. In our view, digital self-custody is one of these new frameworks/tools that will continue to increase in importance in the years/decades/centuries ahead.

Just as you custody cash in your physical wallet, blockchains now enable us to custody assets in a digital wallet in a similar way. Instead of only having the option to use a bank, or a brokerage, or another type of institution to hold your assets on the internet, you now have the option to hold your assets for yourself. Key word being “option”. As an example, instead of a bank having full control to lend out your assets (for a mortgage, vehicle loan, etc), self-custody puts you in full control of when your assets are lent out. If you do choose to lend them out, you generate the full yield from this lending instead of a fraction of it. Our view is that having the option to self-custody digital assets just as you do physical assets is a monumental change that’s in it’s very early stages. We believe that this change will ultimately lay the foundations of how we engage in finances digitally in the future.

As you may have heard before, a blockchain is similar to a ledger or digital bookkeeping system. The difference is, instead of taking place in a gated excel document, it takes place in a transparent fashion where everyone in the world can verify it’s validity. There are many educational videos and articles out there further explaining the technological side of this that you can find on Youtube, Google, etc. So if you want to understand more of the underpinnings, feel free to go dive in. That said, we believe that most people won’t need to know the technological details of “how” this technology works, just that it works. Similar to how most people don’t know how Amazon Web Services works to power much of the internet, we just know that the internet works. So how do we use the blockchain? How do we self-custody our assets?

It all starts by using what the space refers to as a “wallet”

Wallet Basics

Self-custodial wallets are your gateway to the onchain world. Before just a few years ago, it was incredibly difficult to go through the technological process of storing funds onchain. The good news for all of us is that this process has become much easier today. There are hundreds of wallets to choose from and we’ll talk about a few of them in a bit, but let’s start with the basics.

A wallet is simply the app you use (and it links directly to various blockchains so you don’t have to). You can download a wallet just as you would download the Robinhood app. Here’s an example of what the Coinbase Wallet looks like:

A few terms to know:

Private key - This is the password to your wallet that ultimately grants access to your funds. It usually has a “seed phrase” attached to it, which is a list of 12-24 words. It’s important to know that this is being abstracted away, meaning some wallets today and in the future won’t require you to write down your seed phrase.

Public key - This is the “address” that is public-facing and visible on the blockchain. People can send assets to this address, and you’ll receive them in your wallet.

Hot wallet - The wallet is attached to the internet. Mostly used for people who want to utilize onchain applications.

Cold wallet - The wallet is not connected to the internet. Primarily used for people who want to simply hold assets onchain but not use applications (such as trading).

Signing - When you transact onchain, depending on the wallet, you’ll often be asked to approve the transaction. “Signing” allows the onchain app to move your funds.

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Wallet vs. Exchange

As mentioned above, a self-custodial wallet allows you to custody your digital assets. Therefore, the assets are not held on an exchange such as Coinbase, Gemini, etc. If someone holds their assets at one of these exchanges, they don’t actually have full control (self-custody) over them. Just like we don’t have full control over what a bank does with our money when we deposit it. All of that said, exchanges can serve as gateways to the self-custodial wallet. Here’s how that flow works using Coinbase and Coinbase Wallet as an example:

Open Coinbase Account

Link Bank Account

Deposit Money

Buy ETH

Download Coinbase Wallet

Send ETH to Coinbase Wallet

You might be thinking, but doesn’t Coinbase Wallet give Coinbase control too? The answer is no. Coinbase Wallet was built by Coinbase, but the person who downloads the wallet has control of the private key and, therefore control of the funds that the wallet holds. Coinbase built this so people could more easily move onchain and utilize other goods they were building there.

Regarding the steps above, many people have stopped at step 4. This is for many reasons, mostly because the technological understanding to complete steps 5 and 6 was complex, and the incentive to complete these last steps wasn’t as prevalent. Unfortunately, stopping at step 4 was a major downfall for many (at no fault of their own) in 2022 when FTX’s fraudulent exchange went down. This is why you’ll often hear us talk about how we don’t view FTX as “crypto”, “onchain,” or “self-custody” at all. FTX doesn’t represent these things and is more reflective of the traditional financial system, one in which an individual trusts a company with their money instead of having self-custody.

So now that you know the “why” behind the importance of self-custody wallets and the high level “how-to” steps of getting funds into the wallet, let’s dive in a little deeper on a few best practices.

Wallet Best Practices

When you download a self-custodial wallet  Here are a few things to keep in mind:

Pick a reputable wallet - Here is a great place to start looking for a wallet solution. The 401 Financial team uses Coinbase Wallet, Safe, Argent, and Rainbow Wallets.

Secure your private key if applicable - With most wallets today, you will be given a seed phrase to store safely. Write this down and make sure you know where to find it. Keep it in a secure location.

Keep software up-to-date and use 2FA

2 Wallet System - Use one wallet for using onchain applications (such as Uniswap) and a second for holding long-term funds. This is a safety tip if you find yourself on a malicious website. Within Coinbase Wallet, for example, you can have two wallets within the same app and easily switch back and forth between the two.

Security Extension - The Fire extension will alert you if an app appears to be malicious. Coinbase Wallet also has an alert when you transact. Using both in tandem could serve as a defense.

Summary

The world of self-custody is evolving right before our eyes, and we anticipate the technology will get even more accessible to access in the months ahead. By holding your digital assets in self-custody, you’re taking control. Please reach out if you’d like to chat about solutions here and get setup! We’re actively helping clients navigate this space today. Next week we’ll cover one of the foundational onchain use cases, swapping assets.

Until Next time,

This newsletter is copyrighted by 401 Financial, Inc. It is published and provided for informational and entertainment purposes only and not for individualized investment advice.  Please go to our website, www.401financial.co for additional information.