How the FTX collapse highlights the importance of bitcoin self-custody
And other fundamental properties of bitcoin
I present you two claims:
“Crypto” offers you very little opportunity to physically secure your wealth and ensure it will retain its purchasing power.
Bitcoin offers you an unprecedented opportunity to physically secure your wealth and ensure it will retain its purchasing power.
Is it obvious how these are both true? If not, I hope the following will help give you some categories to think about this.
To me and many like me, this week’s events are not surprising at all and loudly announce bitcoin’s importance to the world… if you can hear it.
This week’s events
If you haven’t been following, “this week’s events” refers to the incineration of billions of dollars of user funds held by a centralized cryptocurrency exchange called FTX , which, secretly, was funneling those funds to its sister hedge fund in order to prop it up after its definitely-gambling “trading strategies” went awry.Oh, and they did this by printing their own “token” out of thin air, which was basically like airline miles for their platform.A competitor of this exchange, Binance, got word of something amiss via media reports and started dumping huge amounts of this token on the open market which caused a good ol’ bank run at FTX, which caused the balance sheets of both the exchange and the hedge fund to unravel in real-time.
Confused? You should be.Disgusted at the world we live in? Me too.
I’ll spare you the why-buy-bitcoin pitch for the purposes of this article to highlight something specific: This week, you’re seeing that bitcoin is a tool that requires knowledge of its fundamental properties to wield properly.If you don’t understand this, you don’t understand bitcoin.Both FTX and its million users who are now broke clearly lacked basic bitcoin knowledge .
[1](#footnote-1)
“Not your keys, not your coins.”
This phrase is just one bit of knowledge.You might have seen it on Twitter this week; even Elon Musk parroted a botched version of it on a Twitter Space.
It’s wisdom gleaned from years of pain and loss.
This week’s catastrophe is, unfortunately, now included on the list of exchange bankruptcies and hacks that have led to the permanent loss of hundreds of millions of dollars worth of bitcoin.A new wave of people now see first-hand that self-custody is not just a cool optional feature of “crypto,” but fundamental to bitcoin as a tool—as money.
Self-custody—people taking self-custody and developers building tools to improve it—is critical to bitcoin being money because if you can’t take self-custody, you don’t hold the thing.
You hold the password to an account that says someone else owes you the thing if you ask for it—also known as an IOU.That is not bitcoin.[2](#footnote-2)
The people who lost everything in the FTX collapse didn’t own the thing, and the thing is gone now.Unfortunately, we still don’t really know where the thing went.
There are some theories, but we’ll find out in bankruptcy court.
Other unintuitive but fundamental properties
We’ll come back to self-custody, but there are other bitcoin properties you might have heard of that may seem optional but are actually fundamental: proof of work and running your own node.
Like self-custody, these both might seem pointless—until you realize that they’re critical and bitcoin doesn’t work as money without them.
Proof of work
For the uninitiated, proof of work is the energy-intensive competition that bitcoin miners participate in to find a block.You could think of it like scratching off lottery tickets millions of times per second looking for the winning ticket.That ticket earns you the right to append the next batch of transactions permanently to the blockchain and reap its associated rewards .
Conversely, most “crypto” networks are proof of stake from inception or have recently transitioned to it , which replaces the costliness of energy with the costliness of “staking”—putting your tokens at risk.
In this system, you put up some tokens for the privilege of “mining” blocks, and if you lie, you’re punished and some of your tokens are taken away.
Because proof of work is tied to real-world energy—bound by the laws of physics—and not internal protocol politics, anyone, anywhere in the world can just plug in and start selling electricity for bitcoin.Critics say this is a waste of precious resources and this energy consumption is destroying the planet.These arguments seem reasonable until reality punches you in the face.
One example of such harsh reality is that, after Ethereum moved from proof of work to the more-politically-vulnerable proof of stake mechanism, the consensus keepers became more centralized and immediately had to start complying with government regulations so as to not risk real humans going to jail or companies being fined.[3](#footnote-3)
Even if governments blacklisting transactions to/from certain addresses was a moral good, it’s almost irrelevant to bitcoin: bitcoin mining censorship incidents have thus far been minor , and even if entire governments conspired to put forth regulation, censored blocks would simply be mined elsewhere.
This is not the case with “crypto,” where those staking networks are trending toward centralization.Bitcoin mining is trending in the opposite direction , which is a key distinction.China banned mining and the bitcoin network became more robust because those miners packed up and dispersed themselves across the globe.
For bitcoin to be a novel and useful tool, it must be different than the incumbent monetary systems—in this case, optimized for being apolitical, neutral, and censorship-resistant.
[4](#footnote-4)
Thankfully, bitcoin node runners are never going to willingly opt for a version of bitcoin that risks being more centralized—and therefore vulnerable to political attacks.It’s not that bitcoin “won’t,” it’s that it really can’t, unless you, the person who so badly wants to fit bitcoin to your worldview, have a magic wand that can undo the self-interest of millions of bitcoin holders.[5](#footnote-5)
You can’t fully grasp that proof of work is fundamental to bitcoin as money with these few paragraphs.But if you want to explore this more, Scott Sullivan did a great job explaining why proof of work is non-negotiable.
Running a full node
“Running a full node” ( what is a node? ) might sound like a weird mountain man fantasy .It’s something at face value that seems valueless (you can interact with “crypto” without ever knowing what a “node” is) but is actually fundamental to bitcoin.
One reason that running a node is important:
Everyone uses a bitcoin node every time they interact with bitcoin.
If you don’t use your own node to verify your own wallet balances and transactions, you’re trusting someone else’s node.
Therefore, you should run your own node, because someone else’s node might be lying to you, and well, this is your money we’re talking about, so that’s pretty important.
If you held your net worth in bitcoin, would you want to trust someone else’s bitcoin node to verify for you that, yes, you do in fact have a net worth of, say, 20 BTC? And even if you do, do you want to compromise your privacy in the process?
Another reason:
Bitcoin has rules, called consensus rules, that dictate important things about the protocol—the [21 million supply cap] being arguably the most important.
By running your own node you are opting to run one version of bitcoin over the infinite possible other versions of bitcoin.
If anyone ever tries to change bitcoin—say, debase it by loosening the money supply, or conversely, erode trust in bitcoin’s monetary policy by artificially tightening it—you can just keep running the version of bitcoin that didn’t make that change.[6]
Currently, most people don’t run their own node.
They just trust someone else (the wallet they run on their phone, most of the time) to tell them their balances and they don’t worry about protocol changes.The people who run nodes are doing that job for them.Unlike in “crypto,” this is a problem being actively worked on in bitcoin.See Umbrel and others.[7](#footnote-7)
As highlighted above, for bitcoin to eventually function as a global monetary system, bitcoin must optimize for each user to at least have the ability to confirm their own balances and decide for themselves to opt for true bitcoin.These are just two of many reasons why running a node matters both for bitcoin holders and for the bitcoin network .
Superficially similar but fundamentally different
“We might cheekily go even further and say we are intellectual honesty and responsibility maximalists–which itself explains our fascination with bitcoin.” — Allen F.
and Anders L.
Any “crypto” that dispenses of any of the above things (hint: they all do) is worth dispensing of itself.These financial instruments offer less ability for users to control funds themselves (self-custody), no open and permissionless joining of the associated economy nor physical real-world costliness to security (proof of work), and no mechanism for decentralized, credible, neutral, apolitical enforcement of the consensus rules (full nodes).
I empathize if you find these distinctions hard to grasp.They are.But these are just a few reasons bitcoin is at best superficially similar to “crypto.” The creators of these other coins and the runners of exchanges and other businesses built on them, in most cases, understand this—that bitcoin is fundamentally different.
They just want your bitcoin.
For a masterclass on bitcoin vs.“crypto” from a philosophical, technical, and economic perspective, see Allen Farrington and Anders Larsen’s Only The Strong Survive .
Self-custody, “crypto,” and FTX
“No one would ever be comfortable holding their net worth in crypto because it’s too difficult or too risky,” someone might say after watching what unfolded this week.
And that’s so very true! If FTX-is-“crypto”-is-bitcoin, then bitcoin is awful money.
FTX, and the “crypto” tokens that it most profitably promotes, almost ubiquitously dispense of the fundamental properties of bitcoin.You see, these things are related: self-custody is about taking control of and cryptographically verifying your ownership of a decentralized money that has a credibly fixed supply and is protected by a firewall of real energy.
If you dismantle the latter two properties in your quest for short-term dollar profits, it’s easy to see how the first one goes too.What would the owners of these tokens even be protecting in self-custody?
So let’s try this again:
“Crypto”
“Crypto” offers you very little opportunity to physically secure your wealth and ensure it will retain its purchasing power.This is because “crypto” opts for trade-offs that make it:
Difficult to self-custody securely: There are sparse tools to do so, and there is little if any incentive for these tools to be built.
More prone to censorship: The relatively centralized nature of proof of stake makes it more likely, if not certain, that validators will comply with censorship requests.
Difficult if not impossible to run a full node: You, the person who regretfully decides to use this token as money, must trust third parties to verify things like wallet balances and you generally have very little influence over protocol changes.[Hard forks, galore] .
These trade-offs properly understood would be impediment enough for someone to use these “crypto” tokens as money in the real world, but to make things worse, these properties all incentivize every user to just give up caring, trust an exchange like FTX with their “crypto,” and hope for the best.The exchange holds the keys.
The exchange pools the stakers.And the exchange runs the nodes.
Obviously, that doesn’t work out so well.
Bitcoin
Bitcoin, on the other hand, offers you an unprecedented opportunity to physically secure your wealth and ensure it will retain its purchasing power.This is because bitcoin optimizes for being:
Built for self-custody: With a robust self-custody ecosystem, we’re even seeing the emergence of [multisig collaborative custody solutions which solve real problems] .
Censorship-resistant: Proof of work is minimally vulnerable to politicization and centralization, and miners serve the nodes.
A system where it is technically and realistically possible for normal people to run a full node: Independently verify everything without trusting third parties and know that in 50 years it’s extremely likely that its monetary policy (i.e.total supply, issuance rate, etc.) will be exactly the same.
Now, bitcoin is a complicated organism.
There are too many angles to approach it from.Too many questions that you, the reader, rightfully have bubbling up in you as you read these things.
But my hope was that between the top of the article and here you would be able to grapple, at least a little bit, with why these two things are true.Again, these are just a few of the fundamental differences.
Check your financial privilege
If you live somewhere less prosperous and free than the West, the differences here are easier to grok, because your lack of trusted financial institutions makes the benefits of these aspects that bitcoin prioritizes a massive advantage for your daily life, rather than some abstract and perhaps uncompelling alternative to the relatively sound dollar and the safety of traditional financial institutions and FDIC insurance.
In this less privileged position, you find bitcoin liberating because it might be the first time you’ve had a secure money you can depend on that doesn’t have gatekeepers.
With a bit of work, you can learn how to take custody of it properly, understand why it’s sufficiently decentralized (and therefore can’t be changed at the whims of your local leaders or those abroad), you can actually participate in bolstering its decentralization, and you can verify everything about all of these things for yourself without having to trust any intermediaries.
Securely taking custody of an apolitical digital bearer instrument is empowering people across the globe to control their own money in the face of tyranny, but make no mistake: We in western democracies would be hubristic to think we won’t one day need to have that same capability—regardless of which modern faction tyranny might erupt from.
Taking personal responsibility
Currently, most people, even those who do already understand why this is meaningful (and that’s not easy), just don’t trust themselves enough to do it.
Amidst the FTX chaos, bitcoin is exposing that we don’t like personal responsibility.We don’t like the responsibility of figuring out self-custody, and we don’t even like the responsibility of figuring out why it matters.
Even if you do enjoy the comforts of the dollar and our existing institutions, even if you live in the United States, you still live in a world filled with people who will do anything to make money on your money.That’s now clearly true of FTX, but it’s, critically, also true of most of the traditional financial system.
Self-custody bitcoin is a neutral tool that anyone can learn to wield that offers an alternative.
[1]
Sam Bankman-Fried (FTX’s CEO fraudster) was clearly malicious, but if he understood bitcoin, he might have prioritized his company’s accumulation of bitcoin.He did not.According to the Financial Times, FTX, held zero, yes zero , bitcoin .
[2]
The innovation of bitcoin is that it is a peer-to-peer digital bearer instrument (aka cash).
Eliminating trusted third parties is the problem bitcoin solves by definition.
[3]
If you think that governments should stop certain “crypto” addresses from being legal to interact with, I disagree, if not only because it’s pointless.These rules are unenforceable at scale and to show the government’s incompetence on this issue.For instance, it’s currently illegal to just receive funds sent from a blacklisted address.In “crypto,” there is no way to stop these transactions from “being received.” In other words, “that’s not this works.That’s not how any of this works.”
[4]
Proof of work mining has kept it such, because anyone, anywhere in the world, can just start mining and receive bitcoin rewards.
As opposed to proof-of-stake, where you have increasingly few options to avoid going through regulated and centralized entities to exchange your dollars (or other fiat) to enter those “crypto” economies.
[5]
For more on the unlikeliness of bitcoin to change its consensus rules, I highly recommend a book called The Blocksize War , which explains in detail a multi-year civil war in bitcoin between factions who had different visions of the protocol’s future and how node runners, as opposed to miners (who are obviously a far more centralized and corruptible cohort) ultimately controlled the protocol’s future.
[6]
Unlike other technologies where iterative improvement leads to better products and greater adoption, it was the curious and unique combination of many innovations from the start, and subsequent reluctance to change these things, that got bitcoin to where it is today.
[7]
Most people don’t want to run their own node because of the technical challenge, but emerging plug-and-play options like Start9 Labs , Ronin Dojo , and Umbrel will help people figure out that they can own their own data (pictures, contacts, apps, etc.) while also running a node..
