Your deposits aren’t really yours – why Bitcoin’s self-storage is important
Given the recent uncertainty surrounding bank deposits, interest in keeping your own funds has been high – we’ve seen banks that have been around for decades and sometimes centuries fold. While depositors have so far been “whole” through the use of monetary intervention – the lurking thought in everyone’s mind is that their money and the balance they see in their bank accounts is really theirs.
The harsh reality is that, most likely, without any conscious thought and action, the vast majority of the numbers in the form of bank statements do not mean as much custody and ownership as most would think. BitcoinsbitcoinBTC principles of self-custody offer a stronger form of access and control over your own funds than deposits in your local bank – or indeed, bitcoin or other cryptocurrencies held on an exchange. This has never been more acute in our modern times since the sudden failures of Credit Suisse and Silicon Valley Bank.
The Great Depression of the 1930s was correlated with a series of regional bank failures. More than nine thousand banks (representing about 30% of the total banks in the United States) failed between 1930 and 1933.
They were brought down by a series of banking panics, although some of the failures were also attributed to the continued weakness of the agricultural sector throughout the 1920s. There is still active debate between whether or not the causes of the Great Depression caused bank failures, or whether the bank failures themselves turned what was supposed to be a mild recession into a depression.
This gave birth to the Federal Deposit Insurance Corporation (or FDIC for short) which was intended to prevent a similar episode of bank runs and the panic that followed by providing insurance from the federal government for deposits in the US banking system. This was the federal agency that insured (beyond its prescribed limits) the deposits of Silicon Valley Bank – a modern echo of those volatile times.
So, what are bitcoin’s self-custody principles and how can they be properly implemented to handle the potential bank volatility during this period?
1- Your keys, your belongings
We are now used to the idea of online passwords. To access your deposits, most will now interface with an online banking portal that shows how much you have on deposit with a particular bank. But what do you actually get access to when you take a look?
If we’re talking about a wallet that follows bitcoin’s self-storage rules, then you’re talking about a store of value that you can choose to send to any address without restrictions. Once you’ve entered the key, you have full access to the assets shown in, which exist in their entirety.
Your bank deposits are an abstraction with limits on them – and for good reason – to precisely cover the risk of bank panics and a run on the banks. That deposit amount is only available at a fraction: this normally doesn’t matter for most people’s everyday life, but is of great importance precisely when there is a bank run.
As a result of the fractional banking system, banks are allowed to use the deposits they have (which are essentially liabilities on the bank’s balance sheet) to get as much return as possible on the deposit amounts. That means they wouldn’t have the cash on hand to meet a large majority of deposits if they all fell due at once – the exact definition of a bank run.
Your funds are subject to controls on how you can spend them as a result. You can only withdraw so much in cash at one time as a retail customer in ATMs. If you are going to send money electronically, there is also a limit. The bank can choose to freeze your money if you trade with something they don’t find agreeable. They may refuse to bank with you for various reasons.
Bitcoin flips that paradigm. Instead of having to deal with a cumbersome intermediary, you can have full control and access to your own assets.
Or to sum it up very simply in bitcoin-speak: your keys, your bitcoin.
2- Watch out for guarantees
Although the recent Silicon Valley Bank run was partially covered by an extended warranty of FDIC insurance, it’s not something you can absolutely count on in the future. Former FDIC Commissioner Shelia Bair argues that the real problem is the possibility of bank runs along with the need to sell securities at a loss in a higher interest rate environment. This is a risk category that applies to all banks, not just banks with a particular level of risk centered in one industry, or banks with a high level of uninsured deposits.
As seen in the case of SVBVB, you can’t really definitively audit your bank for internal practices, and the world has become a more volatile place, where standard assumptions may no longer be the norm. The low interest rate policy of the last decade already seems to be a relic. Unexpected triggers such as the sudden OPEC+ production cut loom on the horizon: creating inflationary pressures that could force central banks to keep raising interest rates. Banks like SVB that did not have a chief risk officer, and that did not take into account changing circumstances that can only become increasingly volatile, are not going to be as reliable as they were in an unchanging, favorable macro environment.
Although there were banks that managed interest rate risk well (staying away from buying certain securities while interest rates were low, forgoing immediate profits to avoid having to write off potential losses), many did not – and during in the coming months, and maybe even years, this could all unfold before our eyes.
While the Federal Reserve and the FDIC stepped in decisively here, with Silicon Valley Bank, deciding to cover the large number of uninsured deposits that had technically exceeded the $250,000 insurance limit, there is no guarantee that the Federal Reserve and the Treasury Department will be able to do it. this or maintain it into the future.
For other countries with weaker monetary states, the guarantees baked into deposits weaken the domestic currency and imply a level of loss for the citizens of that country: for example, the deal between Credit Suisse and UBS triggered a fall in the Swiss franc. How durable is an unlimited state guarantee behind deposits? It’s possible that the guarantee could break – and even if it doesn’t, it would come at a cost to every person who holds that currency.
Instead of relying on the promise that is your bank deposit and government guarantees that they will bend the rules to make you whole, it is more attractive to have the assets available to you at all times, under your own control, in an asset that is priced by market mechanisms rather than politically driven artificial scarcity (or plenty).
3- With great power comes great responsibility
Self-storage is not a solution to all problems. It may not even be the solution to your particular problem. With the great power of detention comes great responsibility. This includes choosing the best custody option for yourself, knowing that access to a key that can send out money could allow actors to compromise your money – raising the level and knowledge of digital security you need versus the practical option of parking that risk ( and control) with someone else.
Some people keep their bitcoin on exchanges and others want to keep cryptocurrencies too, with the lure of betting keeping them captive and greedy. Still, as the fall of FTX and Celsius shows, when you leave bitcoin on an exchange, you rely on the same fiat logic as with bank deposits: it can be a risky game.
This is where the spectrum of self-storage solutions comes in. Most people do not want to store large amounts of funds in “hot wallets” that are connected to the Internet and can move money quickly. However, you can have a custody solution like Wasabi Wallet or something similar if you want a reasonably fast way to send funds on-chain. A popular solution is to split funds from hot wallets for use and cold wallets for savings.
For hot wallets, Lightning Network wallets are preferred as they have lower transaction fees and are more suitable for microtransactions that are present throughout life – the 2023 answer to can you buy coffee with bitcoin is a resounding yes.
Here is a list of example Lightning Network wallets:
- Wallet by Satoshi
- Phoenix wallet
- Breeze
There is also the option of having your bitcoin stored in a hardware wallet (perceived as cold), usually one that is not connected to the Internet and requires physical input.
- Coldcard
- Trezor
Some people will also decide to do what is called a paper wallet: literally put their private key on paper. Finally, a selection of people can opt for a more managed service that includes 2-of-3 key combinations (including hardware wallets) for cold storage. One of the most famous in this regard is Casa.
Bitcoin’s self-custodial principles give you the power over your funds – not in an abstract way like an online bank balance, but rather in a real tangible sense of being able to send the amount in your wallet anywhere you want without restrictions and without the need for any guarantees. Yet it also comes with some responsibility: the ownership of your assets comes with ensuring that how you store the keys, more powerful than the bank password to your deposits, can be done safely and efficiently.
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