Essential jargon

Crypto-assets, such as Bitcoin or Ethereum, are held in addresses that may be disposed of using the associated private key:

• An ‘address’ is a combination of letters and digits, such as ‘1F9cZYh3ZB6gdF9mnzLgFn6yqnFvpP9iHn’ in the case of Bitcoin. Crypto-assets are stored at such an address. The address is therefore comparable to the IBAN of a bank account on which fiat currencies may be stored. An address can theoretically be disclosed to third parties (and must be disclosed if one wants to receive funds from another person).
• A ‘private key’ is a similarly long string, such as ‘5Kb8kLf9zgWQnogidDA76MzPL6TsZZY36hWXMssSzNydYXYB9KF’ in the case of Bitcoin. There is normally one matching private key for each address. With the private key, one can dispose of the crypto-assets stored on the corresponding address. The private key is therefore comparable to a PIN code, with which one can dispose of the balance of a typical bank account. A private key must not be disclosed to anyone else; whoever knows the private key can make a payment from the address to which the private key belongs.

Addresses and the associated private keys are stored in a wallet, which allows crypto-assets to be easily received and sent without having to enter the lengthy letter/digit combinations shown above. There are many different types of such wallets. Mobile wallets on a smartphone, also called ‘hot wallets’,[1] are the most convenient; one can dispose of the crypto-assets on one’s mobile device at any time, but it is not necessarily secure (i.e., malware may surreptitiously steal the crypto-assets). Hardware wallets, also called ‘cold wallets’, are small, USB drive-like devices that are more secure but less convenient.

Self-custody

In this context, self-custody means the owner of the crypto-assets holds the private keys. This gives them full control over the crypto-assets.

• Pros: In the world of crypto, self-custody is generally seen as the safest way of owning crypto-assets, as there is no need to trust anybody else (which aligns with the fundamental ideals of Bitcoin’s inventor, the pseudonymous Satoshi Nakamoto).
• Cons: However, there are disadvantages, since holding crypto-assets (i.e., basically bearer instruments) boils down to safely holding the private keys. If the private keys are lost (e.g., due to hardware failure) then the crypto-assets become irretrievable. If the private keys are obtained by an unauthorised internal (e.g., family member or employee) or external (e.g., hacker) party, that person has full access to the crypto-assets and can run away with them.

External custody

External custody refers to crypto-assets held on addresses to which an external custodian (and more importantly its officers and employees) has the private keys.