Newbie's Typical Path to Bitcoin Security: Exchanges to Self-Custody

Bitcoin has become increasingly popular among those seeking exposure to the world’s first and foremost decentralized financial system, along with the financial benefits and value it offers. However, many newcomers begin their journey with Bitcoin through centralized exchanges, where they unknowingly allow the exchange to hold custody of their Bitcoin. This arrangement means they lack full control over their assets. As users become more educated on the principles of Bitcoin, many transition from custodial setups to more secure self-custody and multi-signature solutions. This article explores the typical path of Bitcoin ownership, from initial exposure on an exchange to advanced self-custody solutions like multi-signature wallets.

Normal Step 1: Initial Engagement Through Exchanges

Most people begin their Bitcoin journey by purchasing Bitcoin on a centralized exchange, such as Coinbase, Binance, Luno or Kraken. These exchanges offer user-friendly platforms that allow people to buy, sell, and store Bitcoin. However, users are often unaware that by keeping Bitcoin on an exchange, they are not the true owners of their Bitcoin. 

When Bitcoin is purchased on an exchange, the actual cryptocurrency resides in wallets controlled by the exchange itself[^1]. Users are provided with a balance displayed on their dashboard or app, but this balance is essentially a promise from the exchange rather than Bitcoin they control. The Bitcoin associated with these balances technically belongs to the exchange, and users have no direct access to the private keys, which are required to control Bitcoin directly. 

The risks of exchange-based custody became widely recognized after the collapse of FTX, where customers suddenly found themselves unable to withdraw funds due to the exchange’s mismanagement[^2]. Additionally, exchanges sometimes experience "glitches" when many users attempt to withdraw Bitcoin simultaneously, revealing that users' assets are not entirely under their control[^3]. The mantra “not your keys, not your coins” encapsulates the idea that Bitcoin is not truly owned until it is in the user's self-custody.

Normal Step 2: Transition to Self-Custody with Hot Wallets

After understanding the limitations of custodial ownership, many users move to self-custody solutions. A popular choice is a self-custodial hot wallet, such as Muun, which allows users to control their own Bitcoin through a mobile app. In a hot wallet setup, the private key, which grants ownership of the Bitcoin, is encrypted and stored on the user’s device. This means the user, not the exchange, has control over their Bitcoin, though it remains connected to the internet[^4].

Hot wallets are convenient and offer greater security than leaving Bitcoin on an exchange. However, they come with certain risks, as they are still susceptible to online threats like hacking and malware. Nevertheless, hot wallets like Muun represent a significant step toward self-sovereignty and enable users to have full control over their Bitcoin[^5].

Normal Step 3: Enhanced Security with Hardware Wallets

For users seeking a higher level of security, hardware wallets are the next step. These wallets, such as Ledger and Trezor, store the private keys offline, making them less vulnerable to online attacks. Unlike hot wallets, hardware wallets remain "cold" until they are physically connected to a device for a transaction[^6]. This added layer of security significantly reduces the risk of unauthorized access.

Using a hardware wallet can initially feel daunting due to its technical nature, but it provides a level of security that is generally regarded as best practice for long-term storage. As a result, many experienced Bitcoin holders prefer hardware wallets to store larger amounts of Bitcoin[^7].

Eventual Step 4: Multi-Signature Solutions for Maximum Security

The most advanced security option for Bitcoin is a multi-signature wallet. In this setup, multiple private keys are required to authorize a transaction, protecting against single points of failure[^8]. For example, a user may set up a “2-of-3” multi-signature wallet, where two out of three keys are needed to access the Bitcoin. This arrangement ensures that even if one key is lost or compromised, the Bitcoin remains secure.

Multi-signature setups are widely considered the safest option, particularly for larger holdings. They provide redundancy and a safeguard against threats, such as theft or accidental loss of a single key. For individuals and businesses serious about Bitcoin security, multi-signature wallets represent the pinnacle of self-custody[^9].

Kevlar: The User-Friendly Multi-Signature Solution

Kevlar offers a user-friendly approach to multi-signature wallets, combining the security of multi-signature with the ease of a hot wallet. Kevlar simplifies the multi-signature process, allowing users with traditional banking experience to manage Bitcoin securely without the steep learning curve often associated with hardware wallets[^10]. This hybrid model makes advanced security accessible for all, including less tech-savvy users, such as family members or spouses.

Institutional Custody for Corporate Entities

For corporations like MicroStrategy, which holds vast amounts of Bitcoin, multi-signature solutions are essential but are managed differently than individual custody. Institutions often have a custodial setup with layered controls and approval processes. While this arrangement reintroduces some custodial risk, it allows for a level of oversight and failsafe mechanisms suited to corporate governance[^11].

Conclusion

The journey from exchange-based Bitcoin ownership to secure, self-custody solutions reflects an evolution in understanding and security practices. Users begin by entrusting exchanges, gradually taking ownership with hot wallets, hardware wallets, and eventually multi-signature setups as they seek to mitigate risks. Kevlar's user-friendly approach to multi-signature storage provides a bridge between convenience and robust security, enabling everyone to protect their Bitcoin effectively.

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Footnotes
“Bitcoin Ownership and Custodial Risks.” Investopedia. Retrieved from https://www.investopedia.com/articles/investing/032216/bitcoin-ownership-and-custodial-risks.asp

Thompson, S. “Lessons from the FTX Collapse: The Risks of Custodial Exchanges.” Financial Times, 2023. Retrieved from https://www.ft.com/content/4adf7e96-497f-11e8-8ae9-4b5ddcca99b3

“Exchange Glitches and Withdrawal Freezes: The Risks of Custodial Bitcoin.” Bitcoin Magazine, 2023. Retrieved from https://bitcoinmagazine.com/business/exchange-glitches-and-withdrawal-freezes

“Understanding Hot Wallets for Bitcoin.” Cointelegraph. Retrieved from https://cointelegraph.com/bitcoin-for-beginners/what-is-a-hot-wallet

“Muun Wallet Review: A Beginner-Friendly Hot Wallet for Bitcoin.” Crypto Briefing, 2023. Retrieved from https://cryptobriefing.com/what-is-muun-wallet/

“What Is a Hardware Wallet?” Ledger, 2023. Retrieved from https://www.ledger.com/academy/what-is-a-hardware-wallet

“Bitcoin Storage Options: Hot Wallets vs. Cold Wallets.” CoinDesk, 2023. Retrieved from https://www.coindesk.com/learn/what-are-bitcoin-wallets/

“Multi-Signature Wallets Explained.” Bitcoin.org, 2023. Retrieved from https://bitcoin.org/en/multi-signature

“Security Benefits of Multi-Signature Wallets.” Blockonomi, 2023. Retrieved from https://blockonomi.com/multisignature-wallet/

“Kevlar: Multi-Signature Security Made Easy.” Kevlar.com, 2024. Retrieved from https://kevlar.com/multisig-security

“Bitcoin Custody Solutions for Institutions.” MicroStrategy Bitcoin Report, 2024. Retrieved from https://www.microstrategy.com/en/resources/bitcoin-institutional-custody