What is Bitcoin Custody?

Custody refers to an arrangement where a custodian holds assets on behalf of the owner. In traditional finance, this often includes assets like cash or stocks, managed by institutions such as banks. With Bitcoin, custody takes on a new role since Bitcoin is a digital, decentralized asset. Here’s a closer look at what Bitcoin custody entails and how it differs from traditional banking.

Bitcoin custody involves securing and managing private keys. The Private key is the access to your Bitcoin. It can be displayed as 12 or 24 words. Unlike other assets, Bitcoin does not exist physically. Bitcoin only exists on the dezentralized ledger - the Blockchain. Whoever controls the private keys essentially “owns” the Bitcoin, as these keys allow the user to sign transactions and move funds.

There are two main custody models for Bitcoin:

Self-Custody: Users control their own private keys, taking full responsibility for their Bitcoin.
Third-Party Custody: A third-party provider, often a cryptocurrency exchange holds the private keys on behalf of users.

Bitcoin Custody vs. Traditional Banking

Ownership of Assets
- Traditional Banking: When you deposit money in a bank, it becomes part of the bank’s asset pool, and the bank holds an obligation to return an equivalent amount. Banks use this pooled capital for fractional lending, meaning they loan out most deposits to generate interest, keeping only a fraction available for withdrawals.
- Bitcoin Custody: Bitcoin custodians do not physically possess Bitcoin but hold the private keys controlling access to the Bitcoin. Custodians commonly keep Bitcoin in cold storage (offline). Not all Bitcoin custodians hold full reserves, and this can lead to significant risks. For instance, FTX’s 2022 collapse demonstrated the dangers of custodians lending out customer assets instead of maintaining a full reserve.
Security and Privacy
- Traditional Banking: Banks, though generally considered secure, have been vulnerable to cyber-attacks targeting funds and identities. The fractional reserve model means that, in rare but historical cases, banks have been unable to meet withdrawal demands.
- Bitcoin Custody: While Bitcoin custodians often use cold storage to protect against digital threats, relying solely on a custodian means trusting them entirely with private keys. Losing control of these keys can lead to irreversible loss. Multisignature (multisig) wallets offer some security by distributing control, but they still place partial custody in third-party hands, which can reduce self-sovereignty and increase counterparty risk.
Accessibility and Control
- Traditional Banking: Access to bank accounts can be subject to hours, holidays, and jurisdictional laws, with governments able to freeze or access accounts under certain conditions.
- Bitcoin Custody: Bitcoin, as an asset is more flexible. However with using Bitcoin Custody you still rely on the custodian.

Alternativ: 2-of-3 Multisig with one custodian vault

For those seeking a balance between self-custody and added security, a 2-out-of-3 multisig wallet with a custodian can be a good option. In this setup, three private keys are created, and any two are required to access the funds. Typically, two keys are held by the user and one by a Bitcoin custodian.

This model allows for flexibility and security doesn’t give the custodian control over your funds. At the same time you erase the single point of failure: if you loose one of the keys, you still have access to your funds.

Why Self Custody?

At Bittr, we believe in self-custody. We’re not big fans of custody solutions because they add a layer of trust and dependency that goes against Bitcoin’s core values. By holding your own keys, you’re in charge, free from third-party risks or potential restrictions. Our focus is to help people understand and embrace self-custody, making Bitcoin ownership straightforward and secure without needing to rely on custodians. We do not want to host an account with funds for you and make it easy to buy Bitcoin directly into your own Wallet.

Final Thoughts

Ownership Control: With Bitcoin, custody focuses on controlling private keys rather than holding a physical asset.
Security Approach: Bitcoin custody can be risky and lead to loss of funds when the custodian is not honest. That happened with FTX 2022 where a lot of user funds got lost.
A Multisig Setup with a custodian vault can be hybrid solution