What Assets Should I Use in Self-Custody?
TLDR:
You can self-custody physical assets (gold, cash) or digital assets (bitcoin, digital dollars), but digital assets almost always make more sense since it’s way easier to securely use them.
Using tokenized assets like digital dollars in self-custody gives you protection from banks. Using bitcoin not only gives you protection from banks but also gives you protection from the devaluation of your tokenized asset, which could happen either by its hyperinflation or by its issuer blocking redemptions. You can decide your bitcoin allocation by how much protection you want from the latter risks.
Our last two posts (here and here) describe the failures of centralized finance and the value of self-custody. If you read them, you might want to start using self-custody (maybe you even downloaded Lava), but you might be confused about which assets to actually use in self-custody. This post will help you decide that.
For starters, there are two types of assets you can self-custody:
Physical assets: Physical assets (ex. gold, physical dollars) enable you to self-custody without reliance on the internet. However, using physical assets can be complex and costly. For example, securing $1M dollars of gold requires access to a secure physical vault, hiring security guards that you then have to trust not to steal your assets, and also moving that gold is costly. Additionally, you can’t use physical assets in financial contracts (ex. oversecured loans) without trusting a central party. For example, if you wanted to take a loan against your gold, the process entails giving your gold to the lender, trusting them not to steal it, waiting days or weeks to receive a loan, trusting your lender to give you back your gold when you repay the loan, and physically transporting your gold to and from the lender without having it stolen.
Digital assets: Digital assets (ex. bitcoin, digital dollars) on the other hand can be thought about as physical assets with digital superpowers. They retain the positive properties of physical assets (sovereignty, privacy); but, they are faster and cheaper to use, accessible to anyone with internet access, and can be used in financial contracts like borrowing without trusting a central intermediary. In the digital asset space, gold is paralleled by bitcoin and physical dollars by digital dollars. Moving cash or gold across the world is often so costly, it’s not worth it, but moving bitcoin or digital dollars can be done with no fees and with instant settlement. It’s so difficult to secure gold and cash at scale that only nation states can properly do it, but anyone with internet access can secure their bitcoin or digital dollars with the same level of security as a nation state uses to secure their digital assets. Borrowing against gold is impossible without trusting your counterparty, but you can borrow against bitcoin without trusting your lender and you can do so in seconds.
If you want to self-custody digital assets, there are two types you can use:
Tokenized assets (ex. digital dollars): Tokenized assets are assets issued on blockchains which are backed 1:1 (ex. digital dollars like USDC), and when you use tokenized assets, you are protected from the many risks in using banks. Their privacy and legal guarantees make them more challenging to confiscate than assets held at a bank. For example, digital dollars can be used privately, so it’s hard to confiscate your digital dollars without compromising the entire digital dollar userbase whereas bank dollars can’t be used privately, and banks can confiscate balances of individual users. As this post documents, banks have confiscated and censored dollar movements on multiple occasions.
Native assets (ex. bitcoin): Native assets are assets where instead of the rules being governed by an issuer, the rules are governed by the decentralized consensus of people running code of the protocol that secures the asset. For example, bitcoin is a native asset, and the rules of the asset (supply, account of who has what) is enforced by a bunch of people who run the bitcoin protocol code. Amongst other native assets, bitcoin does the best at being digital nation-state resistant savings, and when you self-custody bitcoin, you not only protect yourself from banks, you also protect yourself from the risk of the devaluation of your tokenized assets. Your tokenized assets can be devalued in 2 ways: censorship or hyperinflation. Since tokenized assets are by definition issued, the issuer is a single point of failure, which means there is the risk that a single entity can cause the failure of that asset. There is a risk that the issuer could block all redemptions of tokenized asset, thus nullifying it’s value. This is unlikely though as doing so would mean the entire asset base would be affected, but nevertheless, it’s a possibility. Another way your tokenized asset could be devalued is by extreme issuance (ex. hyper-inflationary money printing). However, it is important to note that hyper-inflation alone might not boost bitcoin’s demand as the demand could instead shift towards other assets, such as stronger currencies. This has been observed as countries experiencing hyper-inflation so far tend to dollarize. But if the risk of hyper-inflation of the strongest currency (USD) increases, then the demand would shift to bitcoin. Bitcoin’s price is volatile, but that’s exactly the point. It’s price is a function of how much demand there is for protection against the censorship of tokenized assets + protection from the hyperinflation of the strongest currency (USD). So, a good way for you to decide how much bitcoin you want to hold is your answer to how much protection you want from the latter 2 possibilities.
FAQ:
Why choose bitcoin vs other possible solutions to digital nation-state resistant savings?
When you decide to use a digital nation-state resistant savings tool, you want it to fulfill 3 traits:
You want guarantees your asset can’t be censored by the strongest nation-state
You want guarantees the asset’s supply is predictable (ideally fixed) to protect yourself from the devaluation of the asset
You want to make sure you can use it securely and easily.
A comparison can be found below on how bitcoin ranks vs other solutions to nation-state resistant savings on these traits.
If decentralization becomes commoditized, why is BTC then valuable?
You can think about bitcoin as a protocol which enables a community to enforce certain rules: total supply cap of BTC (21 million), permissionless changes to the BTC UTXO set (accounting of who owns what). When you buy BTC, you're making a bet that this community will continue to enforce the rules (supply cap, permissionlessness).
Other communities might try to replicate bitcoin, but it'll be hard for them to grow their community to be as decentralized as bitcoin's given it has a significant network effect being the first to launch (first mover advantage). Bitcoin's fair launch, where no insider was allocated tokens at before or at launch, also helps secure it's position because other coins which tend to copy it end up having a large insider base, and this discourages non-insiders to opt-into these newer networks given the asset base tends to be very skewed. If the coins don’t have an insider base, then there’s little incentive for someone to launch a new coin versus just upgrade bitcoin. Whenever someone upgrades bitcoin, users get equal tokens on both forks. So, if you want to access nation-state resistant savings, you can feel comfortable choosing bitcoin with the understanding that even if the protocol changes, the UTXO set will live forever, and you can secure your spot in the UTXO set now.
What if another technology is better than bitcoin at its intent?
If some new technology can improve bitcoin at nation-state resistant savings, there's no reason why bitcoin wouldn't ultimately integrate that technology.
If I don’t want bitcoin, is it still useful?
A digital nation-state resistant savings tool is important, even if you don’t have a need for it right now, for 2 main reasons:
Counterbalance to centralized control
Centralized finance has risks as explained here and here. Such a savings tool enables people who don’t feel served by the centralized financial system to opt out. And for those using the centralized financial system, such a tool serves as a check and balance for it, helping regulate the system and incentivizing it to better serve the people using it.
Response to authoritarian overreach
Capital allocation is a tool to organize labor and resources. Authoritarian regimes try to take the power of capital allocation from the people and bring it to the authoritarian. If people have financial freedom, specifically ownership over their own money, they can more easily organize, protest, and leave authoritarian regimes.
What should be bitcoin’s market cap?
The value of bitcoin comes from how much people want it as a solution to self-sovereign savings. This rises when the centralized financial system is more at risk and vice versa.
Is bitcoin still useful even if it’s not fully private?
Privacy strictly improves bitcoin’s value proposition of being digital nation-state resistant savings. However, certain privacy technologies can be at conflict with more important properties for bitcoin, like censorship-resistance, re-org resistance, and predictable supply. In the status quo, users can get privacy with carefully acquiring and using UTXOs, using privacy applications on top of bitcoin, and even using off-chain solutions to transfer bitcoin like OpenDime.
Is there any reason to hold gold or physical assets?
The primary reason to hold gold or physical assets is as a safeguard against internet-related vulnerabilities. It’s important to note though the lack of a predictable supply schedule for gold is an added risk you take when holding gold vs bitcoin.
Definitions:
Proof of Work (PoW): In PoW, miners compete to solve complex mathematical problems. The first miner to solve the problem gets the right to add a new block of transactions to the blockchain and is rewarded.
Proof of Stake (PoS): In PoS, validators are chosen to create a new block based on the number of coins they hold and are willing to 'stake' as collateral.
Miner-Extracted Value: MEV refers to the maximum value that miners can extract from block production in excess of the standard block rewards and transaction fees. This can include strategies like reordering, inserting, or censoring transactions within a block to maximize profit. MEV leads to unfair advantages for sophisticated miners.
Contributors:
This article was written by Shehzan Maredia.