FTX-ed crypto investors return to hardware wallets

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It wasn’t long after the wheels fell off at FTX that the I-told-you-sos started. On November 11, the crypto exchange filed for bankruptcy and billions of dollars worth of crypto from customers were missing. How was it possible? Because FTX was not just a place to trade tokens, it was also where users stored them.

Weather-beaten veterans of the crypto industry will tell you that by allowing a third party to store coins on their behalf, the victims of the FTX collapse made a fatal mistake. “Not your keys, not your coins”, they like to say. Instead, they advocate a system called self-custody, in which people manage their own private crypto wallets, secured by secret alphanumeric keys.

The message is filtering now. A person with funds trapped in FTX, who asked to remain anonymous to maintain his financial privacy, says he now stores the crypto in a personal wallet or an interest-bearing peer-to-peer contract. Another, who requested anonymity for the same reason, says he now only holds tokens on exchanges for an hour at a time for trades and stores them himself. “Fuck Sam,” he says, referring to FTX CEO Sam Bankman-Fried. “But I should have managed my risk too.”

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Companies that provide devices for self-custody are profiting from the chaos in the industry, including Ledger, one of the biggest makers of hardware wallets. November, the month of FTX’s collapse, became the most successful in the company’s history, according to its CEO, Pascal Gauthier. Between June 2022 and February 2023, amid the crypto turmoil, the company sold 1 million units, after only selling 5 million in the previous eight years combined. Data from blockchain analytics firm Chainalysis shows that the collapse of FTX, Celsius and other major crypto firms corresponded in 2022 with large increases in the movement of funds out of exchanges into personal wallets. Just like the sector’s banking crisis in March.

The problem with storing crypto in a personal wallet, however, is that there is no room for error: misplace the private key and 12-word recovery phrase and the crypto inside is lost forever. A Briton famously suffered that fate when he mistakenly threw away a hard drive in 2013 that contained the credentials of a wallet containing 7,500 bitcoins, worth $220 million at today’s prices. today. Estimates suggest that around 20% of all bitcoins, worth tens of billions of dollars, were lost this way.

“There is a significant user experience problem in crypto, and much of it has to do with self-custody and key management,” says Hugh Brooks, director of security operations at the blockchain security firm. CertiK. FTX may have made storing crypto with an exchange “less appetizing,” he says, but “for the average user, self-custody is a much bigger risk.”

Beyond storing wallet credentials in email, digital notepads, and other insecure locations, Brooks says, people tend to forget where they put their recovery phrase — a simple human error, easy to do. But the consequences of basic mistakes like this are “exponentially magnified” when cryptography is involved, he says. In the worst case, life savings can be lost.

But with more and more crypto investors turning to self-custody, manufacturers of software and hardware wallets are trying to make their products more accessible and the process less risky.

This week, Ledger is launching a new service called Ledger Recover which splits a wallet recovery phrase – essentially, a human-readable form of the private key – into three encrypted shards and distributes them to three custodians: Ledger, the crypto custody Coincover, and code escrow company EscrowTech. If someone loses their recovery phrase, two of the three shards can be combined – pending identity verification – to regain access to locked funds. Ledger Recover is essentially an additional safety net; for the price of $9.99 per month, this eliminates the risk of the crypto version of stuffing dollars under the mattress. It will be available in the UK, EU, US and Canada and will arrive in other territories later this year.

Gaultier says he views user-friendly, low-risk self-custody as a historic step in the development of the crypto industry — a necessary concession to convenience on the path to mass adoption. “A lot of people say they can’t get into crypto because they can’t handle the recovery phrase. That’s the industry’s problem,” he says. many more people to join space.”

Ledger’s main competitor in the hardware market, Trezor, has its own solution, called Shamir Backup. The tool allows users to split their recovery phrase into 16 shards that can be distributed to trusted people or stored in secret locations, and specify the number of shards required to recover their wallet. It is also free for owners of the most sophisticated Trezor device. Josef Tětek, bitcoin analyst at Trezor, says he hopes more people will adopt Shamir Backup as crypto literacy improves. But the first step, he says, is to make it clear to newcomers that personal responsibility is an entry cost, if they are to take direct ownership of their money, described in crypto circles as financial sovereignty. “If you want to claim financial sovereignty, you have to be in charge,” he says. “We shout that to the user at every step.”

Not all self-guards require hardware. The team behind MetaMask, a popular software self-custody wallet for the Ethereum blockchain, has set their sights on an ambitious technical solution. The risks of running a recovery phrase are so alien, says Simon Morris, chief strategy officer at MetaMask’s parent company ConsenSys, that “it’s like teaching people to drive, but in an F1 car. “. It’s too much, too soon. So, to bridge the gap, the team is pushing for a new technical standard for Ethereum that would create a new variant of self-custody – the account abstraction, in the jargon – that looks like an in-between solution. It’s a “big business,” admits Morris.

But Gauthier says “geeky” approaches don’t fit the bill; self-care must become simpler and more user-friendly. “The industry started with geeks. But when the industry is ready to scale and move into the mass market, you can’t lead with technology. You have to lead with a product,” he says.

Ledger Recover is a service, he says, not a feature, which provides all the niceties and security mechanisms ordinary people are looking for. The recovery phase shards are encrypted and stored by each custodian on specially secured servers, and the user’s wallet balance is covered up to a value of €50,000 ($55,000) in case something goes wrong, a bit like deposit insurance in a bank. . It is also designed with a less technical user in mind.

The company’s chief experience officer, Ian Rogers, is an Apple alumnus and friend of iPod creator Tony Fadell, who helped Ledger develop his latest wallet. Rogers says he wants to combine an Apple-like UX philosophy with add-on services that make crypto less scary for non-technical audiences. In his approach to solving the big self-custody puzzle, Rogers says, Ledger is reading Steve Jobs’ book, working backwards from the end goal – mass adoption of self-custody wallets – to identify the steps needed to get there. “We have a hill to climb in terms of usability,” says Rogers. “But not everyone got the first version of the iPod on day one.”

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