Know your service, KYS
In this article, we will explore the factors that influence the selection of a service through which we operate our assets, the risks of choosing different services, and the differences between them.
Table of Contents:
- Questions when choosing a cryptocurrency intermediary;
- What is a custodial service;
- Risks of using custodial services;
- Avoiding risks;
- Non-custodial services;
- Key differences between custodial and non-custodial services;
Questions when choosing a cryptocurrency intermediary.
The general elements in the decision we make when choosing a service through which we can manage our funds are trust in such a service, ease of use, and cost-effectiveness. In a confident decision, these elements coexist positively and do not contradict each other. The risky consequences of such a decision are minimal. However, sometimes we make decisions in which, by favoring one or more of these elements, we compromise others. This situation arises, for example, when we choose either a convenient service or a service we can trust. By making such a decision, we choose convenience, while the issue of trust remains doubtful or vice versa.
The rapid growth of the cryptocurrency market has given rise to many cryptocurrency intermediaries offering services that facilitate cryptocurrency transactions and make them more convenient. These intermediaries include cryptocurrency exchanges, which allow for quick exchange of one cryptocurrency for another or for fiat; cryptocurrency processors that facilitate cryptocurrency transactions (sending and receiving), and cryptocurrency custodians, among others.
When assessing a service for its ease of use, we pay attention to the clarity of its interface, the availability of customer support, and additional information and services. These options will undoubtedly be advantages when deciding which service to choose.
However, if accessing the service requires disclosing personal information and effectively handing over your assets, the decision to choose such a service can be questionable without an appropriate level of trust, and the consequences of its acceptance can be risky.
We have encountered the first trust issues when dealing with traditional financial institutions (banks, processing services, etc.), which essentially acted as our trusted intermediaries when handling funds entrusted to them. Issues of trust were partially resolved by the presence of public information about the financial intermediary, and the risks of their wrongful actions were addressed through government regulation and legal mechanisms for the recovery of violated rights.
The operating model of some cryptocurrency services is similar to the model of traditional financial institutions; they also receive our assets to carry out certain operations on our behalf. But how can we determine trust in this context?
What is a custodial service.
A service that needs to take possession of an asset to provide a service is considered custodial. In the terminology, the term 'custodian' has already appeared, referring to an intermediary that has control over a client's key or crypto asset, executing agreements or actions at the client's request.
"Control" means the ability to hold, trade, transfer, or spend crypto assets. Individuals who can use crypto assets or change its disposition have control over them. "Control" may include situations where keys or account data required to change the location of assets are held by other individuals. Initially, the owner has control over the crypto assets or keys, but by using the services of custodial intermediaries, this control is transferred to them.
In other words, custodial intermediaries are those intermediaries to which you transfer your assets in order to carry out a specific operation. To access such services, users typically need to authenticate, obtain account data on the service, and disclose personal information, at a minimum, such as email, phone number, password, and sometimes personal details (last name, first name, address). The information you disclose is stored on the servers and databases of such a service. Therefore, in addition to crypto assets, these services also obtain personal information about the client.
Risks of using custodial services.
The issue of trust always arises when interacting with anyone, and it comes with the presence of risks in such interactions. Key risks when dealing with a trusted intermediary include the risk of asset loss, which can occur both at the stage of actual transfer of crypto assets and during the disclosure of personal information. History has already recorded cases of loss of crypto assets when transferring them to intermediaries. The most common reasons for such cases are artificial bankruptcy of a custodial service, cyberattacks leading to the withdrawal of clients' crypto assets from the intermediary's wallets, and freezing of crypto assets due to regulatory actions against the intermediary's violations of the law. The disclosure of client information for access to cryptocurrency intermediary services also poses risks of asset loss. This often happens as a result of data compromise in the case of hacking attacks. Criminals obtain your contact information, making it easier for them to access your funds. For example, through hacking a custodial service's database, a criminal gains access to your account password, which provides direct access to the wallet with crypto assets. Additionally, the information obtained from the compromised accounts can be used to compromise your email or other accounts, as people often use the same passwords for various accounts. The reverse can also be the same. By gaining access to your email, a criminal can attempt to recover access to the service and manipulate your crypto assets.
Furthermore, for criminals to obtain additional information about you, they may use social engineering to regain access to your account. Social engineering involves deceiving the account holder to obtain additional information or using known data to deceive the service's support, as custodial services typically provide account recovery mechanisms when the account is lost.
When using cryptocurrency services, doubts about trust can be amplified, and the risk of asset loss significantly increases due to the absence of official registration of such a service provider in existing jurisdictions and its lack of subordination to government control. You may not even know who stands behind a particular service and to whom you have given control over your crypto assets or keys, as well as disclosed information about yourself. Interaction with such a service is not supported by a system of influence from government authorities, which leads to a loss of legal mechanisms for restoring your rights in case of their violation.
Therefore, the mere fact of transferring funds and information to intermediaries raises doubts about trust and entails the risk of asset loss.
Sometimes, when using certain services, we imagine that the wallet of the service accounts is our own, and the assets stored on it are safe. However, if when using the service, your crypto assets can be frozen or access to such a wallet is restricted, for example, due to service access blocking, such a wallet is not yours. It belongs to the cryptocurrency service, which simply associates it with you, similar to accounts in a bank. By transferring assets to such a wallet, you effectively hand them over to the intermediary.
Avoiding trust risks.
So, can cryptocurrency services be used without the risks of crypto asset loss and information leakage mentioned above?
The answer to this question was once given by Satoshi Nakamoto in his Bitcoin whitepaper, where he highlighted the issue of trust in financial institutions, justifying it with unnecessary transaction costs and the risks of asset loss when transferring them to such intermediaries. He solved this problem by eliminating intermediaries from asset transactions. This possibility is enabled by the technology he developed, which aimed to provide the ability to conduct peer-to-peer (P2P) transactions, i.e., transferring assets directly from one participant to another. As you may have already understood, this refers to blockchain.
This form of interaction can be called non-custodial, meaning that it is conducted without the intermediate transfer of crypto assets to an intermediary for further processing.
Non-custodial services
The convenience of conducting P2P transactions, whether it's asset transfers, exchanges, or storage, is provided by non-custodial services, which offer services without taking control of crypto assets, keys, or client account data.
This possibility is achieved through automated solutions for P2P transactions, eliminating the need to receive, store, and transfer your cryptocurrencies for the provision of intermediary services. Non-custodial intermediaries have no control over clients' crypto assets and cannot influence the course of the transaction. In fact, these services offer software that facilitates P2P transactions without transferring control of crypto assets to third parties. Therefore, control over crypto assets and keys remains with the service user, and any issues with such a service, whether it's bankruptcy, regulatory sanctions, or hacking attacks, will not result in the loss or restriction of ownership of crypto assets by their owners.
To provide a convenient interface, using a non-custodial service may require client authentication to create their account data. However, the information in such account data is not linked to access to the client's wallet, so a compromise of this data will not lead to the loss of crypto assets. Control over the wallet and crypto assets remains with the owner.
Key differences between custodial and non-custodial services
In summary, we can briefly outline the main differences between custodial and non-custodial services.
Custodial services require the transfer of assets or keys and account data to a third party. The cost of using such services is typically higher because it involves additional expenses for asset storage and service maintenance. Transaction times are usually longer, as more transactions are needed to complete a single operation, and you need to wait for confirmation of fund withdrawal. In most cases, custodial services also require identity verification (KYC) and collect and store your personal information. Using such a service is convenient due to an attractive interface and customer support, and it provides peace of mind by offering the ability to recover access to a wallet with crypto assets in case of loss, by contacting customer support.
When using non-custodial services, there is no transfer of assets, keys, or account data to a third party i.e. intermediary. Control over assets and wallets belongs solely to their owners. The cost of using such services is typically lower. Transaction times are shorter, thanks to the execution of a single P2P transaction. Non-custodial services do not collect your personal information and do not require identity verification (KYC). Convenience in using such a service is ensured by an interface whose account data does not grant actual access to your wallet or assets. Customer support can only be contacted for technical usage-related issues since non-custodial services cannot influence the course of your transactions.
In summary, the key differences between custodial and non-custodial services are as follows:
The key criteria outlined in this article serve as a foundation for making informed decisions when choosing a cryptocurrency service. We hope that this article has been useful to you, and that the decisions you make will have positive outcomes.
Your non-custodial cryptocurrency service Bcon.
