What do the infamous Mt. Gox exchange, the latest cryptocurrency restrictions agreed to by the world’s regulators, and my exit from the bitcoin exchange space after eight years have in common?
The answer is bitcoin custody (how and where you secure your bitcoin) – what it was like, what it will be like if nothing changes, and how it can evolve for the better if we take the right steps. To understand why, we need to go back to the beginning, or at least to the beginning of my bitcoin trading journey.
Back in 2013, when Coinfloor was about to become a reality, the bitcoin exchange space was dominated by mount goxthe colossus of the Tokyo-based exchange.
Many people kept their bitcoin on Mt. Gox until one day it all disappeared. Users could no longer gain access to their hard-earned or purchased bitcoins. For reasons that are still not entirely clear, much of the capital held in custody with the platform disappeared, and to this day the subset that has been recovered has yet to be returned to its rightful owners.
This Mt. Gox drama was one of the main reasons our exchange, Coinfloor, was created. We wanted to restore trust in the exchange space and make it safe to hold bitcoin on an exchange. At the time, many thought that getting users to hold their bitcoins securely on exchanges was a lofty goal. But now I realize that this goal has simply created a different risk for the currencies of the exchange’s clients.
You see, eight years ago, after Mt. Gox, no one trusted exchanges to hold their money, but they wanted better ways to buy bitcoin. They would buy your bitcoin and quickly withdraw it from exchanges as fast as they could. Now, eight years later, there are dozens of decent exchanges and brokers that make it easy to buy bitcoin and trust in the exchanges is strong. Ironically, as a result, the percentage of bitcoin holders who hold their bitcoins on exchanges is at all-time highs.
You may think this is not a problem, but this is where the world’s regulators come in, through an organization called the Financial Action Task Force (FATF). FATF , is an unelected international advisory body that issues guidance designed to prevent what most countries consider financial crime. While no country is required to enact one of its recommendations, the potentially devastating effects on international trade of ignoring them mean that its proclamations are consistently implemented in almost every country in the world. So when the FATF “advises” a country to take a regulatory stance, it can assume that it will be implemented. In June 2019, they issued a guide to cryptocurrencies that included a controversial provision called “travel rule”. This rule advocates that all cryptocurrency exchanges and bitcoin brokers only allow cryptocurrency transfers to parties that they can properly identify. The challenge is that the identityless nature of cryptocurrencies makes complying with this guidance, while allowing customers to withdraw to their own wallets, difficult at best and impossible at worst.
So, once again, we are heading into a future where large cryptocurrency exchanges prevent their clients from taking possession of their own coins. But this time it will be due to an overabundance of regulation rather than a lack of it, as was the case at the time of Mt. Gox.
Over the years, I have watched the direction of regulatory travel and the growing disinterest of many investors in taking control of their coins. It seemed obvious that this was going the wrong way and needed to be resolved if we were not to risk escaping the fiat frying pan of bitcoins being held hostage on exchanges.
“But why is it a problem to keep most of my bitcoin on an exchange?” you ask. Simply put, if a regulated third party is in control of your bitcoin, no matter how trustworthy they may seem, they may be forced to prevent you from taking custody of your bitcoin. With the latest FATF rule, we already see countries like India, South Koreaand Estonia seek accelerated regulation to this effect and we can expect more to follow. If left unchecked, the end result could be that the majority of bitcoins are stored in a handful of centralized exchanges, leaving bitcoiners without sovereignty of their own.
This is a concern because Bitcoin is only successful if all of its core components (mining, payments, software development, and custody) remain strong and decentralized. For someone dedicated to seeing Bitcoin reach its potential to separate money from the state and thus create a fairer world through a more efficient economy, nothing could be more important than strengthening the foundations of Bitcoin. Helping protect these core areas of Bitcoin was one of the main reasons I decided to sell my company and leave the bitcoin exchange space, which is why I sought to become a member of the board of directors of the Bitcoin developer incubator. ₿Trustand why I am also involved in solving the custody issue with my support of FediMint.
FediMint is a new form of escrow that allows users to form groups in which members hunt each other’s bitcoins. It’s still in the early stages of development, but it shows a lot of promise. It leverages the smart technology and very human circles of trust we all possess to provide a custody solution that is more convenient than holding bitcoin on a third-party exchange and less expensive and complex than most self-custody solutions. FediMint has the additional advantages of improving user privacy, scaling Bitcoin, reducing on-chain usage fees, and can provide a no-exchange bitcoin custody solution that is equally viable for people in the western world and the rest of the world.
FediMint has three simple yet powerful elements:
The first is that FediMint is designed to be used by pre-existing groups where members already have high levels of trust with each other. Families, close friends, small towns, community groups, etc. are all examples of groups with strong second party Relationships This is in contrast to the distant third party relationships offered by an exchange or the first party relationship offered by self-custody. This setup also has the additional advantage that it is often exempt from most regulatory considerations, as the third-party relationships and lack of profit would mean that it is considered a non-commercial activity.
The second part is to split the custody challenge in two. It does this by recognizing within any given group that there will be some more capable of protecting the group’s bitcoin than others. The most capable “pool keepers” do the heavy lifting, hosting the pool wallets and processing transactions, while the other pool members have an ultra-simple app that offloads all the complex stuff to the pool keepers. Side note: This may sound unusual, but it’s already commonplace these days. Anyone who has been in the Bitcoin space for a while has probably experienced a time-poor or less tech-savvy relative or friend asking you to buy, sell, hold or transfer bitcoin on their behalf, thus acting as their gatekeeper. Bitcoin. As a long-time bitcoin exchange trader, I’ve heard so many anecdotal examples of this happening that I wouldn’t be surprised if most bitcoin “owners” are already acquiring their bitcoins through guardians, but there’s no way of knowing. . Of course.
The final part of FediMint is the use of two powerful technologies, federations and mints chaumian e-cash, to eliminate any weak points and maintain total privacy for all users, and is the reason behind the unusual name of FediMint. A federation is a mechanism that shares custody of the group’s bitcoin among all custodians. This ensures that the majority of guardians must act to complete a transaction and that the system can tolerate noncompliance by a minority of guardians without affecting its performance. Chaumian e-cash mints are a cryptographic tool that allows the federation gatekeepers to process transactions on behalf of any member of the group without knowing who they are or how much they have. This ensures financial privacy even though the members of the group have delegated the complicated task of managing their bitcoin holdings to the gatekeepers.
As a whole, the FediMint system provides a custody solution superior to any other:
* Protocols exist to deal with many of the shortcomings of naive self-custody, but they add more expense and even more complexity.
† The costs to set up and operate a FediMint are similar to those required to properly set up and operate a multisig hardware wallet, but the cost can be shared among all members of the federation group.
†† Federation guardians could potentially recover a user’s bitcoin in the event of loss, forgetfulness, or death by using their existing trusted second-party relationships (ie, friends or family) to verify the user’s identity.
††† Sovereignty is delegated to trusted third parties, so it is not as perfect as true self-custody. However, the process of backing up a hardware wallet’s private key likely involves trusting third parties such as friends and family, or even third parties such as banks or safe deposit vaults, which makes the real difference between the custody of a second and a first is less. significant.
When I was first introduced to FediMint by its inventor (who goes by the alias “elyrion“) in mid-2021, I immediately saw that this was a practical solution to the Bitcoin custody challenge. I now support the FediMint project and encourage all Bitcoiners to do the same. With time and effort, we can help FediMint become an essential part of the infrastructure that makes Bitcoin reach global adoption while remaining decentralized and strong Helping make this happen and preventing Bitcoin users from losing access to their own coins is a truly noble goal.
For more detailed and technical information, visit FediMint.org.
This is a guest post by Obi Nwoso. The opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.
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