Safeguarding your BTC with noncustodial exchanges and wallets

6 August, 2019

There is little doubt that being able to deposit BTC to play online is a great option to have. The online gambling industry has shown great willingness to embrace the cryptocurrency community by accepting popular cryptos like Bitcoin, Litecoin, and Ethereum as payment systems. Yet even in the midst of all of the positivity and good feelings, crypto users still have to take a pragmatic approach to security.

It is with that in mind that we want to bring up the topic of noncustodial exchanges and wallets. Exploring this topic reveals that how you store your crypto assets is just as important as how you spend them. It is great to talk about Bitcoin gambling and depositing BTC to play slot. But without proper attention to storage and security, you could lose all of your digital assets overnight. Playing slots with BTC would then be a moot point.

A Bitcoin refresher

Let us begin with a quick refresher about how Bitcoin actually works. Bitcoin is a cryptocurrency platform developed as an alternative monetary system about a decade ago. Bitcoin trades on exchanges under the symbol BTC. If you own it bitcoins, you own BTC.

You obviously know that BTC is not represented as physical coins you carry in your pocket. There are no physical bills you can deposit into a bank account. BTC exists as encrypted computer data on a distributed ledger. It is for this reason that security is such a big concern.

The proof that you own BTC are the addresses you use to send and receive coin. Furthermore, the digital wallet in which your BTC resides is not any more physical than BTC itself. It is merely computer code that provides a framework for you to generate and save addresses. What it all comes down to are those addresses. Without them, you have no access to your BTC.

Private keys and mnemonic seeds

Public and private keys are required to transact business in BTC. A public key is broadcast across the entire Bitcoin network immediately following a transaction for the purposes of alerting computer nodes that the transaction has taken place and needs to be verified. The nodes use that public key to do what they do.

A private key exists between sender and recipient so as to facilitate the actual transfer of coin. Once again, you need to store your private keys - as both sender and recipient - in your digital wallet. And if you use a digital wallet that also makes use of encryption, you need mnemonic seeds to access your BTC once it has been placed in the wallet.

Not to beat a dead horse here, but once again none of this is tangible. It is all just data. The question is who controls the data. That leads us to the discussion of custodial and noncustodial control

Custodial vs noncustodial control

The idea of control in the cryptocurrency space is nearly identical to control of more traditional securities. Imagine an investor with mutual fund holdings. That investor gives money to the fund manager to invest on his behalf. Because the fund manager has possession of the money and is responsible for investing it, he is considered the custodian of that money and the assets associated with it. He has custodial control under the law.

Cryptocurrency works much the same way. When you purchase BTC on an exchange and then store it there, you are giving the exchange custodial control. If you use a service like Coinbase and leave your BTC holdings in that account, you have given Coinbase custodial control.

Essentially any exchange or wallet service that stores your BTC assets for you has custodial control. You only take control yourself by creating your own wallet and storing your own data in it.

As for noncustodial control, the phrase is really a misnomer. A third-party organization that provides noncustodial services doesn't actually have control over your assets. Still, we used the phrase to differentiate two different kinds of services. Coinbase acts as a custodial exchange while a service known as ShapeShift provides noncustodial services.

A noncustodial exchange

ShapeShift is a relatively new kind of cryptocurrency exchange that offers its service on noncustodial basis. They would certainly be a good choice for converting fiat into BTC for the purposes of online gambling. They allow you to make an easy and quick conversion with virtually no strings attached. You can take your newly converted BTC and deposit it at an online casino with relative ease.

How does ShapeShift work? It starts with you opening an account by visiting their website. Next, you have to actually create a BTC wallet into which you can accept funds. This might require you dig around a bit to find a wallet you are happy with. For the sake of this discussion, we will assume you have downloaded a wallet app to your laptop computer, installed the app, and created a wallet.

You can use your wallet app to create a one-time address. Then go to the ShapeShift website and use your credit card to buy some BTC. ShapeShift will ask you for the address you want the coins sent to. You provide the address generated by your wallet. That's it. Within minutes, the transaction will be completed, and you will be the proud owner of BTC.

Now you have BTC in a wallet and the capability of generating more unique addresses. You can use those addresses to buy things with BTC. You can use them to make BTC deposits to play slots. You can even use them to convert between BTC and other cryptocurrencies on the ShapeShift website.

The point here is that ShapeShift does not maintain custody of your BTC. Every time you complete a transaction, whether it is purchasing new coin or converting between cryptocurrencies, ShapeShift sends the funds to your wallet using the unique address you generate. They never hold your assets. As such, they act as a noncustodial exchange.

A bank vs a currency exchange

If you are still not getting it, think of it in terms of a physical bank and an airport currency exchange. You can deposit fiat into your bank account. If you need a foreign currency because you are planning an overseas holiday, you can go to the bank and withdraw a certain amount of funds converted to the other currency. Meanwhile, the bank maintains custody over those funds remaining in your account.

What if you didn't have a bank account? You could still procure your foreign currency by taking fiat with you to the airport. You stop in at the airport currency exchange and make the swap. What you give in your native currency is returned to you in foreign currency. The currency exchange makes the swap without maintaining custody over your funds. They are noncustodial as opposed to your bank being custodial.

Why any of it matters

Hopefully you now understand at least the basics of custodial versus noncustodial control. If so, perhaps you are wondering why any of it matters in light of the fact that you only use BTC to make small purchases and to play or other casino games. What you are wondering is not unusual. But please understand that the answers to your questions are quite important.

Allowing an exchange or online wallet service to maintain custody over your digital assets is no different than allowing a bank custody of your fiat. At least there is no difference in principle. There is a significant difference in practical administration though.

Fiat is tangible where cryptocurrency is not. The likelihood of you being locked out of your bank account is quite slim as long as you can prove your identity. And should the bank lose your money for one reason or another, it is covered by a government insurance. The chances of you ever completely losing money stored in a bank account due to fraud, theft, and acts of God are pretty slim.

The same is not true for cryptocurrency. Because your digital assets exist only as computer code on a network, you are already at a disadvantage in recovering lost assets. But the challenge is exacerbated by the fact that your private keys, addresses, and mnemonic seeds are the only things that give you access to your assets. If you lose any one of the three, you are forever locked out. You cannot recover your funds.

Storing BTC with an exchange or an online wallet service means you are trusting that entity to safeguard your assets. What if that organization goes out of business without first providing you with the addresses pertaining to your coins? What if the company suffers a massive hardware failure and loses all of its data?

Your exchange or online wallet service could also be hacked. Perpetrators could steal your BTC just by stealing the addresses and keys that go with it. The whole point of using noncustodial services and maintaining your own cold storage wallet is to protect against these very things.

Playing with BTC is a wonderful thing. We wholeheartedly endorse it. But we also encourage our readers to look into noncustodial services like ShapeShift. They make it possible to buy and sell in the cryptocurrency space with significantly less risk.