Ask CryptoVantage: Does Holding Bitcoin in a Bank Defeat the Purpose?

How Did We Get Here?

There is often a narrative around Bitcoin that it is nonpolitical and indifferent to anyone’s race, religion, sexual orientation, or geographical location. It only works and remains censorship-resistant if it works for everyone, regardless of their individual makeup.

While this narrative is certainly true and fundamentally what makes Bitcoin work, the narrative that it is nonpolitical is not strictly accurate. We know this because Satoshi Nakamoto told us.

The political ideology of Bitcoin does not lie within any one political party or in any traditional framework. Rather, it is based on a single issue that is direct and pointed at the corrosive nature of the current financial makeup of central banks.

Again, we know this because, within the Genesis block of the Bitcoin blockchain, Satoshi left a message.

“The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.”

The message is short, succinct, and clear in its meaning. That Bitcoin is a means to remove the current banking infrastructure from the equation.

Yet, as adoption grows and Bitcoin becomes more accepted, we should not be surprised to learn that banks and institutions are increasingly interested in establishing themselves as the trusted custodians of this new currency. Based on what we know about Satoshi Nakamoto’s intentions from their message in the Genesis Block, we then need to ask ourselves if an individual holds Bitcoin in a legacy bank, does that defeat the purpose of Bitcoin?

Demand for Custodians

Bitcoin was and is designed to be a peer-to-peer electronic cash system. This effectively removes the need for third-party intermediaries like banks. Historically, individuals relied on banks to hold and transfer their funds from one account to another or use some form of cash in person.

With the invention of Bitcoin, all the friction that exists between banks and across borders falls by the wayside. Individuals can transact directly with one another, anywhere on the planet, and without the need or approval of anyone else. This is why Bitcoin is such a radical invention.

However, the freedom that comes with removing banks from the equation also brings with it the responsibility of self-custody. By removing banks, individuals effectively become their own banks and are themselves responsible for safely and securely storing their Bitcoin. This can be a terrifying concept for many and a large reason why many people new to Bitcoin are drawn to custodial exchanges that hold their private keys for them. This trend will most likely accelerate as more people who are Bitcoin illiterate and crypto-foreign are onboarded.

The trend of preferring custodial third parties is especially prevalent in markets that have historically been stable with layers of institutional trust built in. Countries where the banks historically haven’t caused hyperinflation or pillaged users’ funds and where there is a peaceful transfer of power between governments.

Why would someone who trusts the system be worried about trusting their bank to hold Bitcoin similar to their fiat if they have never had a problem to date?

Bitcoin’s Purpose

It is precisely that you don’t need to trust – that Bitcoin works. This is why someone in a historically stable economy wouldn’t need it. Bitcoin is referred to as being trustless. No single person, government, or institution can alter or change its code without the community’s consent. You simply need to refer to the code, which anyone can do, and be reassured that your transactions are secure and accurate.

Bitcoin’s architecture is designed to remain immutable, censorship-resistant, and un-seizable. As long as the user remains in control of their private keys, these fundamental tenets remain true for that user. It is whenever users start engaging with third parties that the issues start to arise.

The Problem with Third-party Custodians

When we look at the recent history of centralized custodial exchanges that offer to hold Bitcoin on behalf of their customers, we see a disturbing trend. The trend is that whether through mismanagement, corruption, or embezzlement, these centralized exchanges frequently result in spectacular collapses.

In 2014 Mt.Gox was the largest Bitcoin exchange, moving over 70% of all Bitcoin transactions at its height, before losing over 650,000 BTC from its reserves from a simple hack.

A full cycle later, in 2018, the Canadian-owned QuadrigaCX exchange faced a similar fate when its founder, Gerald Cotton, was suddenly reported dead, taking with him the only record of private keys to the main account on Quadriga.

Finally, how can we forget the largest and most recent collapse with Sam Bankman Fried and his FTX exchange. Valued at over $40 billion at the time, the exchange unraveled within a matter of days and took a large portion of the industry with it.