Self-custody costs money
We often talk about holding your own keys like it doesn't cost anything. This isn't true.
I don't think individuals are generally stupid. So if many of them are doing something (using a custodian), I wonder if they have a good reason.1
Maybe the reason so many people use things like Wallet of Satoshi or leave their bitcoin on an exchange is that they think it's cheaper than self-custody.
How much does custody cost?
Costs of onchain self-custody
- Transaction fees
- Educating yourself on best practices
- Running a node
- Risk of theft or loss through user error
Costs of using an onchain custodian
- Rug risk: you could lose everything
- KYC/AML compliance
- Transaction fees
- Lack of convenience
- Lack of privacy
From this rough comparison it seems that onchain self-custody may not be free, but it is cheaper than giving up custody.
Many custodians pass transaction fees on to their customers or force you to wait on their convenience to make a transaction. Custodians massively increase your exposure to attacks through database leaks or bad actors inside the company and because they often compel you to report identity and amounts to governments. I don't see any case2 where it is cheaper for an individual to use a custodian than it is for them to hold the keys themselves.
Is custody cheaper for Lightning?
Costs of lightning self-custody
- Locking up liquidity
- Convincing someone else to lock up liquidity
- Running a lightning node
- Paying attention
- Channel setup/close fees
- Rebalancing fees
- Routing fees
Costs of using a lightning custodian
- Rug risk: you could lose everything
- KYC/AML compliance
- Transaction fees sweeping to onchain
- Routing fees
- Lack of privacy
- uxto bloat in your onchain wallet3
If you use a custodian for lightning, you don't have to manage a node and you don't have to manage liquidity. You receive when you want and you send when you want, no sweat. However, there is the risk that you will be rugged/shotgun kyc'd or otherwise curtailed in your use of your bitcoin. This risk is probably4 the biggest cost of using lightning with a custodian. But it seems clear that, while lightning transaction fees may be lower than on chain, it costs more to be self-custodial. I can't tell if using a lightning custodian is cheaper than being self-custodial.
The Moral
Transaction costs are not the only costs associated with a given layer-2. It is also important to think about how much it costs to be self-custodial. This was a bit of a revelation for me.
Footnotes
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It is possible that I have recreated an individual version of the efficient market hypothesis which is bunk, so let's add that people can be mistaken and might not have full information. ↩
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Perhaps the Uncle Jim situation is an exception: granny giving her keys to her grandson might make sense. ↩
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Presumably, there is some number of sats, over which the risk of a rugpull is simply too large for most people to accept. We probably all have a different number, but the lower bound of this number is based on the perceived useful size of a utxo. EXAMPLE: if you think 100k sats is all that you will trust to a custodian, any time you near this limit, you might transfer out of the custodian to a wallet you control. If this is an onchain wallet, you will be creating a bunch of 100k or less utxos for yourself. (If you are transferring out to a self-custodial lightning wallet, I'm curious why you were also using a custodial one). Therefore, if your limit is too low (eg. you are only willing to trust a custodian with 25k sats) you effectively prevent yourself from using the custodian at all. ↩
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Is there such a thing as a risk-adjusted cost of using a custodian? I have never heard of any reliable way of calculating such a thing. It may be so fraught with unknowables that it isn't worth trying. ↩