FTX-ed Crypto Investors Are Moving Back to Hardware Wallets

It wasn’t long after the wheels fell off at FTX that the I-told-you-sos began. On November 11, the crypto exchange filed for bankruptcy, and billions of dollars worth of customers’ crypto was missing. How was this possible? Because FTX wasn’t just a place to trade tokens, it was where users stored them too.

Weather-beaten veterans of the crypto industry will tell you that, in allowing a third-party to store coins on their behalf, the victims of the FTX collapse made a fatal mistake. “Not your keys, not your coins,” they like to say. They advocate instead for a system called self-custody, whereby people manage their own private crypto wallets, secured by secret alphanumeric keys.

The message is now filtering through. One person with funds trapped in FTX, who asked to remain anonymous to preserve his financial privacy, says he now stores crypto in either a personal wallet or interest-bearing peer-to-peer contract. Another, who requested anonymity for the same reason, says he now keeps tokens on exchanges for only an hour at a time for trading and otherwise stores them himself. “Fuck Sam,” he says, referring to FTX CEO Sam Bankman-Fried. “But I should have managed my risk too.”

Companies that supply devices for self-custody are profiting from the mayhem in the industry, including Ledger, one of the largest makers of hardware wallets. November, the month of the FTX collapse, became the most successful in the company’s history, according to its CEO, Pascal Gauthier. Between June 2022 and February 2023, amid the crypto turmoil, the firm sold 1 million units, having sold only 5 million in the previous eight years combined. Data from blockchain analytics firm Chainalysis shows that the collapse of FTX, Celsius, and other large crypto businesses corresponded in 2022 with sharp spikes in the travel of funds away from exchanges, into personal wallets. As did the sector’s banking crisis in March.

The problem with storing crypto in a personal wallet, though, is that there’s no margin for error: Misplace the private key and 12-word recovery phrase and the crypto inside is lost forever. Famously, a British man suffered this fate when he mistakenly discarded a hard drive in 2013 that held the credentials for a wallet containing 7,500 bitcoin, worth $220 million at today’s prices. Estimates suggest that roughly 20 percent of all bitcoin, worth tens of billions of dollars, has been lost this way.

“There is a significant user-experience problem in crypto—and a lot of that has to do with self-custody and key management,” says Hugh Brooks, director of security operations at blockchain security firm CertiK. FTX may have made storing crypto with an exchange “less appetizing,” he says, but “for the average user, self-custody is a much greater risk.”

Beyond storing wallet credentials in email messages, digital notepads, and other insecure locations, Brooks explains, people are prone to forgetting where they put their recovery phrase—a simple human error, easily made. But the consequences of basic mistakes like this are “amped up exponentially” when crypto is involved, he says. In a worst-case scenario, life savings can be lost.

But with more crypto investors shifting to self-custody, both software and hardware wallet makers are trying to make their products more accessible and the process less risky.

Ledger is preparing to launch a new service called Ledger Recover that splits a wallet recovery phrase—basically, a human-readable form of the private key—into three encrypted shards and distributes them to three custodians: Ledger, crypto custody firm Coincover, and code escrow company EscrowTech.  If somebody loses their recovery phrase, two of the three shards can be combined—pending an ID check—to regain access to the locked funds. Essentially, Ledger Recover is an additional safety net; for the price of $9.99 a month, it takes the jeopardy out of crypto’s version of stuffing dollars under the mattress. It’ll be available in the UK, EU, US, and Canada and come to other territories later in the year.

Gauthier says he sees user-friendly and low-risk self-custody as a landmark step in the development of the crypto industry—a necessary concession to convenience on the road to mass adoption. “A lot of people say they cannot enter crypto because they can’t manage the recovery phrase. It’s the industry problem,” he says. “Making that pain point go away will trigger a lot more people to join the space.”

Ledger’s main competitor in the hardware market, Trezor, has its own solution, called Shamir Backup. The tool lets users split their recovery phrase into as many as 16 shards that can be distributed to trusted individuals or stashed in secret locations, and to specify the number of shards required to recover their wallet. It’s also free for owners of Trezor’s most sophisticated device. Josef Tětek, bitcoin analyst at Trezor, says he hopes more people will adopt Shamir Backup as crypto literacy improves. But the first step, he says, is making clear to newcomers that personal responsibility is a cost of entry, if they want to take direct ownership of their money—described in crypto circles as financial sovereignty. “If you want to claim financial sovereignty, you need to be in charge,” he says. “We’re screaming that at the user at every step.”

Not all self-custody requires hardware. The team behind MetaMask, a popular software self-custody wallet for the Ethereum blockchain, has set its sights on an ambitious technical solution. The risks of managing a recovery phrase are so foreign, says Simon Morris, chief strategy officer at ConsenSys, parent company to MetaMask, that “it’s like teaching people to drive, but in an F1 car.” It’s too much, too soon. So to bridge the gap, the team is pushing for a new technical standard for Ethereum that would create a new variant of self-custody—account abstraction, in the jargon—that is something of a halfway house. It's a “large endeavor,” Morris admits.

But Gauthier claims “geeky” approaches don’t fit the bill; self-custody needs to become simpler and more user-friendly. “The industry started with the geeks. But when the industry is ready to evolve and go to the mass market, you can’t lead with technology. You have to lead with a product,” he says.

Ledger Recover is a service, he says, not a feature—one that provides all the niceties and safety mechanisms regular people are looking for. The fragments of the recovery phase are encrypted and stored by each custodian on specially secured servers, and the balance of the user’s wallet is covered up to a value of €50,000 ($55,000) if something goes awry, a little like deposit insurance at a bank. It’s also being designed with a less technical user in mind.

The company’s chief experience officer, Ian Rogers, is an alumnus of Apple and friends with Tony Fadell, the creator of the iPod—who helped Ledger develop its latest wallet. Rogers says he wants to combine an Apple-like UX philosophy with complementary services that make crypto less scary for a nontechnical audience. In its approach to solving the big self-custody headache, explains Rogers, Ledger is reading from the book of Steve Jobs, working backwards from the end goal—mass adoption of self-custody wallets—to identify the necessary steps to get there. “We have a hill to climb on ease of use,” says Rogers. “But not everybody got the first version of the iPod on day one.”

Correction, 10:55 am 05/02/23: Corrected the launch date of Ledger Recover, to reflect that its release has been delayed.