Institutional bitcoin HODLing may seem antithetical to decentralization and greater inclusivity, but it could be the harbinger of better digital asset security.
Distributed ledger technology has only scratched the surface of its potential, and bitcoin is in many ways bringing these possibilities into the limelight, so much so that it has sparked unprecedented global adoption.
Moreover, the growing institutional embrace is a force to be reckoned with, and MicroStrategy’s accumulation is just one strong example of the accelerating purchase pace. CEO Michael Saylor has been a strong proponent of corporate balance sheet additions and institutional acceptance, even convincing Elon Musk to add over $1.5 billion of the seminal cryptocurrency to Tesla’s treasury.
While bitcoin enthusiasts may view the development as contradicting their perception of decentralization, in many ways, greater institutional embrace may actually strengthen bitcoin’s appeal, and in time, its resilience. What may be lost on the decentralization and inclusivity champions is bitcoin’s still-steep learning curve preventing their vision from fully materializing. Institutional investors may - surprisingly - hold the key to unlocking its potential by promoting better asset custody methods, the Achilles’ heel of the current wallet structure.
The Storage Conundrum
Troublesome digital asset storage has long dented bitcoin’s reputation. Some estimates postulate that as much as 3.7 million bitcoin out of the approximately 18.8 million currently mined are permanently lost due to forgotten secret keys, amounting to nearly a quarter of a billion dollars at today’s prices. Whether the result of negligence, accidents, theft, or otherwise, this staggering figure highlights the true scope of the problem and just how easy it is to misplace a password.
Would institutional investors enter a market where the risk of total loss was so effortless that an entire multi-million or billion investment portfolio could be compromised by a single point of failure? Probably not. If anything, they would demand robust digital asset security that isn’t necessarily widely available.
For instance, you certainly don’t believe that Michael Saylor is the only holder of the 24-word seed phrase for MicroStrategy’s wallet. Imagine that he suddenly forgot the passphrase in one fell swoop and compromised the entire company’s holdings. This will not happen. The company has likely recognized this glaring risk and incorporated digital asset security measures that store private keys, restrict access, and facilitate recovery efforts if the worst-case scenario unfolds.
The very complexity at the heart of bitcoin’s design is anything but a hindrance, and in fact, this same complexity is the source of bitcoin’s robust architecture. Yet, the highly complex storage matter has been at the heart of many efforts to reverse this reality. In effect, removing the single point of failure posed by human error is instrumental for preventing more widespread permanent loss, and assuring bitcoin’s long-term resilience.
Functional Resilience In The Form Of Reduced Complexity
Among the answers to the storage quandary, vaults represent one of the many solutions proffered by digital asset custodians, effectively forming an offline consensus mechanism for accessing locked cryptocurrency. Offline storage is practical but nevertheless flawed, primarily if your consensus mechanism relies on people to be physically present to unlock the “vault” and bring one’s cryptocurrency out of cold storage and back online. Guaranteeing a 24-hour physical presence presents apparent obstacles. Accordingly, creating their own functional “vault” is possible but logistically tricky for institutional investors that require constant and immediate access.
One alternative to this physical custody option is the multisignature (multisig) wallet. Through this wallet security model, each transaction requires multiple signatures from multiple parties, known as cosigners, to process. For instance, when creating an Electrum multisig wallet, the number of cosigners must be selected along with the number of cosigners who must sign transactions to process them. For instance, a wallet with four cosigners might require two cosigners to sign a spending transaction.
Each cosigner then generates a new seed for the two seed types (Segwit or Legacy). Once generated, it is the responsibility of the cosigner to keep it secure (and not share it with the other cosigners). After confirming the seed, Electrum generates a master public key (MPK) which should be shared with the wallet cosigners. Once all cosigners have all the master public keys, the wallet can be created. Once completed, the service will generate a wallet address, which requires the cooperation of cosigners to process any spending transactions from the wallet.
There are slight variations on this theme, like Specter Desktop, which allows users to list hardware devices like Trezor or Ledger S wallets as cosigners, requiring a certain quorum of the devices to sign and send transactions. Still, some of the hurdles are similar to those exhibited by vaults. While a single-signature wallet’s single point of failure problem is addressed, exploitable code vulnerabilities have arisen historically. Moreover, as teams change, signatures and permissions must be updated, not to mention the previously described availability element.
Even the idea of hardware security modules (HSMs) has been promoted, but that ends up steering the conversation back to the single point of failure. HSMs effectively encrypt private keys and decrypt them for transactional use. While effective against theft, it doesn’t mean they can’t be compromised by an enterprising hacker and used to drain a wallet address. Greater still is their expense, putting them out of the reach of most ordinary bitcoin HODLers.
One of the viable alternatives that can mitigate these different variables is multiparty computation (MPC). To avoid the single point of failure, MPC eliminates a single private key and replaces it with a process that involves at least three endpoints that don’t share the entirety of secret keys. This allows for a distributed signature consensus process to validate and sign transactions. Besides reducing the risk of theft and hacks by distributing secret key storage, among the most significant benefits is modifying the process or endpoints without requiring parties’ consent with signature rights like in the storage models mentioned above.
According to ZenGo CMO Elad Bleistein, “MPC-powered crypto wallets don't think a 24-word seed phrase is viable for most humans and have built this tech into their user experience. This means only you can access your assets, but also that they're recoverable in the event of a mistake."
Allaying Institutional Fears As The Key
When evaluating investing technology’s historical track record, institutional innovation eventually trickles down to the retail level. Institutional investors have the firepower and capital to develop and implement novel solutions, which ultimately become the gold standard for other institutions and retail investors alike. This paradigm may also ring true in the cryptocurrency markets, and MPC solutions could herald an enormous transition in storage methodologies.
MPC solutions effectively remove the single point of failure issue. Alongside their growing track record and increased institutional interest, they may pave the way for internal storage models that invite more widespread institutional participation. Moreover, it may be a boon for individual HODLers who seek a more robust methodology for protecting their private keys.
Together, these parties and systems can keep the maximal amount of bitcoin in circulation, which, in turn, contributes to the overall resilience and longevity of the bitcoin cryptocurrency. How adoption evolves is anyone’s guess, but it’s hard to argue against the benefits of more straightforward and accessible wallet key security and storage methodologies.
This is a guest post by Reuben Jackson. Opinions expressed are entirely their own and do not necessarily reflect those of BTC, Inc. or Bitcoin Magazine.