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When individuals forget their online banking credentials, they simply need to visit their local bank branches with the necessary documents to identify themselves and regain access to their accounts. The same goes for traditional brokerage firms, where they can reset their password online or contact support for assistance with the recovery process.
But while recovery is easy for custodial services like online banking and brokerage firms, things can get a bit complicated in cryptocurrencies. On the one hand, self-custodial significantly reduces counterparty risk and prevents loss of funds in cases like the Mt.Gox hack and FTX bankruptcy. On the other hand, it also comes with more responsibilities for investors.
If crypto investors lose their private keys or seed phrases, there is no customer support team to help them recover their self-custody wallets. At that point, the funds are lost forever. In fact, the Chainalysis report notes that Estimates 3.7 million Bitcoin (BTC), worth over $220 billion at $60,000, have been lost, representing 18.74% of the current circulating supply. Meanwhile, personal research by Coinbase CEO Conor Grogan showed Reveals More than 912,000 Ethereum (ETH) coins have been lost forever (worth $2.41 billion). While this represents only 0.75% of the total circulating supply of Ether, lost keys account for 27.5% of cases.
The most common scenarios for losing access to cryptocurrency wallets
In what situations do seasoned crypto users, Web3 creators, and business owners lose access to their cryptocurrencies? Let’s take a look at some typical scenarios to better understand the events that can lead to key loss.
in Scenario 1A crypto user stores the private key on his desktop and keeps a backup copy of his seed phrase on the same machine. After upgrading to a new machine, he wipes the hard drive of his old computer, forgetting that he stored his keys and seed phrases there. Thus, his crypto holdings are gone forever.
Scenario 2 This article presents another horrific case of human error. This time, an investor backs up his recovery phrase offline, prints it out on a piece of paper, and stores it in his home with other documents. However, after moving to a new apartment, the paper with the seed phrase disappears, and the investor is unable to recover his wallet.
in Scenario 3The founder of a cryptocurrency startup trusts the organization’s COO to manage the company’s finances. In addition to the company’s bank and exchange accounts, the COO controls all the private keys belonging to the project’s digital asset wallets. After a heated argument with the founder and other team members, the COO resigns, refusing to provide access to the startup’s cryptocurrency wallets.
While the organization can regain control of its custodial accounts, it cannot interact with its digital asset holdings because the COO has left with the private keys. In this case, a forensic investigation is the only reasonable course of action the startup can take to recover its assets. However, the case could take several years to conclude, and success is not guaranteed.
These are just a few examples of how experienced cryptocurrency users have lost access to their digital asset wallets. Other instances of cryptocurrency loss may include data corruption, hardware failure, malware, hacks, counterparty risk, death, and fraud.
Prevent users from accessing their cryptocurrency wallets
If crypto investors do not have access to their private keys or seed phrases, their only hope is wallet recovery solutions. However, the chances of success are slim in most cases, and many fraudulent service providers operate in this space, asking for upfront payments without providing any real service.
This is why a more efficient alternative to wallet recovery services is decentralized trust. When creating a decentralized trust, cryptocurrency investors designate a backup wallet in case something happens to their main wallets. Let’s say they accidentally misplace their private keys and seed phrases, resulting in losing access to the digital assets stored in their main wallets.
In this case, after several months of inactivity, the decentralized trust recovery mechanism automatically transfers users’ assets from their main wallets to their backup wallets. Since investors have access to their backup wallets, they can now interact with their crypto wealth, which would otherwise have been lost.
There is also no need to worry about losing money due to the owner’s death. A decentralized trust can be set up to pass the inheritance to heirs based on pre-defined terms and conditions set by the donors.
The next step in the evolution of cryptocurrency wallets
Thanks to multi-signature technology, decentralized trust funds require multiple private keys to sign transactions. This eliminates single points of failure (like the COO of the crypto startup in scenario three), reduces the chance of human error, and protects funds from unauthorized access.
Therefore, decentralized trust is the ideal choice for DAOs, distributed Web3 teams, non-profits, and other crypto organizations to efficiently manage their collective assets. Business owners and DAO members can even configure signing rights in a flexible way to secure project assets and prevent misappropriation of funds.
Available at a fraction of the cost of their traditional counterparts, decentralized trust funds provide an effective solution for restoring access to lost wallets. As the next step in the evolution of cryptocurrency wallets, they have the potential to become a popular solution for storing cryptocurrencies. As more investors replace their legacy wallets with decentralized trust funds, fewer digital assets will be lost due to human error, fraud, hacks, counterparty risk, and single points of failure. Ultimately, this will help create a more secure and resilient crypto industry.