Can DeFi have a positive effect on the self-custody of assets?

Centralized exchanges like Coinbase and Binance have onboarded hundreds of millions of new people into cryptocurrencies. It is likely that without them, current adoption would be significantly lower. The problem is that these people leave assets on exchanges and have no interest in the self-custody of their assets. Can DeFi change that?

How many people hold assets in their own wallets?

Based on the on-chain data analysis it is possible to find out how many addresses exist on which there is value (assets). Unfortunately, it is not possible to determine if one user owns multiple addresses. It is common that people to use multiple blockchain addresses. It is even a recommended practice as it increases privacy. It is also impossible to know if the addresses belong to a centralized exchange (some exchanges publicly mark the addresses as theirs). One exchange address may contain many coins that belong to a large number of users. The private keys to these addresses are held by the exchanges.

What is the ratio between users of exchanges and those who hold assets in their own wallets?

Analytics have examined how many people around the world own cryptocurrencies. If the analysts' results are to be relied upon, that could be 420 million people. The total number of users can be confronted with the number of blockchain addresses with value. We have to take into account the number of people holding a particular cryptocurrency. Let's say BTC is held by 75% of all cryptocurrency holders, which could be 315M people.

All existing BTC coins lie at 40.5M Bitcoin addresses. As we indicated, this number does not reflect the number of users. If each user had their BTC at an average of 4 addresses, there would only be 10M people using their own Bitcoin wallet. If the average number of addresses used by a user was 10, there would be only 4M users.

If we compare the number of BTC owners with the number of on-chain addresses, we find that only about 1-3% of people use their own Bitcoin wallet. Even if everyone who holds BTC in their own wallet used a single Bitcoin address, those people would be roughly only 12%.

More than 90% (but more likely over 95%) of people hold BTC on a centralized exchange or other custody solution.

How many ADA holders are there in the world? Research done in the US suggests it could be 6-10M. If we consider that the US has approximately 13% of the total number of cryptocurrency holders, there could be roughly 50M ADA holders. If one percent of all cryptocurrency holders also own the ADA coins, that would be 4.2M people. Given that Cardano has been in the top 10 since 2017, this project is publicly well-known. Therefore, it is plausible that ADA can hold 5-10% of those who hold cryptocurrencies. This brings us to 20-40M.

There are 2.3M Cardano addresses with value (ADA coins). This is the potential maximum number of users. However, if we divide the number of addresses by 4 and 10, similar to Bitcoin, we get to 230K-575K ADA holders. Addresses of exchanges are included in the result.

In the case of Cardano, it appears that only about 1% of people hold ADA in their own Cardano wallet.

Similar to Bitcoin, most ADA owners hold coins on exchanges. It's very likely that more than 95% of people do (maybe as many as 99%).

We will make a few comments on the results.

In the case of Cardano, it would be very dangerous if most of the coins were held by the exchanges. Given that the largest exchange, Binance, currently has only a 4.2% stake in staking (it used to be over 10%), it is likely that Cardano whales stake ADA from their own wallets and a large number of people on the exchanges hold small amounts of ADA coins. This topic deserves more exploration.

It is possible that the research is not accurate and the total number of cryptocurrency holders is significantly smaller. In that case, there would be a larger number of people using their own blockchain wallets. However, even if there were only 100M holders of cryptocurrencies in the world, exchanges would dominate as a place where people hold them.

Centralized exchanges have helped many people own cryptocurrencies, and it's possible that if people were forced into self-custody, they wouldn't be interested. Centralized exchanges are essentially becoming modern-day banks (some even offer their own credit cards). While exchanges still perform an important function in onboarding new people, they go against the principles of the blockchain industry.

In April 2018, there were only 15.7M Bitcoin addresses with value. This was after a bull run in 2017. Since then, another one took place in 2021. In 5 years, the number of Bitcoin addresses has more than doubled. The growth in the number of addresses can be attributed not only to the higher number of users but also to the increased use of the Lightning Network. At the end of 2018, there were 10M registered users on Binance. In 2023, there are already 130M users. That's a 13-fold growth. Consider that we are talking about a single exchange and there are many more of them around the world. From this, we can conclude that the number of exchange users is growing significantly faster than the number of self-custody users.

What's wrong with custodial services?

We could repeat the saying "Not your keys, not your coins". Still, it's worth looking into this a bit more.

When people hold crypto assets on exchanges, they are exposed to their high volatility. People can sell coins quickly at a new high and then buy at a new low. This is the only utility available to them. Maybe some people hold coins on exchanges as a long-term investment or use them for making Dollar-cost averaging (DCA).

Although it is theoretically possible to use an exchange as a bank account and pay for goods and services from it, it is user-unfriendly and fees can be higher (exchanges may have higher withdrawal fees to discourage people from withdrawing).

If users hold crypto-assets on exchanges, they cannot use the coins for anything else, not even for payments. Access to second layers can be more complex (Lightning Network, Milkomeda, etc.). Users cannot use coins in DeFi or stake them. Some exchanges have started offering staking so people are not economically motivated to withdraw PoS coins.

Exchanges do not inhibit adoption in terms of exposure to potential market value growth. They do, however, fundamentally inhibit adoption from a utility perspective. Self-custody of assets is important not only to avoid third-party risk but also from the perspective of being able to use the coins in a newly built economy.

BTC is mostly a HODL coin from the perspective of most users, so it's less of a problem than for projects that will only be successful if people use DeFi and other utilities (NFTs, tokens, DID, stablecoins, etc). Cardano may fail as a project if most people hold ADA on the exchanges (not having other own Cardano wallet), as they will be cut off from the functionality the project offers.

It seems that self-custody is not yet a sufficient reason for cryptocurrency adoption, as most people trust third parties. This could also be interpreted as people holding cryptocurrencies as speculation and expecting someone else to make them succeed. Current holders will benefit if the number of holders grows, the businesses and banks start using blockchain, the number of DeFi users grows, etc. People believe that it is not necessary to hold cryptocurrencies in their own wallets. They just need to wait for someone else to make the projects successful. People treat cryptocurrencies like stocks.

This is a problem because the shares cannot be used in any other way than to buy them and sell them later. Cryptocurrencies are there to be used and become an alternative to the financial system. That certainly won't happen if more than 95% of them are on centralized exchanges.

What is the real adoption of cryptocurrencies?

Only people who have crypto assets in their own wallets should be counted in the real adoption of cryptocurrencies. If that were the case, adoption would be significantly lower than currently reported. Let's take another look at the numbers.

The population of the US is 330M, and the adult population is 140M. We figured there are 4-10M BTC holders. Roughly 13% of all cryptocurrency holders live in the US. That means there are roughly 500K-1.3M BTC holders in America. It seems that in the US there will be roughly 1% of the adult population that holds BTC in their own wallet.

There may be roughly 30K-75K of real ADA holders in the US.

Try to imagine how many real holders live in your country. If it were a smaller European country, it might not even be 100,000 people holding cryptocurrencies in their own wallets. These are only estimates which may not be accurate.

Look at it from another angle. If people have crypto assets on the exchange then most transactions will be related to deposits and withdrawals. In addition to the on-chain fees, there are also fees to pay to the exchange. Using cryptocurrencies may seem like an expensive option compared to fiat currencies.

At the time of writing, roughly 800K users have used Bitcoin and 60K users have used Cardano in the last 24 hours. If, say, 80% of transactions were associated with centralized exchanges, that leaves only 20% for payments, DeFi, and other utilities. In the case of Bitcoin that would be 160K transactions, for Cardano 12K transactions. We dare say we are very optimistic.

On the other hand, if we look at the on-chain data of the 5 largest applications in the Cardano ecosystem, we find that there are roughly 100K transactions per day (remember that a single Cardano transaction can contain multiple outputs for multiple users).

DeFi as a motivation for self-custody

We believe that DeFi, staking, and the NFT sector may be a stronger reason for many users to self-custody their assets than speculating on market value growth. People need to have coins in their own wallets if they want to use other services that blockchains and especially smart contract platforms offer nowadays. This is definitely the case with Cardano which has staking, a strong NFTs sector, and DeFi.

Holding ADA on an exchange that doesn't offer staking is an economically disadvantageous situation since people miss staking rewards. These people can either transfer their ADA to another exchange that offers staking or ideally start using their own Cardano wallet. The best solutions on the market are hardware wallets (Trezor or Ledger).

I'm convinced that people will start doing this as soon as long-term successful DeFi services are established that offer interesting yields. Many DeFi protocols offer rewards for staking + other rewards tied to financial services. For example, for providing liquidity.

Exchanges may not be able to compete with DeFi service revenues unless they start using users' coins in DeFi like the bankrupt Celsius did, for example. The problem is that exchanges are not legally allowed to use user deposits in this way. Exchanges must hold 100% of user deposits and remain liquid.

We think it will be economically viable in the near future to withdraw ADA and other crypto assets from the exchanges and start using DeFi. The NFTs sector, stablecoins, and other tokens are often undervalued in this regard and they too may drive people to use their own wallets.

Consider Vodafone's recent decision to use Cardano for token minting. If they are able to offer interesting use cases and Vodafone customers start using Cardano wallets from their mobile, it will be a ticket into the Cardano ecosystem. At this point we don't know how Vodafone customers will hold NFTs, so let's not cheer, but hope for the best.

We think many BTC holders who have lost coins in services like Celsius will start thinking more about DeFi. Bitcoin doesn't have DeFi, so the only option is to tokenize BTC, transfer it to the Cardano ecosystem, and start using DeFi.

None of the options described above can be done from a centralized exchange. People should realize this and think more about Satoshi's vision. If they want cryptocurrencies to succeed as Satoshi envisioned, they need to hold crypto assets in their own wallets. The success of cryptocurrencies depends on the growing number of people who use their own wallets to hold crypto assets.

Money sent to an exchange won't change the world much because it doesn't teach people to think and, more importantly, behave differently. Self-custody can be difficult for many people and they may be afraid of it. Teams need to think about how to make this process as easy as possible, and communities should help newcomers as much as possible.

Conclusion

When you think about how people are cheering about the approved Bitcoin ETF, you will see that it does not bring anything significant to the world of cryptocurrencies. Some people want easy access to cryptocurrencies and see them as an investment. However, these people are not going to change the world. The world will be changed by those who understand the meaning of self-custody and start using cryptocurrencies and decentralized services in a peer-to-peer manner.