Self-custodial Exchange: What You Need to Know [2023]

What does self-custodial exchange mean?
A self-custodial exchange is a type of cryptocurrency exchange that does not hold the user's funds in custody. This means that the user is responsible for securely storing their own cryptocurrencies and deciding how to custody them either by managing their own private keys, using a non-custodial wallet of their choice or by delegating custody to a trusted custodian or provider. This added control offered by self-custodial exchanges provides greater flexibility and autonomy to the user. Moreover, they help bigger institutions enter the market by enabling them to hold funds with custodians that are typically regulated and subject to stringent requirements.

Understanding Self-Custodial Exchanges and Their Role in Blockchain Trading
Self-custodial exchanges work by receiving trade instructions or orders signed by the keys of the users, matching the trades through the exchange’s matching engine, and then using the blockchain to settle the trades directly by transferring the assets from the custody of the buyer and seller to each other. In this way, the exchange is able to offer its services with all its desired features without ever having to custody funds on behalf of the user.

Are Self-Custodial exchanges safer?
Segregation of custody from the exchange and brokerage venues is fundamental in promoting transparency, integrity, and robustness in traditional financial markets. Segregating fund custody from the exchange helps keep assets safe by ensuring they cannot be used for any purpose other than as instructed directly by the owner of the funds. Separation of the custody of assets from the venue is necessary in avoiding the commingling of funds from the operational capital of the exchange itself, making it impossible for the exchange to use customers’ funds to support its own business activities or to cover losses. This prevents any issues that could arise in the event of a bank run or bankruptcy as assets are available to the user at all times, as seen with the FTX case. Moreover, self-custodial exchanges and segregation of custody brings greater transparency to the market by making it easier for everyone to verify the integrity, security and activities of the exchange. The added transparency also promotes more responsible behavior from market participants as they can see the amount of leverage in the marketplace and react accordingly or by discouraging mis behaviors such as market manipulation or artificially inflating trading volumes.

Self-custodial exchanges, such as C3, are needed to progress the cryptocurrency markets forward by promoting trust, fairness, and security therefore by making it accessible to more market participants who cannot rely on the exchange to hold their funds. The promotion of trust, fairness and security, make self-custodial exchanges a vital layer of protection for the growth and evolution of a well-functioning cryptocurrency market.