A new kind of hosting can help alleviate the problems posed by third-party hosting (e.g., exchanges) and first-party hosting (e.g., hardware wallets).

What do the infamous Mt. Gox exchange, the latest cryptocurrency restrictions agreed to by world regulators, and my departure from the bitcoin exchange space after eight years have in common?

The answer is bitcoin escrow (how and where you protect your bitcoin) – how it is, what it would be like if nothing changed, and how it could get better if we took the appropriate action. To understand why, we need to go back to the beginning, or at least the beginning of my bitcoin trading journey.

Back in 2013, when Coinfloor was about to become a reality, the Bitcoin trading space was dominated by Tokyo-based exchange giant Mt. Gox.

Many people held their bitcoins on Mt. Gox until one day it all disappeared. Users can no longer access their hard-earned or purchased bitcoins. For reasons that are not entirely clear, most of the funds held in custody by the platform disappeared, and some of the funds that have been recovered to date have not been returned to their rightful owners.

This Mt. Gox drama is the main reason why our exchange Coinfloor was founded. We wanted to restore trust in the trading space and keep bitcoins in a trading safe. At the time, many people thought it was a noble goal to allow users to hold their bitcoins securely on an exchange. But I realize now that this goal just puts a different kind of risk on the coins of the exchange's customers.

You see eight years ago, after Mt. Gox, no one trusted the exchanges to hold their money, but wanted a better way to buy bitcoin. They would buy their bitcoins and pull them off the exchanges as soon as possible. Now, eight years later, there are dozens of decent exchanges and brokers making it easy to buy bitcoin and trust in the exchanges is high. The irony of the result is that the percentage of bitcoin holders hosting their bitcoins on exchanges is at an all-time high.

You may not think it's a problem, but that's where the world's regulators step in through an organization called the Financial Action Task Force (FATF). The FATF is an unelected international advisory body issued to prevent what most countries consider to be financial crimes. Although no country is forced to enact one of these recommendations, ignoring them can have a devastating effect on international trade, which means that almost every country in the world consistently implements them. So when the FATF "recommends" that a country take a regulatory position, you can assume it will be implemented. In June 2019, they released cryptocurrency guidelines that include a controversial provision called the "Travel Rule. The rule advocates that all cryptocurrency exchanges and bitcoin brokers should only be allowed to transfer cryptocurrency to parties they can properly identify. The challenge is that the identity-free nature of cryptocurrencies makes adhering to this guideline while still allowing customers to withdraw to their own wallets difficult at best and impossible at worst.

So once again, we're heading towards a future where huge cryptocurrency exchanges prevent their customers from owning their own coins. But this time it will be due to an overabundance of regulation rather than a lack of regulation, as was the case during the Mt. Gox era.

Over the years, I have observed the direction of regulatory travel and the growing disinterest of many investors in controlling their tokens. Clearly, this is the wrong direction and needs to be addressed if we don't risk escaping the fiat frying pan into the bitcoin fire that has been hijacked by the exchanges.

"But why is it a problem to hold most of my bitcoins on an exchange?" You ask. In short, if a regulated third party takes control of your bitcoins, no matter how trustworthy they may seem, they could be forced to prevent you from keeping your bitcoins. Under the latest FATF rules, we're already seeing countries like India, South Korea, and Estonia looking to fast-track regulation to make this happen, and we can expect more to follow. If left unchecked, the end result could be that most bitcoins are stored on a handful of centralized exchanges – prohibiting bitcoin holders from having autonomy.

This is a concern because Bitcoin can only succeed if all of its major components – mining, payments, software development and hosting – remain strong and decentralized. For those committed to seeing Bitcoin realize its potential to separate money from the state and thus create a fairer world through a more efficient economy, nothing is more important than strengthening the foundations of Bitcoin. Helping to protect these core areas of Bitcoin was a big part of my decision to sell my company and leave the Bitcoin trading space, my quest to become a board member of the Bitcoin developer incubator ₿Trust, and the fact that I also got involved for a big reason to address custody issues through my support of FediMint.

FediMint is a new hosting method that enables users to form groups in which members can find each other's bitcoins. It is still in the early stages of development, but holds a lot of promise. It leverages the smart technology we all have and a very user-friendly circle of trust to provide a hosting solution that is more convenient than holding bitcoin on a third-party exchange, and cheaper and more sophisticated than most self-custody solutions. FediMint has the added benefits of improved user privacy, extended bitcoin, lower on-chain usage fees, and can provide a non-exchange bitcoin escrow solution that is equally viable for people in the Western world and the rest of the world.

FediMint has three simple but powerful elements.

The first is that FediMint is intended for use by existing groups whose members already have a high level of trust in each other. Families, close friends, small villages, community groups, etc. are examples of groups with strong second-party relationships. This is in contrast to the distant third-party relationships offered by exchanges or the first-party relationships offered by self-hosting. This setup has the added advantage of usually being immune to most regulatory considerations, as the second party relationship and lack of profit means that this would be considered a non-commercial activity.

The second part is to split the guardianship challenge in two. It does this by identifying the bitcoins within any given group that are more capable of protecting that group than any other group. The more capable "group guardian" takes on the heavy lifting – hosting the group's wallet and processing transactions – while the rest of the group has a super-simple application that can offload all the complex stuff to the group guardian. Sidenote: This may sound unusual, but it's commonplace today. Anyone who has been in the Bitcoin space for a while has probably encountered a time-pressed or less tech-savvy relative or friend who asked them to act as their Bitcoin guardian by buying, selling, holding or transferring Bitcoins on their behalf. As a long-time bitcoin exchange operator, I've heard many anecdotal examples of this, and I wouldn't be surprised if most bitcoin "owners" have actually acquired their bitcoins through a guardian – but there's no way to know for sure.

The final part of FediMint is the use of two powerful technologies, the federation and the chaumian electronic cash mint, to eliminate any single weakness and maintain complete privacy for all users, which is the reason behind the unusual name of FediMint. Federations are a mechanism for sharing custody of the group's bitcoins among all guardians. This ensures that most custodians need to take action to execute transactions, and that the system can tolerate the failure of a few custodians without affecting its operation. The Chaumian Electronic Cash Mint is a cryptocurrency tool that allows federal guardians to process transactions on behalf of any member of the group without having to know who it is or how much they own. This ensures financial privacy even when group members have delegated the complex task of managing their bitcoin assets to a guardian.

Overall, the FediMint system provides a hosted solution that is superior to any other system.

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* :: Protocols exist to address many of the shortcomings of naïve self-regulation, but they add more expense and even more complexity.

† The cost of setting up and running FediMint is similar to the cost required to properly set up and run a multi-signature hardware wallet, but the cost can be shared among all federated group members.

†† If a user is lost, forgotten, or dies, a federal guardian may be able to use their existing trusted second-party (i.e., friend or family) relationship to verify the user's identity and thus recover the user's bitcoin.

††† Sovereignty is delegated to a trusted second party, making it less than perfect than true self-regulation. However, the process of backing up hardware wallet private keys is likely to involve trusting second parties such as friends and family, or even third parties such as banks or safe deposit boxes, thereby reducing the actual difference between second and first party custody by a significant amount.

When I was first introduced to FediMint by its inventor (pseudonym "elsirion") in mid 2021, I immediately saw it as a practical solution to Bitcoin's hosting challenges. I now support the FediMint project and encourage every bitcoin enthusiast to do the same. With time and effort, we can help FediMint become a vital part of the infrastructure that enables Bitcoin to scale globally while remaining decentralized and robust. Helping to achieve this goal and preventing Bitcoiners from losing access to their coins is a truly noble goal.

For more detailed technical information, please visit FediMint.org.

This is a guest post by Obi Nwoso. The views expressed are entirely their own and do not necessarily reflect the views of BTC Inc or Bitcoin Magazine.