Fedi: Balancing Bitcoin Custody with Community Based Storage Solutions – Crypto Projects to Watch 2023

Bitcoin custody is difficult. There’s always a trade-off between convenience and security when your two choices are keeping your bitcoin on a centralized service, such as an exchange or a custodian wallet, or keeping it on your own device.

The first option means trusting that the platform doesn’t turn your bitcoin into a proverbial pumpkin (like FTX did for example); the second option means knowing that if you lose your device and your backup, no one will be able to help you.

Hardcore bitcoiners would say that you really own your bitcoin when you store it yourself, not hand it over to someone else. But non-custodial storage isn’t easy to get right, and the idea of ​​not having a reliable backup plan if you lose your keys — a private code made up of a series of alphanumeric characters to provide access to bitcoin — can make you feel as uncomfortable as keeping your savings under a mattress: in both cases, the loss will be permanent and irreversible, and your entire responsibility.

Fedi approaches bitcoin custody with the assumption that while full self-custody is the best solution, most people would choose to trust someone else to keep their bitcoin safe. Many users start their exploration of bitcoin by asking a more experienced friend or family member to buy and store their bitcoin for them, Obi Nwosu, CEO of Fedi, wrote in a blog post last March.

“As a long-time Bitcoin exchange operator, I’ve heard so many anecdotal examples of this happening that I wouldn’t be surprised if the majority of bitcoin owners are actually acquiring bitcoin through guardians already — but there’s no way to know for sure,” Nwosu wrote .

By guardian, he means more tech-savvy friends, family members, etc. – someone you trust to help you set up your wallet and buy your first bitcoin, so you don’t worry about making a mistake and losing your money.

Fedi is building a product to help communities store bitcoin together and facilitate crypto transactions between members. Using an open source protocol called Fedimint, Fedi offers a compromise between the comfort of custodial storage and the autonomy of self-storage: outsourcing backup storage to people you personally know and trust.

Users wary of the difficulties of self-custody will lock their bitcoin in a shared multi-signature wallet guarded by several people they know – the guardians mentioned by Nwosu.

To be clear, Fedimint creators say right away: “If you are confident in self-custodial your bitcoin and run your own nodes, we strongly recommend that you do so.” But Fedi lets you share the burden with some people you know and trust, not big companies you barely know anything about and have no reason to trust.

Bitcoin Ekasi, a community of people who pay each other with bitcoin in a South African township, is piloting FediMint, said Herman Vivier, founder of Ekasi. He told CoinDesk that it simplifies bitcoin custody for the elderly and non-technical people.

“Currently, the only alternative to full self-detention is foreign custody services. And these turn out to be unreliable time and time again, said Vivier.

But there is more to it. Fed’s ultimate ambition, according to Nwosu, is to achieve the functionality of other, more flexible cryptocurrencies, without giving up the security of the Bitcoin protocol.

“It runs on top of Bitcoin together with Lightning, providing the missing pieces to the Bitcoin ecosystem. We want to be able to have more privacy if desired, similar to zero-knowledge proof; have additional functionality, similar to smart contracts; and scale bitcoin to millions, similar to rollups,” Nwosu told CoinDesk.

The concept of Fedi is that once a community – or “Federation” – has pooled their bitcoins, they can create tokens – “fm-BTC eCash notes” – that run on top of the Bitcoin blockchain, and use those tokens for community payments , while the bitcoin backing them sits inside the shared custodial wallet. In this way, payments in the community will be faster and more private because they will be invisible to outside observers, unlike bitcoin transactions which can all be seen on a public blockchain.

The Fedimint protocol also allows members to pay each other in the community using Bitcoin’s second-layer Lightning Network, according to the protocol’s website.

In this sense, Fedimint can be seen as a bitcoin version of a popular privacy system on Ethereum: zero-knowledge conversations. “We remove transactions from the Bitcoin network, provide community privacy and [additional] functions in society,” Nwosu said.

A community can also agree to store other things in a shared backup wallet using Fedi, Nwosu said. For example, if they use decentralized identity tools, they can store backups of their credentials in shared storage instead of keeping them in a Google Docs or Dropbox file. They can also manage a shared cloud file storage for content important to that community.

Associations can also start small local funds to finance something the community wants to build, buy or do together. However, Fedi will not offer any online voting functionality found in Decentralized Autonomous Organizations (DAOs). Nwosu believes communities of people whose livelihoods are naturally linked together can govern themselves without any sophisticated technical mechanisms.

DAOs are essentially an attempt “to reinvent the way people have made decisions,” and people don’t actually need it on a day-to-day level, Nwosu said:

“There can be ten thousand societies, and they can make decisions in ten thousand ways. Communities already have their own processes, we just want to reinforce what they already do, he said.

Any voting on how to manage community funds can happen offline – or online, if a community so chooses – but definitely outside of the Fedi environment.

According to Nwosu, likely users of Fedi are communities such as a small village or town, a church or a circle of friends. Over a hundred communities in Latin America and Africa have already signed up for a pilot version of Fedi, Nwosu said. These communities are large, with tens of thousands of members, but Nwosu hopes that smaller groups will also start using Fedi in the future.

Currently, Fedi is still in a pilot phase. The public launch is tentatively expected towards the end of this year, Nwosu said, but the long-term ambitions are big: “Hundreds of thousands of federations will be a target for the next few years.”

The potential problems with federation stem from the very concept of the Fedimint protocol: It is based on trust, as Fedimint’s creators admit on the project’s website.

The well-being of a community using Fedi depends on a group of technical maintainers from this community – the so-called guardians. They run Fedimint nodes, which can be, depending on the particular federation’s needs, any device: “laptops, towers, smartphones, mobile phones, single-card systems or remote cloud computers,” the website says.

Guardians manage the community’s multi-signature wallet as a group and authorize use of that bitcoin outside the community, as well as bitcoin withdrawals by members. In a way, they replace a centralized exchange or custodial wallet for the community they serve. However, unlike an exchange, Fedimint guardians cannot see users’ balances or who trades with whom in the association, according to the description.

And just as with any custodial system, there is a risk that guardians will disappear with the bitcoin community or get hacked or simply fail to properly secure their backups, thereby losing access to the bitcoin they had been entrusted to hold.

There are no technical guarantees against that in Fedi: the only guarantee against guardians’ failure or fraud is the off-chain, offline trust they have already built up in their real-life communities.

“I have no doubt that with all these different federations building up there will be some scandals in there,” Peter McCormack said on his “What Bitcoin Did” podcast in March, adding that he expects to hear news about federation guardians here and it flees with the community bitcoin. In this regard, reputable institutions like Coinbase or Fidelity look like better guardians of one’s bitcoin than a federation, McCormack suggested.

Another risk is that a federation could issue more community tokens than its members’ bitcoin can support, thereby unbalancing the community’s internal economy. This is possible due to the shortcomings of the eCash protocol Fedimint uses – it was invented by legendary cryptographer David Chaum in 1982 and first deployed in his Digicash system in 1989.

Users cannot see how many tokens are circulating inside the union, and no external auditor can either, leaving control of the union’s balance solely at the discretion of guardians.

The only motivation for guardians not to go rogue and blow up their own communities is their good faith and willingness to maintain their good reputation among people they know and live with.

Fedimint critics say this principle effectively undermines the core value of bitcoin: You don’t need to trust anyone but yourself to know your money is safe.

Bitcoin Ekasis Vivier told CoinDesk that the community has not “really considered using the other features” of the Fedimint protocol besides joint custody, but they may be considered once the federation is up and running.

Nick Neuman, CEO of a bitcoin escrow provider Casa, believes Fedi has a good chance of succeeding in promoting bitcoin adoption in Africa and Latin America: “Fedi is explicitly trying to target communities in the Global South. And that kind of cultures, from what I hear, are much more familiar with community-based models for the use and protection of wealth, and they can adapt this technology more easily than we in Europe or the US, where the approach is more individualistic.” Neumann said.

Casa offers a custodian system where clients set up multi-signature wallets using multiple devices they own together with Casa, as a third-party custodian, and hold an additional key, so that if a client loses multiple devices and does not have enough keys to access multisig, Casa will help with the one it has.

Neuman believes that in the future, when Fedimint technology gains some traction, Casa could offer its service to federations as a professional guardian.

Alex Gladstein, chief strategy officer at the Human Rights Foundation and a bitcoin educator, believes Fedi is not a substitute for self-storage, but complements it.

“Unlike current arrangements, you rely on a quorum of people, who are unlikely to budge. They would best be used or thought of as money wallets or checking accounts. For savings, self-storage would of course be recommended,” Gladstein told CoinDesk, adding:

“I would never recommend anyone to use a Fedimint [federation] run by people they don’t know.”