[U50] Bitkey Wallet by Block
Designing a product for almost anyone to use
Dear Readers,
In this Update for Product | Strategy | Innovation I will share more insights into the company Block (previously Square), Cash App, and their recently launched Bitkey Wallet to take control of a user’s bitcoin with self-custody.
The global Financial Services market is expected to reach US$45 trillion by 2028 and includes lending, cards and payments, insurance, reinsurance, brokerages, exchanges, wealth management and investment banking.
The Fintech industry offers financial technology to help improve and automate financial services and is growing fast. Companies like Block, PayPal, Shopify, Intuit, SoFi, Coinbase, Lemonade, Stripe, Affirm, and RobinHood are only a sample of Fintech companies disrupting more traditional Financial Services.
Block is building a network of ecosystems including:
Sellers served by Square,
Consumers served by Cash App, and
Artists served by Tidal.
Block acquired AfterPay in 2022 to help Sellers close more sales with “buy now, pay later” services. AfterPay also fosters cross-ecosystem transactions when Sellers promote AfterPay to Cash App users. These Cash App users can also look for Sellers who offer AfterPay through Square.
Block envisions bitcoin playing a growing role as a store of value, medium of exchange and system of trust across all of these ecosystems. Block created Spiral and TBD to advance bitcoin-related services with open-source development kits and grants to bitcoin developers. Block is also developing open-source bitcoin hardware to mine and self-custody bitcoin.
I started seriously researching the Fintech industry in 2016. I realized Square had a more comprehensive business model than other Fintech companies. And then over time I realized how important Cash App (originally Square Cash) is for an estimated 6 million unbanked consumers in the U.S.
An estimated 1.5 billion people are unbanked worldwide. The target customer for Cash App today is a household with under US$150k in annual income. A key feature enables teenagers 13 years and older to use Cash App when sponsored by a parent or trusted adult.
Square provides simple hardware to use with a mobile app and smartphone so anyone with any part-time or full-time business can transact more sales by accepting a customer’s credit card. More advanced hardware options and software services are also available.
But the transformational feature of Cash App allows a user to direct deposit a portion or all of their paycheck. This does require adding a debit card to receive direct deposits through a Cash App banking partner.
And you can also use the cash balance on Cash App like a bank to:
transfer funds into a savings account that currently pays 4.5% interest,
buy fractional shares of popular stocks and ETFs that are held just like a brokerage account, and
buy fractional units of bitcoin that are held just like other exchanges.
These features give anyone who downloads Cash App the ability to take more control over their financial future. Cash App allows you to buy, sell, send, and receive bitcoin as a digital wallet. The balances for bitcoin, savings and stocks are all shown separately from the cash balance as independent components for a digital wallet.
A key feature of bitcoin is the ability to move units as small as satoshis (1 bitcoin = 100 million satoshis, or sats) between wallets using the Bitcoin blockchain network to settle the transaction. Cash App is considered a digital “hot” wallet to hold, buy, sell, send and receive bitcoin. You can also transfer bitcoin using Cash App to a hardware-enabled “cold” wallet to take custody of your bitcoin with secure cold storage. This will be the focus of this Update.
But why do I need to self-custody bitcoin?
You don’t need to take custody to start your journey with bitcoin. There are multiple ways to gain exposure to bitcoin without holding it directly.
You can buy a spot bitcoin ETF like Blackrock’s IBIT or Fidelity’s FBTC just like any other ETF through a brokerage account.
You can buy shares of public companies like COIN, MSTR, SQ, or TSLA that have acquired and hold bitcoin on their balance sheets. Note: MSTR often trades at a significant premium to the bitcoin value on its balance sheet.
You can buy shares of public companies like HUT, IREN, RIOT or others that mine and earn bitcoin as a core part of their business. Note: Bitcoin mining is a brutal business that systematically eliminates weak miners over time.
You can also buy units of bitcoin directly using an account on an exchange like Coinbase or Block’s Cash App. Cash App provides a lot of flexibility, but Coinbase is a good option, too. The exchange also acts as a custodian and holds the bitcoin on your behalf.
My first bitcoin purchase was a transaction of only US$10 into 32,444 satoshis. After I completed a few transactions to verify the process, I was comfortable purchasing bitcoin.
The cash and savings balances in Cash App are FDIC-insured to limit custody risk. Cash App Investing is a member of the Securities Investor Protection Corporation (SIPC) to limit securities risk for stock and ETF holdings.
Block takes precautions to secure its own bitcoin holdings using cold storage. But any bitcoin exchange holds bitcoin for its customers and uses a centralized ledger to track transactions and the bitcoin balance for each customer account just like banks handle cash accounts. These transactions to buy and hold bitcoin are “off-chain” and are only known to you and the exchange.
Another limitation of buying and holding bitcoin off-chain with any intermediary is it eliminates one of the best features of bitcoin. Moving bitcoin from an exchange to a cold wallet is an on-chain transaction regardless of the amount. The same blockchain technology is used to settle $10 or $35 million worth of bitcoin. So, moving small amounts is adequate just to learn more about the technology. I am more informed by making some on-chain transactions.
The Bitkey Wallet is reported to now be available in 95 countries and is sold online by Block in the US for US$150.
How does the Bitkey Wallet work?
The primary components of the Bitkey Wallet include a small hardware device and a companion mobile app as shown in Fig. U50-1. Each component is associated with a unique key, but Bitkey also includes a third key stored on the Bitkey server as a Server Key.
What are the core features for each of these 3 keys?
Mobile Key
mobile app downloaded for iOS or Android to initiate and sign payments up to the mobile limit you set
setting up or changing the personalized mobile limit requires one-time confirmation using the Hardware Key
encrypted backup on Apple iCloud for iOS or Google cloud for Android in case you lose your phone and need to recover your Mobile Key
Constraint: Mobile Key cannot sign payments over the personalized mobile limit without the Hardware Key
Hardware Key
pairs with mobile app to cosign payments over the mobile limit you set
confirms initial or change to the personalized mobile limit
authorizes Mobile Key recovery
authorizes changes to Trusted Contacts and security settings
hardware device includes USB-C to USB-A charging cable, USB-C charging port, Near-Field Communication (NFC), LED indicator, and a biometric fingerprint reader for added security
Server Key
cosigns payments up to the mobile limit you set
helps recover your bitcoin if you lose your phone or hardware, or both
Constraint: cannot sign payments over the mobile limit you set without Hardware Key
Constraint: cannot authorize recovery attempts without Hardware Key or Mobile Key
Block has partnered with Cash App and Coinbase to integrate the Bitkey Wallet so their users can easily self-custody bitcoin with on-chain settlement. The Bitkey mobile app includes icons to send, receive and add bitcoin. Adding bitcoin uses the integration to either Purchase new bitcoin or Transfer bitcoin from Cash App or Coinbase into the Bitkey Wallet. Transfer is also possible with other exchanges and wallets.
The Bitkey Wallet only supports bitcoin. Caution: transferring or receiving any other digital asset besides bitcoin will result in permanent loss of the funds.
Bitkey’s recovery includes 4 primary capabilities illustrated in Fig. U50-3:
Cloud Backup is for when you lose access to the key stored on your phone. This can happen if your phone is lost or stolen, or even when you upgrade your phone.
Delay and Notify is for when you lose your hardware, or when you lose both the key stored on your phone and your cloud backup.
Social Recovery is an optional feature for when you lose both your hardware and the key stored locally on your phone. This requires setting up one or more Trusted Contacts before Social Recovery is needed.
Break Glass is a feature if you no longer can or no longer want to use the current version of the Bitkey app to access your funds.
More details on recovery are provided in this Bitkey recovery white paper.
What are my key takeaways on the Bitkey Wallet?
Block develops leading hardware and software for Point of Sale systems through its Square business. These systems require onboarding new users to both hardware and software. Cash App is often the #1 free finance mobile app on the App stores. Block product teams understand product development, packaging, mobile, and onboarding workflows.
Block has taken the required time to understand the needs for a more mainstream hardware-enabled digital wallet that still offers multi-signature security to self-custody bitcoin.
The hardware is relatively small for shipping and storage, but solid enough to help avoid losing it. I found the mobile app and hardware set up easy with the provided instructions.
I found connecting the hardware device and phone with NFC required careful placement of the hardware device underneath the top quarter and in the center of the phone for the mobile app to successfully confirm the Hardware Key. Once you realize where the sweet spot is for NFC on the phone, this becomes more routine.
A mainstream solution needs to factor in recovery of keys with a lost phone or hardware device more so than cold wallets that optimize for absolute security. But this also poses some limitations that I will discuss in the next section.
There are currently no fees to transfer a minimum of 0.001 bitcoin from Cash App to your Bitkey Wallet at the Standard transfer speed which can take up ~24 hours. Small fees are incurred regardless of amount for Rush (~2 hours) or Priority (~10 minutes) transfer speeds.
The best feature of using the Bitkey Wallet is creating the on-chain transaction on the Bitcoin blockchain to settle the transferred amount to your Bitkey Wallet. Fig. U50-4 shows the creation of a new block on the left side of the figure and the last verified block 843199 added to the Bitcoin blockchain with the mining reward issued to the Foundry USA mining pool. The Bitkey Wallet can also be used to send or receive bitcoin with another wallet using on-chain settlement of the transaction between the two wallets.
Transactions using the Bitkey Wallet are listed under Recent Activity with a link to a more detailed summary including the 64 hexadecimal character transaction ID, the date and time the transaction was confirmed, the units of bitcoin sent or received and a link to the transaction using the Mempool Blockchain Explorer. Mempool provides the block ID for the transaction and allows you to search for the transaction using its search feature. The 1st 12 or so characters in the transaction ID should allow you to find the transaction.
The Bitkey Wallet is a good option to help continue a bitcoin user journey with on-chain transaction settlement and cold storage for limited bitcoin balances. But long-term cold storage with large amounts of bitcoin are likely better served with another option to be determined later.
What are my concerns about self-custody and bitcoin cold storage?
Even though I have enjoyed my journey with bitcoin including cold storage with the Bitkey Wallet, I still have 3 primary concerns related to self-custody and bitcoin cold storage.
Security
Succession
Cost-basis tracking
I will discuss each separately in the following sections.
Security
Even with many advances in the relevant technology, bitcoin is still an adventure into Fintech’s decentralized “Wild West”. It is estimated at least 3-4 million out of the 21 million total bitcoin are lost forever due to lost access to wallets holding bitcoin. Scams targeting bitcoin holders also contribute to security risk with stolen bitcoin. For these reasons, bitcoin should be considered with extreme caution.
There are much greater risks with the custody of bitcoin than a bank for fixed income investments with FDIC protections and brokerage accounts for registered securities with FINRA protections. Self-custody of bitcoin removes the risks associated another custodian, but also means you now own all of the custodian risk yourself with no recourse if you make a mistake. The probability of losing 100% of the bitcoin you self-custody is not 0%. You have to manage that risk based on allocation and the measures taken to protect yourself from these risks.
Succession
Another risk even if you secure your bitcoin while you are alive is what happens to the bitcoin after death. Bitcoin in self-custody is lost if no one can access the cold wallet after the death of its owner. Unlike bank or brokerage accounts with beneficiaries, this protection is not standard with cold wallets. Owners of cold wallets must plan in advance and provide detailed instructions to beneficiaries in case of death.
Block has taken extensive precautions for recovery of lost keys. I’m sure these will evolve over time. I contacted Bitkey Support about Succession and they indicated they are working to implement succession and inheritance features. One feature they are actively developing allows a user to add multiple fingerprints to the fingerprint reader on the hardware. Although not mentioned, this could allow additional multisig scenarios (example: 3-of-5 signatures) to allow a beneficiary to transfer the bitcoin out of the cold wallet.
Fidelity Investments provides guidance on estate planning and digital assets. Fidelity Digital Assets provides trading for Fidelity Crypto separate from its brokerage services for registered securities. Bitcoin like any other asset should be covered in a Will or Trust. Another option for Estate Planning is to use a service provider like Casa.io for more advanced multisig protection options than those currently provided by the Bitkey Wallet.
The Standard package from Casa is similar to Bitkey with a 3-key vault to secure digital assets. The Premium package from Casa uses a 5-key vault for added security and to setup inheritance for once-in-a-lifetime transfer of digital assets. Before committing to any estate plan, I would want to test various scenarios to verify the functionality. I would also seek recommendations from other trusted sources on the topic.
Cost-Basis Tracking between Cash App and Bitkey
Cash App generates a Form 1099-B if you sell bitcoin within a calendar year. I use a spreadsheet to track each transaction to determine the cost-basis for the bitcoin held in the Cash App account. This also allows me to determine which bitcoin units are transferred to the Bitkey Wallet with a transaction. I transfer bitcoin with the lowest cost basis from Cash App to the Bitkey Wallet. I do not plan to sell these bitcoin in the Bitkey Wallet because they would generate the most tax liability. And if I donate any bitcoin to a non-profit in the future, I would donate bitcoin out of the Bitkey Wallet with the most capital gain(s).
So I maintain 2 spreadsheets. One spreadsheet tracks Cash App transactions to buy bitcoin, determine the cost-basis and transfer bitcoin to the Bitkey Wallet. The other spreadsheet tracks the Bitkey Wallet transactions and determine the cost-basis of the bitcoin held in the wallet. This is feasible because I ‘m not making a lot of transactions. I am not trading bitcoin. I am accumulating bitcoin.
Some Final Thoughts
The approval of multiple bitcoin spot ETFs as regulated securities in January 2024 was a major step towards wider adoption of bitcoin by mainstream consumers, retail investors, institutional investors and corporations. These ETF securities can be held in any brokerage account or self-directed IRA. This reduces some of the risks of bitcoin held by a custodian like Coinbase that drives the demand to self-custody bitcoin.
Global allocation ETFs and other specialized ETFs from Blackrock and other institutions will start including bitcoin in their asset allocations using spot bitcoin ETFs. Blackrock and Fidelity are likely to allocate bitcoin in the future to their target date ETFs. So a large proportion of investors will have some allocation to bitcoin in the future whether they know it or not.
Another option is to accumulate bitcoin directly through a portion of income or cash holdings. But this introduces custodian risk over time without the protection of a regulator like FINRA or the FDIC for digital assets. This risk is mitigated by taking custody of your bitcoin. But self-custody introduces new risks like security and succession planning to prevent the loss of bitcoin.
The Bitkey Wallet is a viable option for mainstream users looking for a secure but simple option for bitcoin cold storage up to reasonable amounts determined by each user. More significant amounts of bitcoin are likely better served with other options unless Block continues to advance their technology for a wide range of users and use cases.
This is a possibility because Block is a Fintech leader and is making serious commitments to advance Bitcoin technology. Taking custody of other assets like gold has similar challenges to bitcoin. But bitcoin is digital with low costs to transfer any amount either now or in the future.
Best,
Stephen
I’m long BTC, HUT, IREN, SQ and TSLA mentioned in this post. Nothing in this Update is intended to serve as financial advice. Do your own research. The opinions and views expressed in this newsletter are those of the author. They do not purport to reflect the opinions, views or policies of any other organization, company or employer.
Oh boy. Another lure to feed the unwary to the grift coin machine and enrich the crypto hegemony. I’m so excited. Hey @mollywhite, here’s another one for you.