What Is Crypto Custody? Digital Asset Safekeeping Explained

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What Is Crypto Custody? Digital Asset Safekeeping Explained

Crypto can be very technical because it’s a novel technology. Countless crypto investors have suffered from lost private keys or stolen funds with little to no chance of getting their funds back. Read on to learn how to keep your digital assets safe using crypto custody options that are currently available.

What Is Crypto Custody & Why Is It So Important?

Crypto custody is the process of securely storing your digital assets.

For example, in the traditional financial markets, custodian banks are responsible for securely storing assets for institutional investors and other financial institutions. Also, there are regulations that guide the relationships between these institutions and their clients. Additionally, individuals who are extremely wealthy can use custodians to securely store financial securities or assets such as gold.

With crypto custody, it works quite differently from that of traditional assets. Crypto custodians do not store crypto assets or secure them physically because they “live” on blockchain networks. Moreover, no one can technically store cryptocurrencies in a particular location or wallet apart from its blockchain network. Instead, crypto custodians secure the private keys of investors, which is the only means of accessing their funds on a blockchain network. Hence, the popular saying, “not your keys, not your coins.”

The emergence of professional crypto custodians has driven massive adoption of cryptocurrencies, especially from institutional investors who were critical of the industry because of inadequate security measures.

Keeping a wallet recovery phrase can be quite difficult for people. And unlike a banking app, where you can reset your password through ID verification, once you misplace your private keys or wallet recovery phrase, your funds are lost forever. There are millions of bitcoin today that no one can access because the private keys are lost. 

Individuals and institutional investors are now leveraging crypto custodial services to mitigate such risks. Firms like MicroStrategy and Tesla have dabbled in the space, with more traditional investors trooping in as there’s the protection of experienced crypto custodians. There are now billions of dollars of digital assets held with qualified crypto custodians.

Cryptocurrency Custody Options: DIY or Third-Party?

The law considers all custody providers as financial institutions and as such, must function only by the capacity provided within the regulatory frameworks of the regions where they are situated. However, with crypto assets, individuals can decide to become their own custodians. Hence, there are two main types of crypto custody: self-custody and third-party custody.

Self-Custody

Self-custody is a less costly crypto custody option, but it comes with some risks. It involves personally holding your private keys to a wallet without any third-party supervision or management. 

You are the only one responsible for accessing and managing your funds, meaning you don’t have to pay any fees to any custodian. And you can leverage your assets to access other innovative web3 solutions like DeFi, GameFi, DAOs, etc.

The risk here is that you have to take on all the technical challenges that come with managing your crypto wallet’s private keys. Losing your private keys or misplacing your cold wallets – paper or hardware – means your digital assets are likely lost forever. Crypto-savvy folks are likely to follow this route when investing as they are naturally inclined to the technical crypto solutions.

Third-Party Custody

Third-party custody is more appealing to traditional and institutional investors who find it challenging to manage their own digital assets since they don’t have the technical expertise in-house. Third-party crypto custodians are typically regulated financial services providers that have the necessary licenses to serve as a custodian of digital assets.

More like a bank, users have to register and open an account with custody, complete due KYC and AML procedures, and sometimes a security check to verify the source of their digital assets.

To access third-party custodians, users have to pay certain fees which are usually deducted from the funds in custody. Some of the popular types of third-party crypto custodians include custodial banks, digital asset managers, and crypto exchanges.

All your cryptocurrencies held in exchanges are typically under third-party custody since you don’t have control over your private keys. Some exchanges add an extra layer of security by employing an additional custody provider. However, as we saw with Mt. Gox, cryptocurrency exchanges can be hacked, causing users to potentially lose all their funds.

On the other hand, you can tread more carefully by leveraging custodial banks. Custodial banks are majorly used by institutional investors as they usually have a high minimum balance that retail investors might not meet. Digital asset managers, for example, often employ the services of custodial banks to optimize the security of their services. 

Although holding cryptocurrencies in third-party custody could be a safer option if you’re scared of losing your private keys, it prevents users from having some flexibility in regards to their assets, and the risk of getting locked out of the funds exists.

Self Custody vs Third-Party Custody: Pros and Cons

Before choosing a particular crypto custody option, you have to take several factors into consideration, ranging from your investment amount, familiarity with crypto technology, and purpose of investments.

Let’s take a look at the pros and cons of each custody approach.

Self Custody

Pros

  • You have complete control over your assets and you can use them at any time without any limitation.
  • Your assets are free from third-party risks.
  • Your privacy is more secure.
  • Cheaper to create and maintain.

Cons

  • Managing your private keys requires some technical expertise and the ability to take on some cybersecurity risks. 
  • No access to insurance.
  • Hackers can target your coins when you’re using an online wallet.

Third-Party Custody

Pros

  • You don’t have to deal with the technicalities involved in securing your crypto assets as the custodian takes care of the whole process.
  • Most custodians insure their assets under their management.
  • It enables easy access, especially for newbies.

Cons

  • It is quite expensive due to the several fees that custodians charge for their services.
  • You don’t have total control over your assets as custodians can limit your access.
  • Third-party risks like bankruptcy exist.

The Importance of Qualified Crypto Custodians for the Institutional Investor Community

Institutional investors are coming into the world of crypto to leverage the technology with the aim of generating higher returns than in the traditional financial markets.

However, issues like cyber theft, misplaced private keys, and regulatory constraints can serve as a barrier for institutional investors. These investors are already used to qualified custodians in the traditional space and prefer to interact and safeguard their assets with qualified crypto custodians. 

Qualified crypto custodians are in compliance with applicable laws that regulate custodians and provide high-grade technology solutions to guarantee the safety of digital assets. These features allow the institutional investor community to safely enter the crypto space.

FAQs

Is Self-Custody Always the Best Option?

Crypto experts agree that storing your digital assets using a personal, non-custodial wallet is the best way to custody crypto. However, for investors who struggle with the technical aspects of managing a crypto wallet’s private keys, storing crypto with a regulated and insured custodian might be the better option.

Who Are the Best Crypto Custodians?

There are dozens of crypto custodians, including Anchorage, Bakkt, BitGo, Coinbase Custody, Fidelity Digital Assets, Gemini Custody, and NYDIG that offer custodial services to large investors. Custodians vary in fees and services provided, which makes it difficult to judge which crypto custodian is the best.

Are Crypto Custodians Worth It?

Qualified crypto custodians charge a fee to safeguard the private keys to your crypto asset holdings. If you are a large investor looking to keep your digital assets safe without having to deal with the technical aspects of private key management, paying a qualified custodian for its services is probably worth it. However, you have to be aware of the trade-offs of storing your assets with a third-party custodian as opposed to opting for self-custody.