The traditional finance space is centralized. It’s backed by FIAT currency, and stored in banks, so a third party manages the finances. Web3, on the other hand, is fully decentralized. Any user can take full ownership of their cryptocurrencies. Cryptocurrencies and blockchains power the functionality.
This decentralization means that users must decide where to store their crypto. As a result, crypto custody is the concept of securely storing digital assets. Today, I will explore the main differences and benefits of crypto custody.
Crypto custody is the term utilized to describe a procedure of essentially storing cryptocurrencies and keeping them safe from theft. Custodians are the third parties that can typically be paid in order to look after a cryptocurrency portfolio on behalf of the investor.
They act as a safeguard for digital money or even FIAT currencies. This can also be cash, securities, gold bars, or cryptocurrencies. Custodians have existed for decades and represent one of the key pillars that form traditional baking systems.
However, when looked at from the perspective of crypto custody, digital asset custodians are not responsible for storing any of the digital assets. The data and transactions only exist on the public ledger known as the blockchain. Instead, what they are safeguarding are the user’s private keys.
A private key is an alphanumeric string. In the sphere of cryptocurrencies, this key enables access to a specific cryptocurrency balance or a digital wallet. If someone were to access this private key, they would be able to steal the cryptocurrencies in question, making its security important.
Crypto custody, in this case, is a reference to keeping the private key secure. In the case of traditional banking, each of the custodians is a financial institution as is required by law. With cryptocurrencies, however, holders can become their own custodians.
Self-custody, for example, occurs when an individual personally holds their private key for their own wallet. They are the only ones that can prove the ownership of their funds or even access the holdings.
This means that they hold all of the risks too. If they lose access to the cold wallet physical device that holds the keys or forget it if it’s in their memory, the crypto could be lost forever. Crypto custody providers can offer professional solutions and meet the demands of even the biggest, most demanding investors out there.
Some of the earliest ways through which digital assets were secured were both primitive, as well as vulnerable. Bitcoin originally emerged around 2009, and it’s whitepaper was launched in 2008. This led to the creation of safeguard keys. The owners, in this case, took up the responsibility of protecting their own keys.
However, they resorted to printing them out on paper or storing them in personal hardware devices. They took up the risk of potentially losing access to them forever if these devices or pieces of paper were misplaced.
Early exchanges, however, were the first that offered custody solutions. They typically provided inadequate security, however, and 20% of all Bitcoin (BTC) has disappeared, according to estimates, due to a lack of proper crypto custody.
Crypto custody has been of vital importance within traditional financial systems, and the same is the case when it comes to the crypto space. It provides a safeguard or protector for a user’s cryptocurrencies.
Each cryptocurrency is highly vulnerable to different types of attacks. These have the potential to wipe out cryptocurrency from the user’s wallets. Moreover, the funds can be at risk of what are known as liquidity crunches. It’s crucial to have a system in place that can secure digital assets and serve the role of insurance that can protect them.
Each user needs to safeguard their private keys and ensure the safety of their assets. This requires them to store the alphanumeric code, or the private key, as securely as possible. If anyone were to lose it, they risk permanently losing access to their crypto balance.
According to data from Chainalisys hackers stole a total of $3.8 billion in cryptocurrency throughout 2022. In general, crypto custody plays a major role in the overall storage of cryptocurrencies. Each investor or trader needs to put in the time and effort to establish a well-protected portfolio and ensure that they always have access to their private keys so that they can make transactions.
According to a Digital asset Custody Survey by PWC, 88% of respondents claim they are leveraging a tech integration with a technological partner specialized in Digital asset Custody.
There are three main types of crypto custody, and these include self-custody, third-party custody, or even partial custody. I will now dive into each type of custody individually to showcase how all of them differ.
Self-custody is a reference for when someone keeps full control of their assets for themselves. This is similar to keeping cash at home, for example, rather than in a bank account. The process is far more complex than cash, however. Users need access to a hot or cold cryptocurrency wallet. Using these options lets them retain full control over their crypto, where there is no third-party involvement.
Third-party custody, on the other hand, is one of the simplest ways to manage crypto wallets and a portfolio. Users utilize cryptocurrency exchanges, crypto custodian banks, or even any other digital asset management firm. The main advantage here is the fact that a custodian manages everything, so users don’t have to worry as much about safeguarding the private keys.
These are also regulated and can offer insurance or programs for passively earning more crypto. According to a survey from Paxos published on March 7, 2023, 89% of the respondents still trust centralized custodians.
Partial custody is a method where the third-party custodian only keeps limited control over the assets. These use different methods for accessing them, including multi-signature protections (MSP) and two-factor authentication (2FA).
Overall, each method has its own pros and cons, but it is convenient that multiple options exist for different kinds of people. Beginners might enjoy third-party custody as it helps them focus on other areas of their crypto journey, such as trading and investing.
However, privacy-conscious investors might pick self-custody as they want 100% control over their crypto balance and might not necessarily fully trust third-party custodial services. There’s also the middle ground with partial custody for those looking for something in between.
The choice an investor makes will be highly dependent on their own unique use cases, market demands, and overall ambitions.
The benefits of self-custody include zero counterparty risk and the fact that the account stays with any user at any point in time.
Third-party custodians also feature benefits, such as increased accessibility for beginners, insured assets, and the possibility of earning interest through staking crypto.
Partial custody has benefits such as sufficient control over holdings and strong security protocols. In general, crypto custody offers the main benefit of attempting to keep cryptocurrencies as secure as possible and making them inaccessible to anyone else but the actual owner.
Crypto custody plays an essential role in the management of a cryptocurrency portfolio, as without it, things would be chaotic for management. Without the proper security measures in place, such as the current system with private keys, any investors would risk having their cryptocurrencies stolen or lost forever.
While not all of the systems currently in place are perfect when it comes to managing cryptocurrencies, a combination of them could be fit enough to meet the demands of any trader or investor.
The loss of a private key in the case of self-custody could result in the loss of cryptocurrencies forever. There is never any guarantee that a person might not forget a private key or misplace a hardware device dedicated to its protection.
However, third-party custody also has drawbacks, including custodian fees, lack of account control, and third-party risks of being compromised.
Partial custody also comes with its own risks, such as dependence on third parties for co-signing transactions, which can result in delays, lack of access, or other issues. However, the risks do not stop just here.
Crypto custody can come in many other forms as well, and when third-party custodians are left in charge of a balance, there will always be some level of risk. As long as there is a server connected to the internet, there is a chance, however slim it might be, for it to get compromised.
What this means is that unless cryptocurrency investors and traders go the extra distance to fully secure their balance through a hardware wallet, or cold storage device, they will always face some sort of drawback or security issue to some degree.
The cryptocurrency exchange known as Gemini provides custody services tailored toward retail clients. However, unlike most of its competitors, it provides a free setup and has no minimum deposit requirements. The company also has a reputation for being one of the most regulated exchanges in the crypto space.
However, not all cryptocurrencies are supported by this third-party custody provider. The company offers a wide range of supported assets which can be found on its website. However, there is no guarantee that your favorite altcoin will get support. In addition, there’s also personalized account management coupled with 24/7 customer support which can always come in handy.
Coinbase offers a custody service, which can enable secure storage, followed by insurance coverage, compliance, or even 24/7 access to digital assets. Coinbase as a company is one of the most popular cryptocurrency exchanges on a global scale, and as a result, it has already established a high level of trust among investors and traders.
While it is not as secure as cold storage devices, millions of users have already placed their trust in Coinbase Custody, and as a result, the team takes a high level of priority on their security, providing peace of mind.
Orbitos is a service that enables users the opportunity to get access to crypto custody with ease. They can also get bank statements for seamless accounting and store appreciating assets. The crypto assets on top of Orbitos are secure for clients, and the platform uses a combination of cold stage, multi-factor authentication, and regular security audits with the objective of protecting the digital assets that they manage.
Multi-factor authentication is also implemented, which adds an additional layer of security. In addition, Orbitos features a security protocol that’s suited to protecting the digital assets of clients.
Cobo Custody has a reputation for being one of the most compliant institutional providers that aim to achieve a mixture of security and efficiency. They have security features, and some of the most notable ones include HSM signing, three-tier private key storage, multi-signature access,, key sharding and global key distribution.
With all of these features put into its mix, it is by far one of the most secure custodians out there that can appeal to serious crypto investors who want to maintain the highest level of security possible. In addition, the platform also enables users to store and connect their NFTs to marketplaces safely and securely, or in other words; it offers NFT custody.
BitGo is one of the most popular cryptocurrency custody providers utilized by traders globally. In fact, it has gathered a reputation for providing institutional-grade security, followed by multi-signature authentication and even insurance coverage. As a result of this, BitGo is tailored more toward those looking for the highest level of security.
What it lacks in convenience, it makes up for in peace of mind. Moreover, it has been a part of the market for a lot of years and has gained a solid reputation and a large community, making it a trustworthy platform to get into. While alternatives do exist, BitGo is deserving of a spot on this list.
As is the case with just about any service, both inside and outside of the crypto sphere, providers are bound to charge a fee for keeping cryptocurrencies safe. Moving cryptocurrencies into and outside of an account can also incur fees.
These costs typically fall within one of multiple categories. There are custody fees, where a custodian can ask for a specific percentage point in accordance with the assets that are under custody on an annual basis, typically lower than 1%.
Then there’s the setup fee, which is a flat rate that occurs at the point in time whenever a user makes an account. Additionally, there is also a withdrawal fee, one that users will need to pay every time they want to take cryptocurrencies outside of their account.
Some exchanges might charge as low as 0.4% as an annual custody fee. For example, The company can waive the setup fee so that users do not have to pay to open an account as well in specific cases. If a person goes with self-custody, they can save on the custody, setup, and withdrawal fees. The user does still have to take care of the wallet and buy a dedicated cold storage wallet to keep it safe.
There are numerous aspects that need to be taken into consideration when picking a crypto custody option.
There is a difference between a regulated custodian and one that is not. A regulated one can hold regulated assets, will feature a lot more licenses, and adhere to numerous regulatory requirements. As a result, they will have far more responsibility surrounding the assets held by them.
Crypto custodians will offer support for a wide range of crypto assets. Each additional asset that gets supported will require a lot of work for the custody provider, and as a result, not all of them will support an equal amount of them.
It is essential to check if the crypto custodian has insurance and, if so, for which occurrences or situations it operates.
Cryptocurrency custodians can have numerous different pricing structures, depending on the value of the assets that are held within them.
There are numerous services outside of just crypto custody offered by these providers, from earning interest on deposited funds to tools surrounding taxes or portfolio monitoring. It is essential to go over everything they have on offer.
With the current plans and services available, crypto custody is here to stay and will likely be available in the future as well. With the development of new technologies such as HSM or MPC, custody providers are able to provide a much higher level of security and availability.
Custody providers will need to keep up with developments and ensure that their security measurements are updated and provide clients with the highest level of protection.
But as evident from the current options available, crypto custody services will be relevant for years to come. Even those who want to engage with self-custody will still need access to physical, cold storage devices, so the industry will still maintain its relevance.
Self-custody, or third-party custody, will always be relevant, as there are consistently new investors popping up in the industry with different skill levels or knowledge within the crypto sector. As a result, having something for just about anyone is essential in order to make the industry as inclusive as possible.
The main purpose of crypto custody is to safeguard the cryptocurrency assets that an investor or a trader might hold. Alongside all of that, there is a high level of utility for crypto custody solutions. Custodian services are typically meant for institutional investors who hold a large number of cryptocurrencies.
They can empower investors who are not interested in dealing with the technical aspects of securing digital assets manually. In addition, they enable investors to enter the digital asset markets as quickly as possible.
We are now at the point in time in crypto where regulated custodians exist, which can provide a lot more value and security for investors. In fact, institutional money has already begun to flow into the blockchain market. As time moves on, new investors will enter the Web3 space and will require some sort of solution through which they can maintain crypto custody.
By having many options available, freedom of choice, variety, and accessibility plays a major role in helping them stay in the market and enabling them to explore what choice works best for their specific needs and demands.