It's tough to overestimate how disruptive cryptoassets have been to the traditional financial system. The industry provides a compelling alternative, as it aims to create a fairer and more equitable system for all. At the same time, the ripples of this disruption have reached security and ownership, guided by crypto's core concept of decentralization.
Today, the common person can take sole control of their cryptocurrencies (and other digital assets) without requiring the involvement of a third-party. With crypto, there's no need for the equivalent of a bank — a centralized entity responsible for holding your assets securely. The act of taking control of your coins and tokens is known as cryptocurrency custody.
Crypto custody is a solution to help address the evolving security needs of cryptocurrency users. As such, it's an essential topic for traders and users of all experience levels to understand and apply.
In this guide, we’ll explore crypto custody in depth, discussing what the term means, why it's essential in securing your digital assets, and the different options available.
TL;DR
Crypto custody refers to the methods through which you store your digital assets. It represents a change in how we manage control of our finances, in the context of cryptocurrencies.
There are three options for crypto custody available: self-custody, which, if properly implemented, can be considered the most secure option, partial custody, and third-party custody.
When deciding which crypto custody option is right for you, it's wise to also look into cold storage and hot storage. These options also impact the security and accessibility of your assets.
When you choose partial or third-party custody, it's important to do plenty of research into the available providers to choose the most secure option. Look into their security protocols and systems and how transparent they are about their service. We also recommend checking if they offer insurance coverage, and any local regulatory requirements.
Understanding crypto custody: safeguarding digital assets and cryptographic keys
Custody in the context of cryptocurrencies refers to a digital asset management solution that supports the safe storage and security of sizable digital currency holdings. Like financial institutions that secure your traditional monetary assets, crypto custodial services protect your digital assets from theft and unauthorized access.
Crypto custody involves the secure storage and management of digital assets while safeguarding private keys — the indispensable components of crypto wallets. These intricate alphanumeric combinations serve as cryptographic passwords, granting access to an individual’s cryptocurrency holdings.
Public keys, meanwhile, are alphanumeric codes designed to streamline the process of receiving funds from others. They can be likened to a bank account number, email address, or username, as they can be shared with anyone.
Unlike traditional providers, digital asset custodians don’t technically store the assets themselves. Instead, they protect users’ private keys. This change underlines a significant shift from securing physical assets to prioritizing the protection of cryptographic keys on the blockchain’s transparent ledger.
Hot vs cold storage in crypto custody
There are two main categories when securing private keys — hot and cold storage.
Hot storage solutions
This involves self-custody solutions connected to the internet, and it offers more accessible liquidity. These software-based wallets provide convenient and immediate access to your cryptocurrency funds and can even engage with cryptocurrency exchange platforms and decentralized applications (DApps). While convenient, users should exercise caution with hot wallets due to their internet connectivity, which makes them more vulnerable to cyber attacks.
Cold storage solutions
This involves hardware wallets or paper wallets that store private keys offline, providing an extra layer of security against online threats. Transactions executed through cold storage are locally signed, significantly reducing the risk of hacks. Cold wallets are particularly suitable for long-term storage and safeguarding significant amounts of cryptocurrency.
The protection of private keys is influenced by the chosen custody method and storage choices. Choosing between these alternatives depends on your individual risk tolerance, usage patterns, and preferences.
Why crypto custody matters: protecting assets and building trust
Crypto custody plays a dual role, serving as a robust shield against security threats while fostering trust within the digital asset ecosystem. It's essential for individuals and institutions who want to store their digital assets securely. The decentralized nature of cryptocurrencies means that users are solely responsible for safeguarding their private keys, which are required to access and transfer their funds. This responsibility can be overwhelming, especially considering the increasing sophistication of cyber attacks.
Alongside cybersecurity concerns, storing cryptocurrencies securely involves protecting against physical threats like fire, flood, or theft. Given the potential value of digital assets, the consequences of losing access to your crypto holdings can be financially devastating. Therefore, individuals and businesses often turn to third-party crypto custodians to maintain the safety of their digital assets.
What are the different types of crypto custody storage solutions?
Self-custody
Self-custody, often termed “non-custodial,” grants individuals absolute control over their cryptocurrencies by allowing them to manage their private keys personally. Its primary advantage is the unparalleled level of control, which removes the reliance on a third party.
This approach aligns with the belief that cryptocurrencies, especially decentralized ones like Bitcoin, empower individuals with unparalleled financial independence. When you own cryptocurrency, you maintain complete control over securing and managing your assets. Conversely, third-party custodians, like crypto exchanges, control private keys when entrusted with custody, exposing assets to regulatory restrictions and security risks. The motto “not your keys, not your coins” underscores the importance of retaining personal control in the self-custody movement.
However, this autonomy comes with limitations — if you lose your private keys, you lose access to your assets without the possibility of recovery. Misplacing private keys — the equivalent of losing a physical wallet — means no recovery option, and funds become irretrievable.
Partial custody
Partial custody, often called “shared custody,” bridges the gap between independent self-custody and complete reliance on third-party custodians. Within this framework, users are responsible for securing their assets with a trusted third-party, typically a crypto custody service provider.
This collaborative setup grants the user and the custodian access to private keys, providing a safety net for potential key loss by enabling asset recovery through the custodian. However, this arrangement also introduces a potential risk factor. If the custodian’s security measures are compromised, it threatens the safety of the user’s assets.
The core principle of partial custody involves splitting the responsibility for safeguarding private keys between multiple parties. This model is helpful in joint accounts, where several individuals need access to the same cryptocurrency holdings.
Partial custody solutions adopt technologies like multi-signature (multisig), secure multi-party computation (MPC), and two-factor authentication (2FA). These improvements make partial custody more available to users. Users gain access to different options that fit their own preferences and needs in managing and securing their digital assets.
Third-party custody
With third-party custody, a service provider would assume the responsibility of storing digital assets on behalf of users. Ideal for institutional crypto custody, this approach offers institutional-grade security, insurance, and flexibility.
However, entrusting private keys to a third party brings with it some key considerations. Users enjoy ease of access but relinquish control, facing potential transaction limitations. Sometimes, third-party custodians may limit transactions, freeze funds, or block access to cryptocurrency wallets — actions that international regulators may influence. Additionally, you could lose all your funds if the custodian goes bankrupt.
What to look for from a crypto custodian
If you decide that a partial or third-party custodian is right for your needs, it's important to research your options thoroughly to make the most secure choice. We recommend exploring the following areas as part of your research into service providers.
Security protocols and systems
Your chosen crypto custodial service must adopt the latest available security protocols and systems to safeguard against crypto's evolving threats. Multisig, MPC, and 2FA should be complemented by processes including segregation of client assets from the provider's own assets.
Trusted custodians also often adopt both hot and cold storage to balance robust security with convenient access to assets. Meanwhile, look to see if encryption algorithms are used to protect sensitive data should it be intercepted. Keep in mind that as crypto's regulatory situation changes, so do the duties of players in the space. Custody providers should therefore frequently be updating their security protocols and systems for maximum protection.
Transparency
Trusted custodial services should also be transparent about the measures they have in place to protect users and their funds. Check to see if a potential provider provides proof of reserves (PoR) or offers a live tracker to prove the platform has adequate reserves to back its users’ deposits.
Additionally, see if the provider has completed the service organization control (SOC) report. SOC reporting involves an audit of a company's processes and procedures to judge their success in managing services and protecting user data.
Insurance coverage
Some custodian providers may offer insurance coverage as another layer of security. That could include compensation in the event of asset loss caused by various threats. Understand what degree of cover is available, as custodians may offer different levels of protection.
Local legal requirements
As you move through the due diligence of finding a crypto custodian, don't forget to consider the legal requirements of the jurisdiction you're based in. As the global regulatory structure continues to take shape, you may find that your local authority has specific demands when compared to another, which inevitably impacts your custodian of choice. Take the time to understand these nuances to make sure you're fully protected.
The final word
Crypto custody solutions aren't just about storing assets but protecting the keys that provide access. This safe solution helps keep large cryptocurrency holdings safe. It protects them from being stolen, unauthorized access, and the risks that come with using crypto.
Meanwhile, the emergence of decentralized finance and blockchain-based smart contracts presents new possibilities for self-custody and peer-to-peer custody solutions. These innovations could disrupt the traditional custodial landscape and give users more control over their digital assets.
As financial services continue to adapt, the role of digital asset custody becomes more important, transforming approaches to financial responsibility in the context of digital assets.
Crypto custody is more than just a technical requirement. It’s a strategic need to build a safe and trustworthy foundation for the digital financial future.
FAQs
Crypto custody refers to the act of storing and managing digital assets. That could see you have total control of your own assets, known as self-custody, or involve a third-party.
Self-custody is one of three types of crypto custody, and it's the option that gives you most control of your assets. With self-custody — also known as "non-custodial" — you take sole responsibility for managing your private keys.
Meanwhile, through what's known as partial custody, you'd share responsibility for managing your private keys. Although this option provides a safety net should you lose access to your private keys, it also introduces a potential vulnerability, because you're sharing custody with another entity.
Third-party custody, meanwhile, sees a separate entity take responsibility for your assets on your behalf. Many institutions prefer this option, but it's important to be aware of the risk involved when giving so much control of your assets.
The best option for crypto custody depends on your personal requirements. This includes your confidence in taking sole responsibility for your assets, how comfortable you are trusting a third party, and the custodians available in your jurisdiction. Self-custody could be the best option if you're familiar with the process of taking responsibility for your private keys and want true financial independence. As always, we recommend doing your own research before making a decision.
That depends on your circumstances and your typical trading activity. Cold storage is widely considered to be more secure than hot storage because this option doesn't involve an internet connection. As a result, cold storage options are more resistant to attacks. Cold storage is often preferred by those who want to hold large quantities of assets over the long-term, as assets can sit dormant safely away from cyber attacks.
Hot storage, however, provides more convenient access to assets, which can be beneficial if you trade frequently. Some traders will adopt both cold and hot storage to capitalize on the benefits of each option.
