July 15, 2024

With the growing institutional adoption of crypto, stories of lost funds remind us to be careful with our cryptocurrencies. Crypto custody offers a way to keep our digital assets safe from theft. This idea isn’t new; it’s been part of the banking world since the 1960s, originally designed to protect cash, securities, and even gold bars. Nowadays, it also covers virtual currencies.

Entities investing in crypto may choose self-custody or custodian services to hold their assets safely. Custodians are special companies that take care of your assets for you, acting as a secure shield against loss. What is a crypto custodian? How does it work, and what are its pros and cons? This article answers these questions.

How Does a Crypto Custody Work?

Crypto custodian is a specialized service designed to keep cryptocurrency assets secure for individuals and, more importantly, institutional investors like banks, hedge funds, and pension funds.

There are two main ways to keep funds: self-custody and third-party custody. Self-custody means you take full responsibility for your own crypto. You manage your own security keys, which are like complicated passwords that access your crypto. It gives you full control but also means you’ve got to be really careful not to lose or forget your passwords.

When an institution decides to invest in cryptocurrencies but doesn’t want the hassle of managing the security and storage of these assets, it turns to an institutional crypto custody provider. This custodian takes the digital currencies and keeps them in a secure environment, away from hackers and thieves. They use advanced security measures like encryption, multi-signature wallets, and sometimes even physical storage devices kept in safes or secure locations.

A reliable custody solution is essential, particularly for companies participating in a market-making program where they provide liquidity on exchanges. It ensures their assets are secure while contributing to the market’s depth and efficiency. A custodian not only provides the peace of mind that their digital assets are safe but also ensures that these assets are handled according to regulatory standards.

Third-party custody involves handing over the safety of your crypto to someone else. It can include:

  • Exchanges or a platform for institutional crypto trading. These digital marketplaces allow you to buy, sell, or trade crypto. When you keep your crypto there, the exchange looks after it for you, making it easier to trade. But remember, since they hold your keys, technically, they have control over your assets.
  • Digital asset managers. These institutions, like banks, possess licenses and specialize in securely storing large amounts of crypto, often for businesses or wealthy individuals.
  • Custodial banks. These are traditional banks that have branched out into crypto, offering to keep your digital assets safe. They combine old-school banking security with new crypto services.

Regardless of the type, third-party custodians might charge fees for their services. These can vary from fixed fees to percentages of the assets under management or even fees for each transaction.

Crypto Custody Pros and Cons

Pros:

  • Enhanced security. Institutional cryptocurrency custody providers employ advanced security measures, such as multi-signature wallets, cold storage (offline), and sophisticated encryption. This level of security helps reduce the risk of theft or hacking.
  • Regulatory compliance. Many institutional custodians are regulated entities offering services that comply with the strict regulatory standards set for financial services. This compliance is crucial for institutions that adhere to legal and regulatory requirements.
  • Efficiency and scalability. Crypto asset custody for institutions can handle large volumes of transactions and manage significant amounts of assets efficiently. This scalability is essential for institutions that deal with a vast number of assets and need to execute transactions quickly.
  • Access to additional services. Beyond mere storage, institutional custodians often offer a range of services, including trade execution, lending, staking, and more.

Cons:

  • Cost. The high level of service and security comes at a price. Institutional custody services can be expensive, with fees that may include assets under custody fees, transaction fees, and other charges.
  • Less control. By entrusting assets to a third party, institutions may have less immediate control over their crypto assets.
  • Counterparty risk. Even though institutional crypto custody minimizes risk, there’s still the counterparty risk associated with entrusting assets to another entity. Should the custodian face financial difficulties or security breaches, the assets might be at risk.
  • Regulatory risks. Changes in laws or regulations could affect how assets are held, managed, or taxed, introducing additional complexity and risk.

Conclusion

Crypto custody is an essential service for individuals and institutional investors. It provides a secure environment for storing digital assets and protects them from theft. While self-custody is an option, third-party custodians offer added convenience and security measures crucial for companies operating with large amounts of money. It’s important to weigh the pros and cons of each option before choosing a crypto custodian.

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