Cryptocurrency Custody

What is cryptocurrency custody?

The finance industry generally explains cryptocurrency custody as the ability to hold, move, and protect assets on behalf of a client, typically by some form of institution. In the cryptocurrency space, it refers to storing and securing crypto or digital assets on behalf of a client. This is also sometimes referred to as digital assets custody.

The initial and primary goal of cryptocurrency custody was to help institutional investors shift the technical challenges of storing digital assets onto a third-party cryptocurrency custody provider. However, now it has become a common practice among individual investors and a legal requirement in several countries.

The use of a custodial service can be highly beneficial to cryptocurrency holders as it can help mitigate several security risks, including cryptocurrency theft. For this, holders can use cryptocurrency custody software. These software products offer custodial services to store and secure digital assets.

In other words, cryptocurrency custody software is an independent storage and security system to store large quantities of digital assets. However, the cryptocurrency custody solution doesn’t store assets. Instead, they safeguard private keys, which are a complex combination of alphanumerics used to access cryptocurrency holdings and perform transactions.

Investors may also come across the concept of custody while researching cryptocurrency wallets. In short, cryptocurrency wallets can be broadly classified as custodial and non-custodial wallets.

Custodial wallets are defined as wallets in which the private keys are held by a third party (custodians). On the other hand, non-custodial wallets grant users complete control over their assets and private keys. Non-custodial wallets are also known as self-custodial wallets.

Types of cryptocurrency custody

Cryptocurrency custody can be classified into three categories: cryptocurrency self-custody, partial cryptocurrency custody, and third-party cryptocurrency custody.

• Self-custody: Self-custody is the best option for holders who require complete control over their digital assets. As the name suggests, it’s when an investor personally holds the private keys. This also means that the holder is fully responsible for the assets, and the risks associated are higher. If the holder forgets their private key, the cryptocurrency is lost forever as there is no third party to intervene. Self-custody can be in the form of a self-managed software wallet or hardware wallet.

• Partial custody: Partial custody is when a third-party provider possesses a key for co-signing the user’s transaction. It’s usually in the form of a self-managed wallet with a certain level of third-party assistance to secure digital assets.

• Third-party custody: Out of the three types of cryptocurrency custody, third-party custody offers the highest level of digital asset protection. Third-party cryptocurrency custodians will provide holders with different types or levels of security to choose from. For instance, holders can store their assets in cold or hot wallets based on their preferences around accessibility. Since third-party custodians hold private keys, users can recover their private key data and regain access to their assets if lost.

Benefits of cryptocurrency custody

The following are some of the notable benefits of using cryptocurrency custody software:

• Security: Cryptocurrency custody solutions make it easier for holders to store and protect their cryptocurrency. It offers greater security, especially for institutional holders, who hackers frequently target. With the help of third-party custodians, businesses can ensure that their assets are less likely to be lost or stolen.
• Convenience: Although self-custody grants holders more control over their assets, it involves a lot of work, for example, generating and keeping track of private keys. With third-party custodians on the scene, investors don’t have to perform any such complex tasks.

• Backup and recovery: As mentioned earlier, if an investor loses their private keys, it’s easier to recover with the help of a third-party custodian as they will have several backups in place. However, in the case of self-custody, a private key lost is lost forever.
• Regulation: Some government regulations make it a requirement for institutional investors to store holdings with custodians. For example, the Dodd-Frank Act by the U.S. Securities and Exchange Commission (SEC) mandates that institutional investors that deal with customer assets worth more than $150,000 should store holdings with qualified custodians.