Cryptocurrency custody solutions are independent storage and security systems used to hold large quantities of tokens. Custody solutions are one of the latest innovations to come out of the cryptocurrency ecosystem and have been expected to herald the entry of institutional capital into the industry.
The main utility of cryptocurrency custody solutions lies in the safeguarding of cryptocurrency assets. Private keys, which are used to conduct transactions or access crypto holdings, are a complex combination of alphanumerics. They are extremely difficult to remember and can be stolen or hacked. Online wallets are a potential solution but they have also proven susceptible to hacks. The same is true of cryptocurrency exchanges.
Other solutions include storing private keys offline, on paper or a hard disk (or other electronic equipment) that is not connected to the Internet. But losing physical custody (or either the paper or electronic equipment) is a real possibility, and in those cases recovery of the cryptocurrency holdings can be impossible. For individual holders of bitcoin, the possibility of losing private keys is a risk; for institutional investors, though, it represents an even more significant risk. The latter go to extreme lengths to guard against this danger. Some major investors have even been known to distribute portions of a paper wallet across numerous storage units in different locations.
The other important reason for the existence of cryptocurrency custody solutions is regulation. According to SEC regulation promulgated as part of the Dodd Frank Act, institutional investors that have customer assets worth more $150,000 are required to store the holdings with a “qualified custodian." The SEC’s definition of such entities includes banks and savings associations and registered broker-dealers. Futures commission merchants and foreign financial institutions are also included in this definition. Within the cryptocurrency ecosystem, very few mainstream banks offer custodian services. Kingdom Trust, a Kentucky-based custodian, was the largest such service for cryptocurrencies until it was purchased by BitGo, a San Francisco-based startup.
Put simply, cryptocurrency custody solutions are third party providers of storage and security services for cryptocurrencies. Their services are mainly aimed at institutional investors, such as hedge funds, who hold large amounts of bitcoin or other cryptocurrencies. The solutions generally incorporate a combination of hot storage, or crypto custody with connection to the Internet, and cold storage, or crypto custody that is disconnected from the Internet.
Both types of storage have benefits and drawbacks. For example, hot storage is connected to the Internet and, as a result, offers easier liquidity. But hot storage options may be prone to hacks due to online exposure. Cold storage solutions offer greater security. However, it may be difficult to generate liquidity from crypto holdings on short notice because of their offline nature. Vault storage is a combination of both types of cryptocurrency custody solutions in which the majority of funds are stored offline and can be accessed only using a private key.
- Public keys are basically a long numeric code associated with a specific wallet or custody solution. It serves as the address of the custody solution and should be paired with the right private key for executing transactions.
- Private keys, on the other hand, are randomly generated binary numbers, which can help in encryption and decryption of transactions. The private key helps in unlocking and verifying a transaction.
With a detailed impression of the basics related to custody of cryptocurrencies and the crypto custody market size, now it is reasonable to focus on different types of solutions. What are the types of custody solutions you can use for cryptocurrencies? Here are the three common types of crypto custody services you can find for individual as well as institutional investors.
One of the foremost options for individual crypto custody solutions would obviously refer to self-custody solutions. Take control over your crypto assets with hardware, software, or paper wallets according to your convenience. Self-custody solutions for crypto help you use hardware, software, or paper for storing the private keys to your crypto assets. The advantages of self-custody solutions include better security and improved control over your assets. However, you have to take on the responsibility of your asset alongside the vulnerabilities of hacking and asset loss.
- Exchange Wallets
The next common entry among cryptocurrency custody solutions would bring exchange wallets into the equation. Exchange wallets are basically the solutions in which investor allocates the control and management of private and public keys to exchanges. However, investors would enjoy seamless access to their public and private keys through an online wallet.
Such types of solutions are suitable for institutional crypto custody where the exchange takes responsibility for managing private keys. While exchange wallets offer considerable simplicity and ease of access for managing the custody of crypto assets, they also present certain counterparty risks.
- Third-party Custodian
The final type of entry among crypto custody services would refer to third-party custodians. Service providers storing digital assets on behalf of customers can easily qualify as third-party custodians. However, third-party custodians offer the facility for including custom-defined features and controls for controlling management of the asset.
Third-party custody services are ideal for institutional crypto custody with exceptional institutional-grade security alongside insurance. You could find the promising value of standardization with clearly defined rules and controls for managing crypto assets. On top of it, third-party custodians also offer better flexibility and security, albeit with a higher cost suitable for institutions.
The next critical factor in any discussion around custody solutions for crypto would focus on its significance. How are custody solutions an important aspect for the growth of the crypto ecosystem? One of the foremost answers for this question would point towards the growing interest of financial institutions, hedge funds, and individuals with a high net worth in cryptocurrency.
Cryptocurrency custody can serve as vital support for expanding their crypto holdings. Around 150 active crypto-related hedge funds have already accumulated almost $1 billion in terms of value of assets under their management. However, around 52% of the hedge funds, financial institutions, and high net worth individuals depend on services of independent custody solutions. Therefore, the growing interest of institutional investors in the crypto space establishes the need for institutional grade custody solutions.
Custody in the case of crypto assets is a broad term with the availability of many solutions. You can discover many unique choices for storing crypto assets and ensure all-around access to your crypto assets. In addition, you should also notice the value of crypto custody solutions and the challenges associated with them.
Cryptocurrency custody solutions have grown in popularity as analysts and institutional investors have increasingly viewed them as a bridge between the traditional institutional investment market and the shifting cryptocurrency space. At least two developments are expected to affect the future of cryptocurrency custody.
The first one is the entry of big players. Established names, such as Goldman Sachs (GS), are conspicuously absent from the list of names offering cryptocurrency solutions. Their entry could shake up the nascent market. Some of that is already happening with Coinbase and Fidelity Investments taking the lead in offering or designing cryptocurrency custody services.
The second one is regulatory clarity. Security provisions pertaining to cryptocurrency storage is absent from current regulation. Not only that, businesses are still unclear about the regulations pertaining to cryptocurrencies themselves. The industry will evolve only after regulators step in and set rules for the playing field.