Crypto custody is the service of storage of cryptocurrency that is provided by a third party. The third party that stores crypto holds private keys - they provide access to coins that are stored on a blockchain. This is done on behalf of individuals. When users delegate this responsibility to third parties, they mitigate the risks that come from managing own private keys, such as accidental deletion, loss, or theft.
Table of contents
- Types of Crypto Custody
- How Do Custodial Services Work?
- Benefits of Crypto Custody
- Risks and Drawbacks of Custodial Solutions
- How to Choose a Reliable Custodial Service
- Alternatives to Custodial Solutions
- Conclusion
How Crypto Custody Works
Crypto custody services store and manage their users’ private keys. Such services usually have very strong security measures, such as multi-signature wallets, special cold storage solutions, and encryption. This is done to protect users’ assets from unauthorized access and cyber threats.
Custodians may offer not only storage but also some advanced features, such as insurance, and regulatory compliance, and some even offer options of account recovery.
Who Uses Crypto Custody?
Many users can use crypto custody services. Those users can be individuals and companies. Individuals or retail investors may use custodian wallets because it is comfortable and secure. Institutional investors such as hedge funds and family offices may need custodial solutions because they are safe and to meet regulatory requirements. Also crypto exchanges and financial institutions may use custodial services to store their users’ funds safely.
Types of Crypto Custody
There are the following types of crypto custody.
Self-Custody
We speak about self-custody when individual users or companies manage their crypto assets on their own, without the help of third-party services. Users have complete control over their funds, but they also are responsible for the safety of their money. Here are the usual self-custody tools.
- Hardware wallets: These are physical devices that store private keys offline.
- Software wallets: These are applications that are installed on computers or mobile devices. They manage private keys locally.
- Paper wallets: These are physical reprints of private keys or QR codes. They keep private keys offline.
Custodial Wallets
Custodial wallets are managed by third-party service providers. They hold private keys on behalf of users. These services are safe, and they are especially good for users with no technical experience. Such custodial wallets are normally offered by crypto exchanges, banks, and specialized custody firms.
Differences Between Self-Custody and Custodial Solutions
Control
Self-custody offers complete control over assets. Custodial solutions delegate this responsibility to a third party.
Security
In self-custody, security is up to the user. In the case of a custodial service, security is up to a professional.
Accessibility
Custodial wallets often provide easier access and recovery options. Self-custody requires careful and responsible key management.
How Do Custodial Services Work?
Custodians store their clients’ private keys within their infrastructure. Normally, custodial services use cold storage solutions to minimize the possibility of threats. Additionally, custodial services apply such measures as multi-signature wallets. In such a case, multiple private keys are used to authorize a transaction.
Who Provides Custodial Services?
Many entities can provide custodial services. The most common providers of custodial services are:
- Crypto exchanges: Platforms like Coinbase and Binance provide integrated custodial wallets.
- Banks: Some traditional banks adopt crypto and offer custody solutions that comply with financial regulations.
- Specialized custody firms: Companies like BitGo and Anchorage provide institutional-grade custody services.
Benefits of Crypto Custody
Simplified Access to Assets
Custodial services have user-friendly interfaces. Users can access and manage their funds easily.
Account Recovery Options
Custodial services offer an option to recover access to a user account if the user loses credentials. But in the case of self-custody, if a user loses his private keys, there is no option to recover them. It results to a permanent loss of money.
Enhanced Fraud Protection
Professional custodians implement robust security protocols, including multi-factor authentication, encryption, and continuous monitoring. This is done to protect user assets from any kind of threats. Some custodians offer insurance, too.
Risks and Drawbacks of Custodial Solutions
When a custodial service controls private keys, a user has to obey the service provider’s rules. If there are some regulatory issues, the custodian’s account may be closed or frozen. This can restrict user’s access to funds.
Even though custodial services employ very stringent security measures, their accounts are a very attractive target for hackers. If a custodial wallet is hacked, it can lead to serious losses, and users not always can recover their funds rapidly.
Custodial services are normally subject to regulatory oversight. This can impact their users. If there are some regulatory restrictions or there are requirements for identity verification, users have to obey the rules.
How to Choose a Reliable Custodial Service
When you choose a custodial service, check these factors.
- Security measures: It is recommended to choose services that employ cold storage, multi-sig wallets, and encryption.
- Regulatory compliance: The custodial service must adhere to legal standards and have all the permissions and licenses.
- Insurance coverage: Choose services that offer insurance against theft, fraud, and other sisks.
- Reputation: You shall research the history of the provider, check customer reviews, and if the provider had any security incidents in the past. The most popular and secure custodial services are Coinbase Custody, BitGo, and Anchorage.
Alternatives to Custodial Solutions
A Hardware Wallet
You can use a hardware wallet, such as Ledger or Trezor. These are the most popular harwaware wallets, and they store your private keys offline. They are very secure, and you are the only one who controls your coins.
Multi-Signature Wallets
To send money from a multi-sig wallet, you will need to get many signatures. This is why this option is very safe. Businesses very often use multi-sig wallets.
Don’t Store All Funds in a Single Wallet
You can store your coins in several wallets, different types of them. This will minimize the risks.
Conclusion
Crypto custody is very important for the entire ecosystem. It helps users to store their digital coins safely. However, custodial services also come with their risks such as potential hacking and regulatory oversight. This is why it is important to choose a custodial service provider carefully and store your funds in various storage options.
