Consider a $100 bill for a moment. When the bill is in your pocket, it is in your custody, and you are its custodian. If you deposit that bill into a bank, the bank becomes the custodian. The same is true with crypto custody.
In short, crypto custody refers to the way in which digital assets are stored and by whom. And you can either choose to custody your digital assets yourself or deposit them with a third-party custodian.
As digital assets begin to rise in popularity and the approval of the first Bitcoin ETFs in the United States indicates signs of market maturation, crypto custody becomes an even more pressing issue. In this article, we'll look at the various types of crypto custody solutions available and how the market is evolving to meet the exacting needs of institutional investors.
Crypto custody solutions store digital assets and tokens and keep them secure. However, as we've seen from many highly-publicized hacks over the years, many custody solutions are vulnerable and prone to security breaches. A report by Atlas VPN found that, in 2020 alone, blockchain hackers stole around $3.8 billion worth of digital assets. While that might sound alarming, 2020 saw the first drop in crypto hacks in five years—a sign that crypto custody solutions are improving and investors are becoming more aware of the risks and taking more precautions.
While the cryptocurrency industry was in its nascency, decent custody solutions were few and far between. Secure offline cold storage options were far too complex for the average person to use, leading many retail investors to leave their digital assets in hot wallets (online wallets) on exchanges prone to hacks. Mt. Gox was the first exchange to hit the headlines for a major crypto hack as almost 850,000 bitcoins were siphoned off by hackers, most of which were never seen again.
As exchange hacks began to hit the headlines frequently, more users opted to store their crypto in cold wallets that keep digital assets offline. But there are many drawbacks to these solutions as well. Storing your private keys (a complex combination of alphanumerics that enable you to access your crypto) in offline solutions such as paper or hardware wallets carry their own risks.
What if you lose physical custody of the paper or wallet or forget your recovery phrase? We've all heard the heartbreaking stories of people misplacing their pins or backup words and losing their assets forever. While cases such as these are without doubt tragic for the individual involved, imagine an institutional investor with significantly more capital, or clients' money, at risk.
Under U.S. SEC regulation, institutional investors holding customer assets worth more than $150,000 must store the holdings with a "qualified custodian." The SEC's definition includes banks, registered broker-dealers, futures commission merchants, and similar types of regulated entities. Yet it wasn't until July 2020 that the Office of the Comptroller of the Currency (OCC) gave the green light for U.S. banks to custody crypto assets. This explains why very few mainstream banks still offer custody services today.
As the space has matured, crypto custody has improved with solutions such as multi-signature, which require users to have at least two out of three keys. This means that, in the case of losing one of your keys, such as your hardware wallet, you can use the other two keys to access your funds.
Exchange security has also gotten better and regulated players have emerged on the market to serve the needs of institutional investors, such as EQONEX's institutional-grade custodian DigiVault that uses a bullet-proof combination of warm and cold storage, and a Vault to keep its customers' assets safe.
These types of solutions are perfect for institutional investors such as hedge funds, endowments, corporate treasuries, and family offices to hold large amounts of cryptocurrency and meet their regulatory burdens. However, as large banks such as BNY Mellon announce their intentions to offer crypto custody services to their clients, using a third-party provider is not an option. The world's largest custodian bank cannot provide custody services to clients and store their assets elsewhere.
The entry of large players like this in the market will likely cause a shakeout in the crypto custody space as many retail-driven or unregulated solutions get left behind. This trend will only continue as regulation surrounding custody becomes more defined. Currently, there are very few security provisions pertaining to cryptocurrency storage, and many businesses are unclear about their obligations.
Crypto custody is a crucial area for the digital assets space and a sector that's likely to see many changes over the coming year. How you decide to custody your digital assets is vital if you want to keep them safe or meet your regulatory obligations. Using exchanges provides convenience and liquidity, but if you're holding large amounts of crypto, you must seek a trusted custodian, like Digivault.
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By now, it's almost impossible not to have heard about cryptocurrency, although you may not be familiar with precisely what it is and how it works. Don't worry, you're not alone.
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