Crypto industry horror stories abound about lost passwords, hacks, and stolen funds. Crypto custody plays an important role here.
Custodians, who have existed since the 1960s, are a pillar of traditional banking.
There is a difference between crypto custody and traditional custody. Because the blockchain contains all data and transactions, digital asset custodians are not technically required to store digital assets.
Crypto custody explained:
The purpose of crypto custody is to secure funds or holdings of crypto wallets off-chain in order to prevent theft or loss.
Institutional investors, hedge funds, and governments are well known for using cryptocurrency custody services.
When crypto custodians combine hot, warm, and cold wallets, they provide the highest level of security. Keys containing complex alphanumerics act as passwords.
Importance of Crypto Custody:
The role of crypto custody solutions in protecting high-net-worth individuals' crypto assets cannot be overstated. Cryptocurrency holdings are protected against cyberattacks, hackers, human error, and internal collusion through institutional-grade custody systems. Those custody software solutions often take advantage of multi-party computation (MPC) to eliminate a single point of failure. How? Simple. They use distributed bank vaults to recover from disasters.
Although there's more to crypto custody than just storage.
Institutions and enterprises can enter the crypto market when assets are shown under custody with regulated custodians.
Operations get interrupted due to these technical challenges and are expensive to tackle.
Categories of Crypto Custody:
It is important to prove the ownership of the wallet. It is equally important to keep the private keys secure and they arrive in these 3 types.
This crypto custody option is perfect if you want complete control of crypto assets via personal private keys. Self-custodians use software across devices or hardware wallets for better security. The downside is that you can’t seek help from a third-party intermediary if you lose the physical device or forget the private keys. It is advisable to protect yourself by updating software, upgrading backup capabilities, and finding ways to recover funds in emergency situations.
Third Party Custody:
Third-party custody services store and maintain digital assets on behalf of customers. Third-party custodians use custom features and controls to manage assets.
They offer institutional-grade security, insurance and standardisation rules. These features make third-party custody suitable for institutions and investors from hedge funds, high net worth individuals (HNWIs), and asset managers.
Third-party custodians are registered, regulated financial institutions with licences on the state or national level. Their service level agreements (SLAs) with customers determine crypto fund storage and access.
HNWIs who do not opt for full third-party crypto management often decide on split or partial custody. These custody solutions offer institutional protections while letting investors have control over holdings.
Partial custody systems work by security protocols such as two-factor authentication (2FA) or multisignature protections (MSP) to hardware wallets. For instance, a partial custody solution may require a third party to co-sign along with the investor for transaction authorization.
This cooperation between both parties is at the core of partial custody. They can create a legal arrangement to decide the amount of control. In case of emergency, these arrangements help investors move funds without third-party keys. Investors must understand the solution provider’s software upgrade, recovery, backup, and transaction identity verification policies before signing an agreement, to protect their interest.
Crypto custodians uses different technologies and the reasons why they choose them.
A cold wallet or hardware wallet holds cryptographic keys securely in a physical device or hardware security module (HSM). HSMs generate and hold private keys securely. They can also approve and sign transactions.
One can’t steal funds without accessing the wallet device. This immunity to hacking comes at the expense of access speed. Due to the access speed, which may take up to 48 hours to transfer funds, the cold wallet is immune to hacking. Cold wallets aren’t ideal for frequent asset trading.
These wallets keep private keys online for ease of transaction. Hot wallets bank on internet connectivity to store, receive, and send digital tokens. It creates and records blockchain transactions without human intervention.
Hot wallets are easy to use but are more exposed to theft because they store private keys online. Any security breach may lead to your losing the keys. Therefore, it’s best not to keep large amounts of crypto in hot wallets.
Crypto custodies generally use a combination of cold and hot wallets.
The warm wallet is a digital asset storage system that uses downloadable software to keep funds secure. With warm wallets, you get the speed of hot wallets and the security of cold wallets. These wallets can still automate transactions, but you must sign them. As a result of this human involvement, warm wallets are safer than hot wallets.
Multi-party computation (MPC):
This is a form of advanced cryptography. By allowing multiple parties to hold different parts of a key, private keys are kept secure. With MPC, private keys are broken down into encrypted shares, and no one knows who holds the other part of the key. A transaction, however, requires the signature of all parties.
MPC allows you to recover assets and remove single points of failure from self-custody. Crypto custody solutions powered by MPC are popular among global asset managers seeking cross-chain trading and liquidity.
Multi-signature or multi-sig approvals (MSA):
In order to digitally sign and approve transactions, it uses multi-party authorization. MSA algorithms allow you to authorise transactions for all authorised addresses or a subset.
Often, hot wallets require multi-signature approvals for signatures. MSA prevents a single person from compromising the assets of a hot wallet.
Key Takeaways - Call To Action:
Crypto custody uses cryptographic keys to secure crypto funds.
To start using crypto custody, you need to:
Choose a crypto custody solution provider.
- Perform Know Your Customer (KYC) and anti-money laundering (AML) checks.
- Move your digital asset holdings to crypto custodians.
There are two types of keys: public and private.
- The public key contains an alphanumeric code that can be used by other parties to make deposits.
- The private key gives you access to wallet funds through encrypted code.
Strings of characters make up cryptographic keys. Data is encrypted so that your key appears random. If you don't have the right key, you can't decrypt it. It's for this reason that key management is so important when it comes to securing crypto funds.