Crypto Dictionary

Crypto Custody Debunked

Explores the concept of crypto custody, from the basics of how it works to the different types of custody solutions and the advantages and disadvantages of each.

In the crypto industry, there are countless real concerns about assets being taken, computers being hacked, and passwords being lost. The custody of cryptocurrencies becomes important in this situation.
 
Crypto custody is nothing but a method of protecting assets from theft. Custodians are outside parties you can pay to manage your cryptocurrency on your behalf. As one of the foundational elements of the conventional banking system, custodians have existed since the 1960s.
 
In the world of finance, the term "custody" describes the process of an institution holding assets for a client. An asset owner may find it advantageous to use a custodial service because it reduces security risks like theft and loss.
 
Let us take a look at how crypto custody works and what the different types are.

Key Takeaways

  • Crypto-custody is the act of protecting the private key that certifies your ownership of the assets stored in your digital wallet. 
  • There are different types of crypto custody (self-custody and third-party custody). 
  • Self-custody gives you full control of your keys and your coins, but you must accept ownership of your asset as well as the risks of asset loss. 
  • Third-party custody is best for beginners, as the custodian takes care of managing and storing their assets, but the custodian can freeze, block, or limit your access to the assets.
  • Cryptocurrency custody is essential to the ecosystem, helping to onboard new users and giving seasoned users cutting-edge trading tools.

Crypto-custody: What does it mean?

In recent years, the rise of cryptocurrencies has been a powerful phenomenon. This is especially true now that trust and security have received more attention. Additionally, the crypto ecosystem is seeing an increase in the demand for rules and standardized procedures. In discussions about crypto custody and trading, centralized and decentralized exchanges have previously dominated the conversation.
 
But in recent years, methods for storing and handling digital assets have gained popularity. Modern crypto custody services, which are essentially independent storage and security systems for cryptocurrencies, can be found.
 
Cryptocurrency custody, put simply, is the act of protecting the private key that certifies your ownership of the assets stored in your digital wallet. Holders of cryptocurrencies have the option to act as their own custodians.

How does crypto custody work?

Any discussion of cryptocurrency custody services must also focus on how they operate, which is a crucial element. Blockchain serves as the basis for crypto, and as the name suggests, cryptographic security is a key component of cryptocurrencies.
 
Key management enables custody of digital wallets through private keys and aids in the cryptographic security of assets. The institutional crypto custody solutions, on the other hand, keep the asset owner's private keys in their possession. The crypto custody solution makes sure that no third party can access a user's private keys.

Different types of crypto custody

There are different types of crypto custody that purely depend on the wishes of the owners of the assets. Let us look at the most common types of crypto custody methods:

Self-custody

Naturally, self-custody options are one of the best choices for private cryptocurrency custody solutions. Utilize hardware, software, or paper wallets to manage your cryptocurrency assets as it suits you.

Self-custody crypto solutions enable you to store the private keys to your crypto assets on hardware, software, or paper. Solutions for self-custody have the benefits of increased security and asset control. You must, however, accept ownership of your asset as well as the risks of asset loss.

Third-party custody

People who don't want to manage their own assets or find dealing with the technology too intimidating may want to contact a third-party custodian. These are incorporated, licensed financial institutions that are authorized to act as custodians on a state- or federal-level basis.
 
Based on the financial institutions, there are three different categories of third-party cryptocurrency custodians:

  • Exchanges - All centralized cryptocurrency exchanges handle the cryptocurrency custody of their clients. Some cryptocurrency platforms and exchanges contract out their security requirements to a third-party custodian who protects the managed assets. In any case, it's important to note that you do not safeguard the private keys to your exchange wallet when you create an account and hold assets on a centralized exchange. So if the exchange goes down, your funds are as good as gone too.
  • Digital asset managers - As cryptocurrencies have progressed as an asset class, the development of digital asset managers that function as banks for cryptocurrency holders has occurred. These organizations, like banks, are regulated and registered to provide cryptocurrency custody.

Advantages and disadvantages of crypto custody

Before jumping to a conclusion on what type of custody to opt for, there are various factors that should be taken into consideration. Let us look at the pros and cons of different types of custody.

Self-custody

With self-custody, you will have full control of your keys and your coins. There is also no counterparty risk associated with self-custody.

Speaking of disadvantages, if you lose access to your key, your assets are as good as gone. In the event of any hacks, there is no insurance for the return of your assets.

Third-party custody

Third-party custody is best for beginners, as the custodian takes care of managing and storing their assets.

But the primary downside of this is that the custodian controls your coins and assets. The custodian can freeze, block, or limit your access to the assets. The activities will also incur fees, and there is a risk of the custodian going bankrupt or getting hacked.

Final thoughts

The fundamentals of cryptocurrency custody demonstrate how it can alter the established standards for handling your crypto assets. There are now more opportunities to lessen the risk and difficulties involved in managing your own crypto assets thanks to new custody solutions.
 
Custodians are essential to the ecosystem, helping to onboard new users and giving seasoned users cutting-edge trading tools. Some have additional insurance to compensate their clients in the event of financial loss.
 
The main duty is to safeguard your backups and private keys, regardless of the size of your financial resources. Additionally, the private keys must be kept apart to safeguard them against any harm.

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