The digital assets market has rapidly evolved into a regulated sector, marking a new era of decentralization and peer-to-peer interactions. Despite this progress, true everyday usability for digital assets requires widespread institutional support.
Amidst ongoing debates, the primary goal remains clear: ensuring absolute security for these assets, even if not with the original owner, but with a trusted custodian.
With the cryptocurrency user base projected to reach 1 billion by the decade’s end and the market cap already at $2.9 trillion, security concerns and regulatory challenges are paramount. Cyberattacks and breaches are rising, with $3.8 billion in crypto assets stolen in 2022 alone, a 45% increase from 2021.
As more users, businesses, and institutions adopt crypto, the need for robust digital asset custody solution grows. These solutions not only protect funds and private keys but also ensure compliance with evolving regulations. In this article, we explore the crucial role of crypto custody solutions in fostering a secure and favorable environment for the digital assets market.
Understanding Crypto Custody
Custody is a state of being under control, guardianship, or protection. Crypto custody refers to the method used to protect cryptocurrency by storing the private keys associated with a cryptocurrency wallet. Since crypto businesses process transactions with millions of dollars on a daily basis, managing custody in-house is a daunting task. Plus, businesses need more time to convince investors of complete security and transparency when something as crucial as fund management is done in-house and is prone to manual manipulation.
Crypto custody platforms are third-party platforms that safeguard digital assets and private keys on behalf of businesses and institutions. Custodians, in the most literal terms, have been around for decades and have been serving as a key pillar for the traditional banking system.
The primary beneficiaries of crypto custody platforms are institutional investors, including crypto exchanges, family offices and HNIs, hedge funds, VCs, and Web3 projects, that require a licensed entity to manage substantial amounts of bitcoin or other cryptocurrencies. Typically, these solutions integrate a blend of hot storage, involving online connectivity for crypto custody, and cold storage, which entails crypto custody disconnected from the Internet.
Some of the best and most innovative custody solutions include Liminal Custody, Fireblocks, BitGo, Atato, and Coinbase Custody.
How Crypto Custody Works?
Crypto custody involves intricate technological processes aimed at securing and managing crypto holdings. The foundation of crypto custody comprises innovation in wallet signing techniques to eliminate the single point of failure that led to multi-sig wallets and, ultimately, MPC wallets. Employing decentralized ledgers and custody solutions ensures transparency, immutability, and a secure record of transactions, paving the way for increased trust, transparency, and mass adoption.
Crypto custody solutions use sophisticated security measures, such as MPC (multi-party computation) wallets, to offer an additional layer of security.
The Role of Private Keys In Crypto Custody
Private keys are at the core of crypto custody. Unlike the traditional banking system, where custodians have the physical custody of funds, crypto custody solutions safeguard private keys (a code necessary to authorize any transaction) and not the actual asset itself. Since crypto assets are stored on the blockchain, the only way to access them is through a private key.
Hence the infamous term, ‘not your keys, not your crypto’.
Cold Storage Solutions
The primary reason private keys get compromised is because an overwhelming majority of users store them online. Anything stored online is and will be prone to hacks. Cold storage refers to storing sensitive data, such as private keys, in an offline environment.
Cold wallets or hardware wallets are extremely popular cold storage tools that provide an extra layer of protection against online threats. Cold storage solutions are basically air-gapped systems, physically isolated from the internet, to mitigate the risk of cyberattacks.
There are different types of crypto custody solutions serving different purposes.
Types of Crypto Custody Solutions
Hot Storage: Hot storage crypto custody solutions use an internet-connected application/software to manage crypto assets and private keys. MetaMask is one of the most popular examples of hot storage custody solutions. Such solutions are very convenient to use and, thus, widely accepted. However, there may be better solutions for large institutions.
Cold Storage: Cold storage custody solutions store private keys offline, eliminating the chances of a cyberattack. Ledger’s hardware wallets exemplify a self-custody cold storage solution. Similar to how a safe safeguards money from direct access, cold storage solutions ensure security by remaining disconnected from the internet. The drawback to this approach is the necessity to bring digital assets online before use, resulting in a lengthier process. The only reason cold storage solutions are less popular is their complex UX.
Custodial Solutions for Institutions: As the name suggests, these solutions are designed to handle enterprise-grade transactions, facilitating seamless transactions to and from institutional investors, such as hedge funds and family offices. These services offer secure storage solutions, often with insurance coverage. Besides storing private keys, they also help institutions comply with regulatory laws and boost user trust. Liminal Custody, BitGo, and Copper Custody are some of the most popular and widely accepted custody solutions out there.
Multi-Sig Wallets: Multisignature (or multi-sig) wallets add an additional layer of security by mandating the use of multiple private keys to authorize a transaction. Almost all leading custody solutions use the concept to offer industry-grade crypto custody solutions.
How To Choose The Right Custody Solution?
Before choosing a crypto custody solution, consider these key factors:
Solution Type: Assess different types, including non-custodial wallets, self-custody, hot wallets, and cold wallets. Match the preferred custody type with your security requirements.
Assets Supported: Evaluate the number and types of assets supported. Some platforms may only support specific tokens like ERC-20, so align with your operational needs.
Security Infrastructure: Stay updated on evolving security trends in the Web3 space. Review the security architecture to ensure it meets your firm’s expectations.
Compliance: Navigate the changing regulatory landscape by selecting a solution that aids compliance with local regulations.
Licenses In Major Jurisdictions: Due to the ever-changing regulatory environment around cryptocurrencies and their interaction with retail investors, jurisdictions have been striding forward by mandating institutions integrate with a regulated custodian who is liable to store, protect, and process assets under strict adherence to industry-standard practices defined as per each regions financial bodies. Partner only with custodians who hold credible licenses issued like FSP and VASP.
Pricing: Ensure the solution fits your budget constraints, making it wise to check the costs beforehand.
Future Outlook
The rising need for enhanced security and interoperability amidst increased security and regulatory challenges has triggered a battle between legacy custody solutions and emerging crypto custody solutions. The role of such solutions is now wider than merely safeguarding crypto assets or private keys.
Emerging custody solutions have triggered a paradigm shift, introducing cutting-edge security, simplicity comparable to traditional finance (TradFi), customization, and interoperability. These wallet infrastructure providers utilize advanced security measures such as multi-signature (multi-sig) and secure multi-party computation (MPC). They also incorporate concepts like account abstraction, striving for a 100% transaction finality rate. Going forward, the impact of such solutions is bound to play a critical role in the shaping of the crypto economy.