What Is Crypto Custody? How to Protect Crypto Asset Keys (2024)

The concept of finance custody should be familiar if you have. Traditionally, you would go to commercial banks, brokerage, or other financial institutions to safe keep cash, gold, or securities.

But today’s investors put their money into legacy asset classes and crypto assets. Since these investors are placing bets on crypto for higher returns, they use cryptocurrency custody software to keep their resources safe.

Crypto custody solutions store and keep digital assets secure with private key encryption. You can also use these crypto storage and security systems to centralize crypto transactions, simplify operational processes, and even trade crypto assets.

Let’s go over the basics first.

What is crypto custody?

Crypto custody is a secure, off-chain storage solution that protects crypto wallet funds or holdings from theft or loss. Hedge funds, governments, and institutional investors use cryptocurrency custody services to protect large amounts of digital tokens.

Wondering whether cryptocurrency wallets and custody solutions are the same thing? They aren’t. While anyone can hold funds in wallets, crypto custody systems are primarily for institutional investors. Crypto custodians offer the highest level of security by combining hot, warm, and cold wallets (don’t worry – we’ll discuss these different wallets later).

Crypto custody continues to gain momentum as cryptocurrency mining enthusiasts and investors look for secure solutions to protect private cryptographic keys. These keys combine complex alphanumerics that act as passwords.

Investors can’t access crypto holdings or conduct transactions without those keys. Wallets can store private keys but are susceptible to hacks. That’s why secure custody solutions are of utmost importance for investors looking to participate in the crypto market.

Crypto custody solutions play a crucial role in protecting high net worth crypto wealth. Institution-grade custody systems mature the crypto ecosystem by keeping investors’ crypto holdings secure from cyberattacks, hackers, human error, and internal collusion. Those custody software solutions often leverage multi-party computation (MPC) to eliminate a single point of failure; they use distributed bank vaults to recover from disasters.

There's more to crypto custody than just storage, though.

Institutions and enterprises can’t enter the crypto market without showing assets under custody with regulated custodians. The Dodd-Frank Act by the U.S. Securities and Exchange Commission (SEC) requires institutional investors with customer assets worth more than $150,000 to store holdings with qualified custodians.

Institutions also encounter technicalities when managing digital assets. These technical challenges interrupt operations and are expensive to tackle. Crypto custody solutions help institutions overcome these problems.

Innovative custody services also open up opportunities for prime brokerage, staking, lending, and accounting services. For example, staking allows blockchain participants to receive rewards in exchange for transaction validation. Also, some digital assets allow participants to vote on future protocol changes.

Want to learn more about Cryptocurrency Custody Software? Explore Cryptocurrency Custody products.

Self-custody lets you hold the private key for accessing crypto wallet funds. This crypto custody option is ideal if you want complete control of crypto assets via personal private keys. Simply put, self-custody solutions consider you as the custodian of your funds.

Self-custodians use software across devices or hardware wallets for better security and improved control over private keys and assets.

The major downside is that you can’t seek help from a third-party intermediary in case you lose the physical device or forget the private keys. Your crypto funds are gone in either of these cases. Plus, you can’t ignore the vulnerabilities of hacking. Protect yourself by updating software, upgrading backup capabilities, and finding ways to recover funds in emergency situations.

Managed solutions or third-party custody services store and manage digital assets on behalf of customers. Third-party custodians ease asset management with custom features and controls.

They also offer institutional-grade security, standardization rules, and insurance. These features make third-party custody suitable for institutions and investors like hedge funds, high net worth individuals (HNWIs), and asset managers.

Third-party custodians are registered, regulated financial institutions with licenses on the state or national level. Their service level agreements (SLAs) with customers determine crypto fund storage, access, and movement policies.

Three types of third-party crypto custodians are:

1. Cryptocurrency exchanges hold assets in centralized exchanges. Chances of potential losses are high since you don’t hold the private keys to the exchange wallet.
2. Digital asset managers are regulated and licensed institutions that act like banks for crypto investors.
3. Custodial banks are nationally chartered banks offering cryptocurrency securities services.

HNWIs unwilling to opt for full third-party crypto management often decide on self-managed wallets, also known as split or partial custody. These custody solutions offer institutional protections while letting investors have control over holdings.

Partial custody systems work by applying different security protocols such as two-factor authentication (2FA) or multisignature protections (MSP) to hardware wallets. For example, 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 heart 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. To protect their interests, investors must understand the solution provider’s software upgrade, recovery, backup, and transaction identity verification policies before signing an agreement.

A cold wallet, hardware wallet, or cold storage safeguards cryptographic keys in a physical device or hardware security module (HSM). HSMs can generate and hold private keys securely. They can also approve and sign transactions.

Cold wallets are generally secure because you can’t steal funds without accessing the wallet device. This immunity to hacking comes at the expense of access speed. It may take up to 48 hours to transfer funds, so cold wallets aren’t ideal for frequent asset trading.

Hot wallets rely on internet connectivity to store, receive, and send digital tokens. These wallets keep private keys online for ease of transaction. Hot storage creates and records blockchain transactions without human intervention.

Hot wallets are easy to use but are more vulnerable to theft because they store private keys online. Any security compromise may lead to your losing the keys. That’s why it’s best not to keep large amounts of crypto in hot wallets.

Crypto custodies generally use a combination of cold and hot wallets.

Multi-party computation (MPC) is an advanced cryptographic technology. It keeps private keys secure by letting multiple parties hold different parts of a key. MPC breaks private keys into encrypted shares and no single party knows who holds the other parts of the key. However, all parties must sign to make transactions.

MPC makes self-custody secure as you can easily remove a single point of failure and recover assets. MPC-powered crypto custody solutions are popular among global asset managers looking for cross-chain trading and liquidity opportunities.

Multi-signature or multi-sig approvals (MSA) use multi-party authorization for digital signing and transaction approval. Depending on the MSA algorithm, you might be able to allow all authorized addresses or a subset to authorize transactions.

Hot wallets often use multi-sig approvals as part of the signing process. Use of MSA in hot wallets prevents one single person from compromising wallet assets.

Crypto custody works by keeping crypto funds secure with cryptographic keys.

To start using crypto custody, you need to:

Now that you know how digital asset custody works, let’s look at the costs.

In the same way banks charge for certain checking accounts, crypto custody providers charge for the safe keeping of crypto funds. These fees generally fall under one of the following categories.

Crypto custody business cases

• Investment funds: Corporate customers can use crypto custody solutions to store and execute individual assets on the market.
• Corporate treasury: Companies investing their liquidity in cryptocurrency may leverage crypto custody software systems to split crypto asset reserves dynamically.
• Retail offering: Retail businesses can use crypto custody to access the crypto asset market.
• Crypto staking: Crypto custody solutions allow investors to lock up a portion of their tokens for passive income.

The European Union (EU) proposed a regulatory framework known as the Markets in Crypto-Assets (MiCA) in 2020. As with other financial services, cryptocurrencies must comply with this law in terms of transparency, licensing, compliance, and oversight.

Among MiCA's provisions are rules requiring capital for asset custody and a procedure for investors to file complaints. Plus, asset-backed cryptocurrency issuers will face more stringent requirements in terms of oversight, investor rights, and capital.

“I have found it amazing during the short tenure of using it. It’s highly secure and flexible for transactions. Plus, it also accepts various cryptocurrencies. Application program interface integration is an added advantage.”

- Coinbase Custody Review, Qamar S.

“Currently, the biggest issue is INR deposits and withdrawals are stopped for Indian users, but now I personally trade from USDT. As of now, all Indian crypto exchanges also facing this issue.”

- Coinbase Custody Review, Rinkesh J.

“Its multiple authorization custody solution is great for defining rules within the organization. Another thing that needs appreciation is the ease of determining various regulations.”

- Ledger Vault Review, Deepak P.

“Rather slow addition of new coins and currencies due to the security overhead for development/integration by Ledger teams. Smart contract transactions on Ethereum are not possible while securing such transactions is often critical. API for managing notifications would be great too. Ledger Blue device UI would benefit from a refresh.”

- Ledger Vault Custody Review, Julien B.

“BlockFi makes dollar cost average investing a piece of cake. Use their credit card for purchases and get crypto back in rewards.”

- BlockFi Review, Chad M.

“I personally feel they're hurting themselves with issues like long delays between withdrawals and charging for more than one withdrawal in a month. If I'm giving up custody of my keys, I want to make sure I'm not paying extra for increasing my risk vs just holding. They also nearly went under in the recent crypto collapse and were bailed out along with Voyager, so to me, they need to tighten up their practices.”

- BlockFi Review, Brady P.

“AmbiVault can be useful for institutional customers such as government departments and insurance companies, as well as funds that have a lot of digital assets and need to share assets.

- AmbiVault Review, Kelly J.

“I don’t see any problems, but the probability of human error when creating smart contracts can be daunting.”

- AmbiVault Review, Kelly J.

“The execution service and low latency of prices are second to none. The offline cold storage for storing your crypto assets reassures that your assets are safe and prevents them from being hacked. I have been trading crypto for 3+ years, and this is beyond the most intuitive platform I have found. This truly will help institutions enter the space due to the custody support and the execution platform.”

- Fidelity Digital Assets Review, User in Investment Management

“The downfall is the platform does not offer that many crypto assets yet since it's a new execution form. I presume as the industry grows, Fidelity will onboard new assets which will be available for storing and execution.”

- Fidelity Digital Assets Review, User in Investment Management

Private keys are the key to keeping crypto assets safe. The best way to protect your assets from theft or damage is to store them with a regulated custodian or in self-custody.

Wondering if digital wallets matter? Check out these digital wallet trends that will influence online purchases and transactions in the months and years to come.