How does cryptocurrency custody work? It is a natural question for people new to the world of cryptocurrencies. However, most people investing in cryptocurrencies are new investors and lack complete information. According to a survey in 2021, 1 in every ten people has currently invested in cryptos in the US.
Cryptocurrencies are still very much in the early stages of adoption, and the technology and infrastructure that underpins them have only just entered adolescence. One thing we know for sure is that traditional financial institutions aren’t going away anytime soon. They’ve done too much good by providing services like credit cards, mortgages, and loans, but where do they fit into this brave new world?
Let’s First Look at How Custody Works in Traditional Finance
In traditional finance, custody is storing assets such as stocks and bonds. Custodians are the companies that perform this service. They’re regulated by the Securities and Exchange Commission (SEC) and must meet security, financial reporting, access rights, and pricing standards.
For example, Bank A wants to buy stock in XYZ Inc., but first, they need to send some money to another bank to make the purchase. Thus, Bank A sends their money over to a third-party custodian who stores their funds until Bank A needs them for investment purposes.
But What About Cryptocurrencies?
As you might imagine, custodians are necessary for cryptocurrency. In fact, in some ways, they’re critical to the success of the industry, but not always in the way you’d expect.
The reason is that cryptocurrencies themselves aren’t regulated. It means that there aren’t any federally-mandated rules about how you should store your cryptocurrency. And with that lack of regulation comes a lack of standards around what makes a good crypto storage solution and who can be entrusted with protecting your assets.
That’s why choosing the correct custodian is so crucial. If you don’t choose one carefully, you could lose all your money by putting it in someone else’s hands.
When it comes to cryptocurrencies like Bitcoin, Ethereum, and Zcash, there are a few options for storing them. Thus, if you plan to invest in Bitcoin, a bitcoin custody will help store your cryptocurrency. When you buy cryptocurrency, it’s stored in the blockchain or the public ledger, where all transactions are recorded. But if you have large amounts of bitcoin or other digital currencies and want to keep them safe from hackers and other threats, then you will need a secure place to store them. That’s where a bitcoin custody comes in.
Digital custody is one of the most crucial and difficult aspects of managing digital assets. One of the options available to you is the exchange, where you buy and sell your cryptocurrency. The exchange stores this information on its servers to track how much you have and where it comes from. But they don’t hold your money; they make it easy for you to exchange one type of currency for another.
A Beginner’s Guide to Digital Custody
Today’s digital consumer is not just interested in investing their money. Instead, they want an experience that makes them feel secure and safe while also feeling like they are making a difference through their choices. Digital custody services have proven to be a great way to achieve this goal because they provide the necessary tools for managing the security of your cryptocurrency holdings.
For your cryptocurrency holdings to be secure, they must remain within your possession at all times, even when they are outside your physical control. It means having physical access and legal rights over those assets so no one else can claim ownership. This kind of protection is what digital custody provides. In addition, it keeps track of all transfers between wallets so one can verify each transaction without revealing personal information about who owns those wallets.
How Does Custody Work in Cryptocurrencies?
How does custody in cryptocurrency work? In the traditional finance world, a custodian is an entity that holds your securities for you. It’s the bank where your stock certificate sits. In digital assets like cryptocurrencies and tokens, however, there’s no such thing as physical documents or ownership records. Instead of owning shares of stock directly, you own a private key that allows you access to those shares. Your keys are essentially your assets; without them, you could lose your coins forever. A German-born programmer, Stefan Thomas, is one such example, who was left with only two guesses to recover his 7,002 Bitcoins worth $220 million back in 2021. It shows how important it is to save and remember your private key when you hold cryptocurrencies.
Therefore, a cryptocurrency custodian would more accurately be described as an asset manager with responsibility over keys instead of securities.
Let’s Talk About Security
Now that you know how cryptocurrencies work, let’s talk about security. As you can imagine, cryptocurrency exchanges are vulnerable to hacks. However, what may be less obvious is that these exchanges aren’t designed to be secure. They do not even have any mechanism for securing your funds when an exchange gets hacked, which happens very often. For example, hackers stole nearly $600 million in one of the biggest cryptocurrency robberies in 2021.
If you’re holding onto cryptocurrencies in an exchange account and not using them actively, it’s crucial to realize that there is no way for you to keep track of who has access or control over those coins. While some exchanges offer 2FA and other measures designed toward user protection and safety from hackers, these measures aren’t foolproof either. They still leave users vulnerable if their accounts are compromised by someone else with malicious intent.
What Kind of Customer Does Your Custodian Need to Be?
If you’re considering using a custodian, here are some things to keep in mind:
Your custodian needs to be a regulated financial institution. That’s because cryptocurrency is still considered a wild west asset class by many traditional investors and regulators. You don’t want your crypto kept at an unregulated financial institution or one that doesn’t know what they’re doing when handling crypto assets.
Your custodian should be able to handle the large amounts of money involved in cryptocurrencies. It means they’ll need deep pockets and access to liquidity from major banks and other institutions where they can securely store your funds while supporting the transfers between accounts. They also need strong security protocols so that no one hacks your bank account or steals digital assets like Bitcoin or Ethereum tokens.
Financial Custodians are Big and Expensive, and They Have a Lot of Rules
A custodian is a financial institution that holds assets in trust for its clients. Custodians are responsible for the safekeeping of assets, ensuring they are properly valued, and managing them on behalf of clients. The term “custody” comes from the Latin word custos, meaning “guardian.”
Custodians must be regulated and licensed by a government agency to ensure that they can meet the needs of their clients while adhering to regulatory requirements. These agencies monitor compliance with all applicable laws, rules, and regulations, such as anti-money laundering laws (AML), and know your customer (KYC).
Cryptocurrency Custody is a Serious Matter
Cryptocurrencies are not like traditional currencies. They don’t exist as physical things, and they don’t have a central authority that can be held accountable if something goes wrong. It means cryptocurrency custody requires extra security measures and regulations to ensure your assets are safe.
Cryptocurrencies are stored in digital wallets, which can be found on your computer, smartphone, or other devices. These wallets have a private key that allows you to access your digital assets.
It’s necessary to be aware of custodians’ capabilities and limitations because there is a lot at stake. A bad custodian can cost you millions, so it’s worth taking the time to do your research.