Crypto Custody: Old concept, new applications.

 

The price of bitcoin and other crypto-assets is again a dinner table conversation due to the latest price correction. However, part of the great benefit of Decentralized Finance is bringing the concept of self-government, democracy, and inclusion. We have talked in the previous articles on what are the associated risks in the crypto-industry: low participation of institutional capital (yet) and high-risk perception compared to the traditional system, both problems faced and partially solved by digital custodians.

In this article, we will dive into the characteristics of a crypto custody company, their relevance in the current context, and the most important innovative solutions offered in the emerging digital asset industry.

What is a crypto custodian?

To define a crypto custodian, we must first describe how traditional custodians operate.

A custodian in the world of traditional finance is a business or company that essentially holds and keeps track of the ownership, exchange, and status of financial assets. 

Custodians are often regulated financial institutions and charge a fee for providing the service. Traditionally, a customer transfers the ownership of the asset to a custodian that offers the benefit of security and efficiency to manage these assets. 

Almost, in the same way, crypto-custodians are certified companies that deliver security and institutional guarantees to customers while holding their crypto assets. They allow them to be sure that their digital possessions are well protected with different layers of security and with backups or insurance against data loss (among other services).

An “essential” for institutional adoption.

One big difference to the traditional system is that with crypto, users often interact via self-governance mechanisms (hardware wallets such as Ledger or Trezor) and become de facto their custodians. However, if they would like to manage and save these assets, a hardware wallet is often not approachable by most people. A more convenient option for individuals and companies is to deliver them to a digital asset custodian.

An important aspect to consider is that crypto custody companies are often regulated (Thailand and Singapore are working on their custodian requirements and framework) and provide institutional-grade security with a relatively easy customer experience.

Today it is challenging for a large company that would like to hold digital assets to secure them by itself. Setting up metamask and any hardware wallet would create some technical and sometimes compliance risks that they are not willing to take.

Custodian services are an excellent solution for everyone who wants to support their digital assets in an ecosystem that meets security requirements and local legislation. It is not a surprise that large players such as Paypall or Galaxy digital are acquiring custodians to secure strategic positions in this growing market.

Security

A pinnacle requirement when working with a digital asset third-party provider is security. Custodians operate almost like traditional custodians but with blockchain technology. They are often using two technologies: Multi-Signature wallet or Multi-Party Computation.

  •     Multi-signature wallets are a digital signing process that enables two or more users to sign transactions as a group. While multi-sig offers solutions to some of the problems of single-signature wallets (e.g. the single point of failure), it also introduces new issues such as protocol accepted and limitations in terms of policies and security rules
  •   Multi-Party-computation (MPC) has quickly become accepted as the next generation of private key security. MPC removes the concept of a single private key; such a key is never gathered as a whole, neither during the first creation of the wallet nor during the actual signature. MPC follows a set of steps to guarantee that there is never a single point of compromise of the private key.

While Multi-Signature wallets have been here for longer, MPC technology brings additional advantages, especially in terms of security and transaction costs. 

All in all, custodians are an essential part of the growing adoption of digital assets. Institutions will not secure their digital assets by themselves but will let specialized technology companies manage this technical and crucial work for them. While custodians are used mainly by exchanges and large financial institutions today, their offerings are growing to offer cost-effective solutions for individuals and small businesses willing to keep a part of their cash reserve in digital assets. Those new players are on the lookout for a simple to onboard custodian, priced accurately, and that ticks all the security boxes that a large company requires.

For more information on crypto-custody, please feel free to reach us at [email protected] 

Maxime