Cryptocurrency custody solutions, one of the latest innovations to the cryptocurrency ecosystem, are independent storage and security systems used to store large amounts of tokens.
Why Does Crypto Need Custody Solutions?
The primary purpose of cryptocurrency custody solutions is to protect cryptocurrency assets. Private keys are a complex combination of alphanumerics used to conduct transactions or access crypto holdings. They are very hard to remember and susceptible to theft or hacking. Online wallets could be a solution, but they’ve already been breached in the past. Cryptocurrency exchanges also face the same problem.
Other options include storing private keys offline on paper or a hard disc (or another electronic device) that is not connected to the internet. However, if you lose physical custody (or either paper or electronic equipment), it is extremely difficult to recover your cryptocurrency holdings. The possibility of losing private keys is an even greater risk for institutional investors. They can go to great lengths to protect themselves from this threat. Some major investors have been known to distribute portions of a paper wallet across multiple storage units in various locations.
Another important reason for the existence of cryptocurrency custody solutions is regulation. Under the Dodd-Frank Act, institutional investors with customer assets worth more than $150,000 must store the holdings with a “qualified custodian.”
According to the Securities and Exchange Commission (SEC), such entities include banks, savings associations, and registered broker-dealers. Futures commission merchants and foreign financial institutions must adhere to these regulations. There are very few traditional banks within the cryptocurrency ecosystem that provide custody services. Kingdom Trust, a Kentucky-based custodian, used to be the largest such service for cryptocurrencies until BitGo, a San Francisco-based startup, acquired it.
What Are Cryptocurrency Custody Solutions?
Simply put, cryptocurrency custody solutions are third-party cryptocurrency storage and security providers. Their services are primarily geared towards institutional investors, such as hedge funds, who hold significant amounts of bitcoin or other cryptocurrencies. The solutions typically combine hot storage, crypto custody with an Internet connection and cold storage, or crypto custody that is not connected to the Internet.
Both types of storage have pros and cons. Hot storage, for example, is connected to the Internet and thus provides greater liquidity. However, because of their online exposure, hot storage options may be vulnerable to hacking. Cold storage solutions provide increased security. However, it may be difficult to generate liquidity from crypto holdings on short notice due to their offline nature. Vault storage is a hybrid of the two types of cryptocurrency custody solutions, in which the majority of funds are kept offline and can only be accessed with a private key.
Major Players in Cryptocurrency Custody
Coinbase, the popular digital currency exchange, is an emerging major player in the cryptocurrency custody space. Coinbase only recently entered the institutional-grade custody solutions market, buying acquisitions like California-based Keystone Capital, a registered broker. Coinbase also acquired the institutional business of storage provider Xapo in August 2019. Vontobel, a Swiss bank, has also launched a Digital Asset Vault aimed at institutional investors in the crypto space.
The Future Of Cryptocurrency Custody
Many analysts and institutional investors now view cryptocurrency custody solutions as a bridge between the traditional institutional investment market and the evolving cryptocurrency space. At least two developments are expected to impact the future of cryptocurrency custody.
The first is the arrival of major players. Though Goldman Sachs (GS) is absent from the list of companies offering cryptocurrency solutions, their future entry could cause havoc to the nascent market. Some of this is already happening, with Coinbase and Fidelity Investments pioneering cryptocurrency custody services.
The second is regulatory clarity. Current regulation lacks security provisions for cryptocurrency storage. Not to mention, businesses are still unclear about the crypto regulations. Only after regulators step in and establish ground rules for the industry will it be able to evolve.
