Crypto custody solutions
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Understanding Institutional-Grade Crypto CustodyCRYPTO ROCKETS
Partial Custody Wallet Plus Solution An emerging option in the crypto custody market is a self-managed wallet that offers some level of third-party assistance and related institutional controls or protections. Such an option may align to the needs of certain retail or high-networth investors who want to control their holdings, but also desire some level of assurance and institutional protections shy of full third-party management.
This amounts to a form of split or partial custody, in which the customer and the third party are generally required to cooperate as part of the signing process. However, the exact amount of control either party has to sign the transaction without the other party—such as in the event of an emergency—depends both on the legal arrangement between customer and provider and the specific key management model of the custody solution.
Third Party Custody Managed Solution Third-party custody solutions allow customer funds to be held and managed entirely by a solutions provider. Service level agreements SLAs dictate the terms and timing conditions regarding the storage, access, and movement of customer funds by the third party. They are the only solutions capable of offering bank-level protection for crypto security and safety, as they provide the most robust level of third-party control.
That said, third-party custody solutions in the market today vary drastically in terms of what they offer Customers also have the option to use multiple third parties full-custody or wallet-plus if they want two or more providers involved to verify instructions and move funds.
The difference between the two amounts to whether the storage system is networked or in any way remotely operable. The two types of systems pose tradeoffs. Online solutions are capable of greater speed and liquidity, as the use of a network connection enables automated access to the system. Being networked, however, means that they are more vulnerable to attacks delivered through the network, resulting in the creation of unauthorized transfers or the potential compromising of the signing keys.
Possession of a signing key is the only requirement to move funds. In relation to fiat currencies, this self-custody solution is similar to carrying cash on you. Hot storage wallets are a popular self-custody solution for regular crypto traders because of their ease of access. As an internet-connected application, this solution lets you quickly make crypto transactions or interact with decentralized applications dapps , much like how you can conveniently spend cash in your wallet at a store.
While the internet connectivity provides much more convenient access to your crypto, it comes with commensurate risk. Because your keys are directly connected to the internet, you may be more susceptible to hacks or scams. Additionally, this solution requires you trust your application provider has not left any vulnerabilities in the application that could expose your private keys.
Cold Storage As an alternative to hot storage, you can use cold storage to secure your digital assets via self-custody. Cold storage is the storage of cryptocurrency where the private keys are not immediately accessible to the internet.
In our fiat comparison, cold storage is similar to storing your money in a personal safe. Just as a safe can prevent money from being taken from your direct person, cold storage solutions provide security by being disconnected from the internet. The drawback to this solution is that you need to bring your digital assets back online before using them, which can make for a longer process.
For instance, in order to spend your digital assets from a cold storage wallet, you would need to connect your keys to the internet, and then send a transaction, much like how to spend your fiat, you would have to take it out of the safe and to a store to buy something. This additional step increases security, but reduces accessibility. Third-Party Custody Third-party custody offers a way to store your crypto assets without the responsibility of managing your private keys. Third-party custodians are often regulated or semi-regulated entities, like exchanges or banks, that are licensed at the state or federal level.
Third-party custody solutions can offer a more convenient method of crypto custody. Without having to worry about key management, third-party custody solutions can offer a similar experience to traditional online banking, with a regular login and password. Third-party custody can offer a more secure solution through regulation. Third-party custodians are often registered and required to follow KYC and AML processes, similar to traditional banks.
This ensures your crypto is coming from legitimate sources and helps better safeguard your assets from regulatory uncertainty. The downsides to third-party custody are control and third-party risk. When a 3rd party controls your private key, you are giving that custodian control over your crypto or digital assets. Though many are regulated and have a responsibility to act in your best interest, self-custody proponents claim this loss of control could lead to asset freezes and or blocked access to your funds.
In addition to control, third-party risk is also a drawback compared to self-custody. Third-party risk is the risk of having outside parties make transactions or perform other financial activities on your behalf. Bankruptcy and data breaches of your custodian could lead to your assets being stolen or frozen.
Some of this third-party risk comes from the fact that not all third party custodians, and their technology solutions, are created equal. Given the immutability of digital asset transactions, the technology that third party custodians use in order to secure your assets greatly impacts that third party risk and how accessible and useful any assets with a third party custodian are.
Knowing how your keys, and associated assets, are actually stored is critical to understanding your third party risk. Institutional-Grade Custody The current investment environment demands a more secure and transparent custody practice for institutional crypto investors. While there are benefits to self-custody, they are typically unavailable to institutional investors due to either regulation or risk. In the majority of institutional use cases, a third party qualified digital asset custodian is not just a smart idea, it is a necessity.
While third-party custody is a viable option for storing large amounts of digital assets, the risks of third-party custody can bring institutional investors to required deeper levels of due diligence to understand how their assets are stored.
Because institutional investors are held to higher standards than individuals, institutional-grade crypto custody solutions have become increasingly popular. Institutional-grade crypto custody offers the regulatory peace of mind and ease of use of third-party custody and implements additional security measures like Hardware Security Modules HSMs and Multiparty Computation MPC.
Both HSMs and MPC solutions, when used by a third-party custody provider, can create a digital asset custody solution that keeps up with the compliance, transparency, security, and integrity standards institutions are required to uphold. Hardware Security Modules HSMs Hardware security modules HSMs have been around for the past several decades and are commonly used in the traditional banking and payment industry. HSMs are physical computing devices designed to securely store and manage data.
While they can be used to directly access your crypto wallet, HSMs are more often used to secure backups in the crypto industry today.
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