The year 2019 witnessed a record high in the digital asset market that necessitated storage and security solution for a large number of tokens. Crypto asset custody solutions rank among the latest innovations from the crypto-currency ecosystem.
Retracing steps back a few years, the cryptocurrency was still a thing but converting those into fiat currency needed some doing. Next in evolution was the crypto exchange. It offered the investors in cryptocurrency a platform wherein to monetize their digital assets easily in return for a small fee.
That being resolved, the want of another aspect became a pressing concern. While individual investors had a handful of tokens to deal in, the institutional investors had those in a huge volume. The threat of hackers on crypto wallets and exchanges loomed largely. This led to the creation of safe and secure storage for crypto tokens in the form of crypto-asset custody.
The two folds objective to the creation of crypto-asset custodians are such:
1. To enable the investors, not wanting to deal with the technical aspect of secure storage of digital assets to invest in this asset class, regardless.
2. To enable institutional investors who need to store their investment at a regulated custodian, to enter the crypto-asset markets.
In a traditional financial format, a financial institution holds the securities and other assets as a representative of the institutional investors. This arrangement is made in order to minimize the prevalent risk of theft or loss. In the era prior to the digitization of financial markets, custodians stored heaps of physical stock and bond certificates. These days most securities are kept in electronic form.
State Street, Bank of New York Mellon, and JP Morgan Chase are some of the largest custodian banks. The last couple of years witnessed the germination of a large number of crypto custody providers. A crypto custodian, likewise, holds digital asset holding of individual and institutional investors.
For crypto custodians, safeguarding crypto assets is of prime importance. The investors possess private keys with which to transact in crypto assets or even access the holdings. This private is a unique and complex combination of alphanumerics. This makes it difficult to memorize and is unsafe to store in any format. Online wallets could’ve been a potential solution but were subjected to breaches as were the exchanges.
Offline storage solutions include pen and paper noting, a hard disk, or any other external storage device, not connected to the internet. But losing physical custody is quite possible and recovery of crypto assets in those cases is impossible.
For an individual investor possible loss of private key poses a substantial risk. The risk involved in the case of an institutional investor is several hundred times more so.
Moreover, SEC regulations mandate institutions with over $150,000 worth of customer assets to store holdings in a qualified custodian.
The SEC defines such entities that qualify to be a custodian. They include banks, savings associations, and registered broker-dealers. Within the digital assets ecosystem, however, very few banks provide custodian services.
Cryptocurrency custody solutions are basically third-party providers of secure storage services. They mainly target hedge funds that hold large quantities of bitcoins. They are providers of both hot and cold storage services.
Hot storage services involve an internet connection thus enabling easier liquidity. They are, however, susceptible to security breaches upon online exposure.
Cold storage is a safer storage method as there is no connection to the internet hence does not run the risk of being hacked. However, owing to their offline nature, generating security from crypto holdings is difficult, on short notice.
Vault storage involves a combination of both hot and cold storage. Here the majority of the funds storing are offline and can be accessed by a private key.
As mentioned above, very few banks and financial institutions have made their presence felt in the arena of crypto custody. However, people expect active participation from leading banks in the next few years along with the updated imposition of regulations.