How Does Cryptocurrency Custody Work?
The widespread adoption of crypto assets and the industry’s rapid growth necessitated the development of efficient methods for securely storing cryptocurrency. Digital cryptocurrencies are usually held in digital wallets that require private keys to access. As a result, if you lose access to your private key, your digital asset in self-custody will be lost forever. Private keys and online digital wallets, which individual holders widely use, are vulnerable to hacks, making these solutions unsuitable for institutional investors. This is where cryptocurrency custodian services come into play.
What is cryptocurrency custody?
Crypto custody is a type of wallet employed to protect assets from theft. There are different ways to keep assets in custody. Technically, digital asset custodians don’t actually store any assets in custody because all ownership data and transactions are recorded and encrypted on a public ledger known as the blockchain. Instead, they protect users’ private keys, the critical component of a crypto wallet that allows access to the funds stored in it.
Cryptocurrency custodians are critical to the widespread adoption of digital assets. Because of the lack of security, many institutional investors are still hesitant to purchase digital assets. The regulation requires institutions that manage large sums of money, such as hedge funds, pension funds, investment banks, and family offices, to have a custody partner to keep their clients’ money safe.
How does cryptocurrency custody work?
Cryptocurrency custody works on top of the foundational layer, i.e., blockchain. Advanced Cryptography help ensure the security of the assets in custody. Usually, in the case of asset custody, an institutional digital asset custody platform holds the private keys of the holdings/ asset in custody on behalf of the respective owner. Custodians ensure that unauthorized parties do not access the asset in custody.
Although processes may differ between custodians, the overall process typically consists of the following steps: The first step is signing up with a cryptocurrency custody provider. The second step is passing AML and KYC checks. Finally, transferring digital asset holdings to custodians’ wallets.
What are cryptocurrency custody solutions?
Hot and cold storage are the two types of cryptocurrency custody solutions offered by crypto custodians.
- Hot storage solutions, also known as hot wallets, imply storing assets in custody connected to the Internet, resulting in easier liquidity. Hot storage options, on the other hand, are more vulnerable to hacks due to their online presence.
- On the other hand, Custody providers can store their clients’ digital assets in cold storage, also known as hardware or cold wallet. This is a physical device that allows for completely offline storage of keys. Removing cryptocurrency holdings from the web helps to protect them from hacking and online attacks, ensuring maximum security for the crypto funds. Because of its offline nature, generating liquidity from a cold wallet takes time.
Custody solutions assist institutional investors in increasing their holdings, opening up new and exciting possibilities for lowering risk and resolving any issues with managing crypto assets.
It’s reasonable to expect cryptocurrency custody to accelerate crypto adoption in the near future by providing access to simplified crypto asset management and storage. Custody solutions are an obvious indicator of the developing ecosystem as blockchain and cryptocurrencies change the world.