What are digital assets?
According to the IMF (The International Monetary Fund), a digital asset is a digital representation of value via technologies like DLTs (distributed ledger technologies) and cryptography. Featuring their own proprietary units of account, digital assets are easily transferred between peers (peer-to-peer) directly without the need of an intermediary. Simply put, digital assets are intangible virtual assets, although some have been connected to real-world assets.
A closer look at asset custodianship
The term “custodianship” is directly linked to the conventional capital markets. In general, custodians are organizations that offer different types of financial services to their customers, including exchange, trade settlement, corporate action execution, clearing, and more. However, one of their essential tasks is to make sure an investor’s assets are properly secured.
In exchange for making sure the assets are protected, custodians require a fee agreed upon between the investor and the custodian. To minimize risk and make sure no fraud occurs, custodians leverage their expertise to ensure safety and security is properly maintained.
What does custody look like in the digital asset space?
The most recent law that attempts to define crypto-related custody assets was drafted by Germany’s BaFin. In this context, custodianship is the act of administering, safekeeping, and safeguarding of cryptocurrency assets or cryptographic keys used in transferring, holding or storing digital assets for people. As opposed to traditional custody services, digital custody also involves protecting private cryptographic keys. There are generally three methods of custody that vary from self custody, like a hardware or software wallet, or cold storage, to third party solutions. One of the core challenges is to find the right balance between safety and usability.
Self Custody: There are multiple ways you can store your own cryptocurrency. This attribute of the technology is appealing to many, as you may want to have more control over your own assets. This approach can involve using a hardware wallet like Trezor, our printing out and storing private keys as ‘paper wallets’. Cold wallets are not connected to the internet and therefore make them harder to use, but also much harder to hack. When using private keys there are no reset options, if you were to lose the key this would mean you would lose access to your assets indefinitely. As there is no service provider to manage the risk or access to the asset, this is similar to storing cash under your own home. You have a high degree of control, however there are risks. No other individuals can access the holdings if one forgot the password, and they cannot be restored if they were destroyed during a damaging event to the property they were stored at.
Some people have divided up parts of their private keys on paper wallets and stored them in different safety deposit boxes in different geographies. So although the self custody option gives unprecedented control to the user, strict planning and due diligence must be carried out on a continuous basis to ensure this is a safe option.
A Hot Wallet: How wallets are connected to the internet and cold wallets are not, as result hot wallets have more accessibility to traders or people interacting with the asset and the crypto community daily. Increased accessibility also comes with greater risks, due to the internet connection they are also open to internet hacking. A wallet on any exchange like Coinbase would be a hot wallet, a downloadable desktop wallet like exodus are generally more secure than exchange wallets.
Members of the crypto ecosystem may use wallets that are to varying degrees supported by a third party provider. This approach attracts individuals who want control of their assets, but also some safety in relying on a third party, therefore they also take on the risks of that provider.
A Custody Partner: Institutional actors in the crypto space may choose a partner who has custody services targeted at high net worth individuals, funds and investment managers. In July of 2020 the Office of the Comptroller of the Currency (OCC), a branch of the Treasury that supervises national banks, published a symbolic letter outlining how US banks can interact with and custody crypto assets, including stablecoins, going forward. This opened the door for traditional financial service providers to compete with crypto native institutions for wealthy and large clients.
The Importance of Partnerships
In the digital realm, the main responsibility of a custodian is to protect the digital assets of their customers via key management, enabling cryptographic security of the digital assets. These expertise are vital for new entrants who have sizeable capital to protect.
Protecting private keys is fundamental, especially since most transactions are irreversible when dealing with DLT-based technologies. Furthermore, in the event that a key has been stolen or lost, it may be challenging and sometimes impossible to recover the digital asset. Choosing the right custodian is therefore essential.
All market participants in the digital asset space – from single investors to institutional investors and new entrants – are in need of transactional ease and security. When it comes to cryptocurrencies and blockchain technology, you can never be too safe. As the global digital asset market keeps expanding, the volume entering from traditional finance taking their first steps into the market continues to grow.
Several of the reasons why investors should consider being extra thoughtful with their first steps in custody strategy:
From an investor’s point of view, storing digital assets via a custodian is a lot easier. Regardless of amount, custodians have the capability to make the process easier, at the same time reducing risk, ensuring security and transparency. Investors may not want to carry this operational burden themselves, and it can be beneficial to distribute the risk.
The digital realm is predisposed to numerous cyber threats. Considering that digital assets are stored virtually, the risks of being hacked while storing cryptocurrency on your own are increased. By turning to a custodian to handle the digital assets, investors are guaranteed that all necessary resources will be used to mitigate all associated risks.
Investor assistance & recourse
Licensed custodians are capable of providing a high level of security and certainty via recourse. Furthermore, chances are they have easy access to trustworthy insurers, thus helping investors keep their assets safe, and giving them peace of mind.
Better than crypto exchanges
Holding large amounts of digital assets on an exchange may seem reliable and easy. However exchanges are far more vulnerable options when compared to self custody or custodian parents.
The complex nature of digital assets poses numerous challenges. Regardless of investor experience in the digital space, custodians can help smoothen the process with their regulatory expertise. This way, investors looking to enter the market can benefit from the knowledge, operational and logistical prowess of an established crypto custodian.
Examples of Digital Asset Custodians suitable for Traditional Investors
Copper is a leader and innovator when it comes to crypto custody. The HFM awards crowned them the ‘Best Digital Asset Custodian’ in 2019 & 2020.
Fidelity Digital Asset
Digital asset custodianship comes down to trust
Choosing a trusted digital asset custodian as a partner is highly recommended because it gives investors and institutions an extra sense of security. Prior to making a decision, look for a custodian with demonstrated experience and a reputable client base in digital asset management.
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