Digital assets are becoming more mainstream by the day, making it crucial for all investors regardless of their experience, to fully understand how they can keep their digital assets safe.
When it comes to digital asset custody, there is no one-size-fits-all solution. That’s why it’s crucial to do your own research (DYOR, as they say) to assess the different custody methods available, and choose the right one depending on your unique needs as an investor.
For those who prefer a more hands-off solution, self-custody may be a suitable option. Self-custody means only the investor and the investor themself, are in control of their private key and retain full control over their assets. Some self-custody methods include software wallets (desktop, mobile or browser-based), and hardware wallets which store the private key in a secured device.
However, it’s important to keep in mind that self-custody comes with its own set of risks. While crypto natives and those deeply involved in digital assets may feel comfortable navigating through all corners of the crypto ecosystem, most non-crypto natives lack the know-how to access their crypto assets in the event of an unexpected scenario. Self-custody implies that the investor themselves hold all responsibility for managing their private key. This means in a case where the investor loses their private key, there are no intermediaries like an exchange to intervene. In the case of hot wallets, self-custody can also come with vulnerabilities to hacks or attacks, depending on the wallet provider.
The crypto community is showing more interest in self-custody, particularly after the fall of some prominent organizations in the industry. However, as crypto increasingly reaches mass adoption, investors of all stripes will look for the safeguards and support found in the traditional financial system. As they say, “no normal person wants to be their own bank”. As more people onboard into the digital asset world, self-custody will not be feasible for everyone.
One of the most commonly used custody methods to date are exchange-hosted wallets. Centralized exchange platforms typically offer hot wallets to users. The exchange controls and manages the investors’ public and private key on their behalf, while the investor maintains access to their assets via the hot wallet. Exchange wallets are easy to use and accessible, making it suitable for high frequency traders or crypto beginners.
While exchange wallets may be convenient for high frequency traders, it’s important to note here that the exchange holds the investors’ keys on their behalf – this introduces counterparty risk. Counterparty risk can take the forum of misuse, clearly demonstrated by the case of FTX, or the form of theft/loss in the event that an exchange suffers from a hack or attack to its database.
As they say, “not your keys, not your crypto”. Giving up control over your private key implies your assets are technically ‘not yours’, meaning the investor should thoroughly vet their trusted counterparty. This is a big fact to take into consideration when it comes to using exchange wallets.
A third-party custodian is a dedicated service provider with the responsibility of protecting an investor’s private key on their behalf, relieving the investor of managing the private key themselves. They are often regulated entities that are licensed at the state or federal level.
A custodian’s principal raison d’être is to safeguard clients’ assets. A professional digital asset custodian provides a highly secure environment and ensures that any movement of assets out of the client’s own wallet takes place only on the explicit instructions of the client. The custodian acts solely as an agent for client assets, never as a principal. Client assets do not form part of a custodian’s own balance sheet.
A professional digital asset custodian provides infrastructure to ensure the safety of client assets, which includes:
For institutional investors in particular, the best practice is for the assets to be held by an entity that does not itself indulge in risk-creating activities. Investors with a large percentage of their net worth in digital assets will require a level of institutional-grade service that other forms of custody cannot provide. Using an independent third-party custodian dedicated to the safekeeping of client assets ensures that not only are clients’ assets segregated and therefore safe, but it also makes them bankruptcy remote, i.e. minimizing the likelihood of any prolonged lock-up of assets caused by, for example, the bankruptcy of the custodian.
Hex Trust is a fully-licensed digital asset custodian that provides solutions for protocols, foundations, financial institutions, and the Web3 ecosystem. We have offices in Singapore, Hong Kong, Dubai, Italy, and Vietnam.