How to choose a crypto custodian

Why cryptocurrency is set to become a mainstream asset

The digital asset market is still considered to be in an early adoption phase but the recent growth in cryptocurrency market capitalisation to over $1.5 Trillion suggests that it is fast becoming a more mainstream asset class. No longer just the realm of speculative investors, cryptocurrencies and digital assets are receiving increasing attention from institutional investors as well as family offices, raising the possibility of a massive surge in crypto investment over the next few years.

Family offices to lead with caution

According to a Goldman Sachs survey, 15% of family offices across the globe and 25% of family offices in America have already invested in cryptocurrencies, with another 45% globally expressing interest in doing so. With significant capital to invest and a long-term horizon, family offices are expected to not only ride the crypto-wave but propel it to new heights as they diversify their assets and look to new stores of wealth. The combination of rising inflation and low-interest rates are also contributing factors to this projection. However, the risk, volatility and regulatory uncertainty that is associated with the digital asset market requires family offices to approach this investment with some caution.

The role of asset custodians

Asset custodianship has traditionally been associated with capital market financial institutions that are responsible for the safeguarding of investors’ assets as well as providing other services like trade settlement, exchange, clearing, and corporate action execution. These custodians are temporarily entrusted with assets and are expected to minimise the risk of fraud, theft or loss to those assets. In line with accelerating investment into the crypto space, the demand for digital asset custodianship has grown tremendously. However, this has proven to be a space that is vastly different from traditional asset custodianship, hence the plethora of new players and technologies that are emerging all the time.

Like their traditional capital market counterparts, digital asset custodians are also responsible for the safekeeping of a client’s crypto assets, however the difference is that these custodians do not hold the asset itself but are responsible for the custody of the keys to these assets. Through safe key management, digital assets are cryptographically secured and the custodian, therefore, ensures that the asset cannot be accessed by any other party. For a family office to have transactional access to an asset, both a public and private key needs to be used.

Why custody is so important in the cryptocurrency market

Asset security and transaction efficiency are common requirements for most investors, whether they be single investors, family offices or large institutions. Crypto custodians play a vital role in achieving both of these objectives. With the amount of value beginning to accumulate in the digital asset space, the safeguarding of this wealth begins to take on a new priority. It should also not be forgotten that digital assets are, by nature, more vulnerable, which means that crypto custodians play a key role in limiting the associated risks. Over the past few years, family offices have been increasingly targeted by cybercriminals so it would make sense for this sector to consider the services of a third-party custodian when exploring crypto investment.

Options for crypto custody

Lets first define a few common crypto terms that are used in this section:

A public key is a long numeric code that is cryptographically derived from a specific private key and is publicly available. A public key allows you to receive cryptocurrency transactions. Anyone can send transactions to the public key but you need the correct, corresponding private key to “unlock” them and prove that you are the owner of the cryptocurrency received in the transaction.

A private key is a randomly generated binary number that is used to encrypt and decrypt information and is only made available to the originator of the encrypted content. A private key gives you the ability to prove ownership or access the funds associated with your public address.

A cryptocurrency wallet is a device, physical medium, program or service which stores the public and/or private keys for cryptocurrency transactions. In addition to this basic function of storing the keys, a cryptocurrency wallet often also offers the functionality of encrypting and/or signing information.

There are many custody options available to both individual investors and institutional players, falling within three main categories:

Self custody: These include hardware, software or paper wallets in which the digital asset investor independently stores private keys.

Exchange wallets: Control and management of public and private keys are handed over to an exchange, but the investor maintains access via an online wallet.

Third-party custodian: Typically aimed at institutional investors and large family offices, these service providers store digital assets on behalf of customers using institutional grade security and controls to protect investors’ assets.

Custodians safeguard digital assets by ensuring that investors’ private keys are maintained securely. This is achieved by either storing the assets online, a method called hot storage, or offline, known as cold storage, or through a multiple approval approach, known as multi-signature and smart contract wallets.

Hot storage vs cold storage?

The key benefit of hot storage is also its downside. Its connectivity to the internet provides investors with ease of access to digital assets but this convenience also leaves it vulnerable to cyber security threats. Additionally, online custodians often restrict access to the private key.

Cold storage holds keys offline which maximises security but does not provide an efficient user experience.

Don’t go it alone

Digital asset custodians are currently leading and shaping the crypto landscape and represent a significant  disruption to the traditional financial services sector, however it is inevitable that the traditional asset custodians start playing a greater role in how this investment category grows and evolves. Either way, projections indicate a significant increase in family office investment into cryptocurrency over the next few years and appropriate measures need to be taken by the family office to ensure adequate risk management. Remember that the digital asset space is still quite new and is certainly very volatile. Partnering with the right crypto custodian is therefore a wise call to make before you take the plunge.