Recent market events have understandably increased the attention paid by investors of all sizes and experience as to how their crypto assets are custodied, whether they are protected if the custodian becomes insolvent and if they should be taking additional steps to make sure their crypto assets are safe and secure.
How does custodying crypto assets differ from traditional finance?
In traditional finance, custodians are charged with the safekeeping of investors’ assets essentially acting as ‘vaults’ that hold investors’ assets in electronic and physical form and they charge investors a fee in exchange for maintaining them securely. Typically the investor agrees to place an asset temporarily in the custodian’s safekeeping until the customer requests the assets return.
To act as a qualified custodian an institution is generally required to comply with regulatory obligations, such as meeting standards for financial stability, insurance coverage, and other protections. Although this varies based on the jurisdiction the custodian operates within. It should be noted that in traditional finance the custodian also monitors the fund manager's behavior to ensure they are operating appropriately (not misdirecting funds).
Custody is different for digital assets. It involves the safekeeping of private keys and other access codes that are used to control the ownership and transfer of the assets. Depending on the service provider, crypto custody services can range from basic storage and security measures to more advanced features, such as multi-signature access control, cold storage, and insurance coverage.
In the crypto ecosystem, many players act as digital asset custodians, which is not the case in traditional finance where the role of the custodian is typically very clear and highly regulated - this is, unsurprisingly, an area of increasing focus for the entire crypto industry.
So what are the different types of custodians in crypto?
There are two broad categories:
Self-custody refers to the practice of an individual or organization holding and managing their own private keys and other access codes for the assets. This can be done with a software wallet that is installed on their own device, such as a smartphone or computer, or by using a hardware wallet, which is a physical device specifically designed for securely storing crypto assets. The major providers in the market include Fireblocks, Metamask Institutional and Ledger.
Self-custody can be cumbersome for institutional investors, especially for those who are dealing with multiple crypto assets, most prefer to use third-party custodians who offer easy transferability and access to trading platforms.
‘Third-party’ custodians offer a convenient way for investors to store their crypto assets without the responsibility of managing their private keys; they are often regulated or semi-regulated entities like brokers or banks. They have access to your private key and store your crypto assets on your behalf. How secure this solution is tends to depend on whether the third-party is a ‘qualified custodian’ operating within a jurisdiction that enforces strict regulatory rules and oversight.
In traditional markets, all custodians are ‘qualified’ but as a nascent asset class, this is not yet the case in crypto. Only some providers, like Aplo, are registered with regulators as a qualified custodian for crypto assets. The jurisdiction of the custodian also matters, Aplo is registered in France and therefore we have to comply with strong banking laws with real enforcement.
If you’d like to find out more about Aplo’s approach to custody or our other prime brokerage services please drop us an email: email@example.com.