Understanding Cryptocurrency Custody

Cryptocurrency has become part of our lives, allowing us a new way to make purchases with more security and transparency than using credit or debit cards. Investors are concerned more than ever about securing their cryptocurrency assets as the number of cryptocurrencies and exchanges increases globally. What is the solution? Cryptocurrency custody. It is a service provided by third parties for storing and securing cryptocurrencies. Cryptocurrency custody will become a popular service among institutional investors since they have the largest amounts of cryptocurrencies. There are few startups (e.g. Xapo) and institutions that offer this service. 

As with any new technology, there will be those who will want to use it for their own purposes. We have seen this happen with computers and cryptocurrency. There are security measures in place for cryptocurrency. One are private keys. They are part of a digital wallet used to authenticate transactions. Private keys must match the public keys in order for the recipient of the transaction to spend the cryptocurrency. They are a prime reason for cryptocurrency custody. Private keys can be stolen or hacked. Digital wallets and exchanges can also be hacked. Even if the private keys are stored offline, a person can still physically lose the alphanumeric address (e.g. written down on a piece of paper or stored on a thumb drive). Another reason for cryptocurrency custody is regulation. Under the Dodd-Frank Act, institutional investors with customer assets worth over $150,000 must have a custodian. This includes futures commission merchants and foreign financial institutions. 

Firms can employ cryptocurrency custody through a combination of hot and cold storage, cold storage or hot storage. Cold storage is when cryptocurrencies are stored without a connection to the internet. They can be stored in a file on a USB stick, on hardware wallets (data storage devices), or in a paper wallet. Hot storage is when the cryptocurrencies are stored with a connection to the internet. This type of storage utilizes servers (or cloud servers). Companies most often use hot storage because of the convenience factor. However, they can be hacked due to the connection. Also, the combination of hot and cold storage is called vault storage. 

Cryptocurrency custody will be a lucrative business as more institutional money is used for digital assets. It will be interesting to see how regulators will further define custodians since the service is in its infancy. 

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