What Is Crypto Custody?
Digital currency traders can benefit from knowing the options they have for custodying cryptocurrencies. While many assets can only be held indirectly, investors can have direct custody of their cryptocurrencies. This feature sets them apart from other asset classes like stocks and bonds.
This article provides a breakdown of the different custody methods in addition to their individual costs and benefits.
Indirect ownership takes place when a third party holds assets on behalf of an investor. By doing this, the third party is custodying the assets for the client.
While financial institutions have been offering custodial services for years, the situation is a bit different when it comes to cryptocurrencies. Digital currency investors who are looking for indirect ownership can hold their assets on exchanges like Coinbase.
Some financial institutions have started offering crypto custody solutions, but these are geared more toward institutional investors than individual traders. Fidelity Investments, for example, announced Fidelity Digital Assets in October 2018.
"We imagine a world, soon, where all types of assets are issued natively on a blockchain or represented in tokenized format," Fidelity Digital Assets wrote in a Medium post. "Addressing custody issues for institutional investors is one critical step in order for these markets to continue to develop. By building native expertise in these technologies we hope to be well-positioned to serve the needs of our clients for the long term."
Shortly after Fidelity Digital Assets made this announcement, Coinbase Custody announced that it had received authorisation to serve as a independent Qualified Custodian. To fulfill this role, Coinbase Custody obtained a charter from the New York Department of Financial Services.
Traders should keep in mind that indirect ownership has its costs and benefits. If an investor holds their digital assets on an exchange, that marketplace takes care of the administration.
However, exchanges also concentrate large amounts of cryptocurrency, drawing the interest of hackers. In 2018, for example, nefarious individuals stole more than US$900 million worth of cryptocurrency from these marketplaces, according to figures provided by Ciphertrace's Cryptocurrency Anti-Money Laundering Report.
Direct ownership takes place when a trader holds their digital currencies personally. The fact that investors can custody their own cryptocurrency sets it apart from other asset classes. If digital currency traders want to hold their digital assets directly, they can do so using cryptocurrency wallets, of which there are many types.
The benefit of direct ownership is that the investor has control. However, the flip side of this is that they also shoulder all of the responsibility. There are many different kinds of wallets that cryptocurrency traders can use, so investors can benefit significantly from conducting their due diligence before making any decisions.
Cryptocurrency traders can custody their digital assets either directly or indirectly. Those who opt to custody their assets directly will have significant discretion over how to achieve this task, as there are many options. However, taking this path also comes with responsibility. If an investor holds their digital currencies directly and these assets are lost, they are responsible.
Indirect custody is the opposite, as a third party takes responsibility for holding an investor's cryptocurrencies. While this approach means that traders don't have to worry about the administration of their digital currency, crypto exchanges naturally drew the attention of individuals like hackers by accumulating digital assets.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…