Navigating Crypto in 2023: How to Choose a Secure Digital Asset Custodian

@nikhilgupta

Crypto Trader, Digital Marketer, Growth Hacker, and Crypt...

The cryptocurrency ecosystem is no longer a niche subset of finance living on its fringes. It is witnessing rapid adoption that is moving its use cases beyond simple peer-to-peer transactions envisioned by the anonymous creator(s) of Bitcoin. Institutional interest in the asset class is higher than ever, with crypto-native concepts like Web3 and DeFi becoming a part of their investment portfolios. Consequently, the crypto industry sits at a valuation of over a trillion dollars, with the number expected to rise drastically.

As medium and large-sized institutions enter the crypto realm, alongside the growth experienced by crypto-native ventures like exchanges, digital asset custodians are becoming chief stakeholders of the ecosystem. They play the crucial role of managing digital assets for institutions and businesses.

The Relevance of Digital Asset Custodians

Handling digital assets is no easy task. The cryptography ingrained in their functioning can make them difficult to store and transact. Managing them comes with a steep learning curve that users must get accustomed to before using their assets frequently for purposes like payments and trading. While the industry’s crusaders tout the self-custody method as the way to go, enterprises may not find too many benefits there.

However, the self-custody advocates are not wrong. Retail investors and holders are better off storing their assets themselves. That way, they evade centralization risks and exercise complete control over their value. On the other hand, institutional investors who frequently execute trades and move massive amounts of digital assets regularly need third parties competent in managing the assets.

Numerous complexities exist in handling digital assets, including storing private keys safely, executing transactions correctly, and interacting with blockchain protocols appropriately. Any missteps can compromise the digital assets and cause irreversible consequences. As a result, users can lose their value, either involved in transactions or the entire asset contents of their wallets. Moreover, the self-custody route is inconvenient for institutions handling several transactions frequently.

That is why custodians are critical to the digital asset ecosystem, enabling enterprises to securely store their private keys and conveniently conduct operations in scalable manners. The hassles of managing the assets are left to third-party experts, heavily reducing their operational burdens and allowing them to focus on other essential aspects of their functioning.

Choosing the Right Digital Asset Custodian

Nevertheless, handing over the control of assets to third parties is no small affair. Since they possess access to such large amounts of funds, enterprises must do their due diligence while choosing a custodian. Beyond credibility, which is an obvious necessity, they must consider multiple other factors to understand the right fit for their requirements.

Asset and Data Security

First things first – custodians must provide top-notch asset security to protect enterprise funds. They should implement the right amount of redundancies while storing private keys, necessarily in cold storage outside the reach of network connections, to prevent easy access to hackers. Instances of massive hacks due to entities leaving the bulk of their digital assets within vulnerable hot wallets are more common than people assume.

One does not have to look further than the infamous Mt Gox hack that led to the siphoning of 850,00 Bitcoins over two years by hackers, which in the present day is worth billions of dollars. Those funds were left in penetrable hot wallets, waiting to get exploited. More recently, Bitrue, an exchange based out of Singapore, experienced hot wallet exploits resulting in a loss of $23 million earlier this year. Those funds represented 5% of the total assets under its management. Luckily, the exchange escaped bankruptcy because it held remaining assets in other wallets, including in cold wallets away from hackers. Regardless, the loss was still considerable, leaving Bitrue in a precarious place.

Custodians, being the solutions for safely managing exchange and enterprise assets, should go above and beyond to ensure secure storage. Despite their default vulnerable status, hot wallets must witness maximum protection because they still hold funds. That requires custodians to implement frequent auditing and bug bounty programs to stay on top of exploitable bugs and vulnerabilities in their software infrastructure. Those doing so are safer to store funds with.

Moreover, security is not limited to how custodians store private keys and other sensitive information. Exploits can occur during transaction signing and while sensitive information is in transit, even from highly secure cold wallets. Such information can include enterprise-related public keys, bank details, and the personal information of decision-makers. Bad actors can use the data to launch external hacks and social engineering exploits to steal their funds.

Making sure custodians address such risks is imperative. They must possess certifications like ISO:27701 (International Organization for Standardization) and SOC 2 (System and Organization Controls), ensuring they meet infosec benchmarks. Industry-related ones like the CCSS (Cryptocurrency Security Standard) are essential, too. Having such certifications verifies they can handle all sensitive data securely, whether in transit or storage.

Convenient Access to Assets

Securely storing private keys and, in turn, digital assets within cold wallets come with a caveat – accessing funds quickly and conveniently from them is not possible. These wallets make transacting value complex for a reason, the reason being security. Regardless, custodians must implement measures to balance the complexity with ease in accessing assets for their clients.

Well-known custodians use a mix of cold, warm, and hot wallets to ensure convenience when customers interact with their assets. That way, custodians can hold most assets under their management in highly robust cold wallets while providing instantly accessible liquidity stored minimally in their hot wallets. The minimal storage ensures marginal damages in case of inevitable hacks on their hot wallets.

This convenience is necessary because of the high volatility associated with digital assets. Not being able to access funds on time can result in a lack of profitability or, at worst, tremendous losses for enterprises. These situations can come because of not being able to execute trades on time when assets exhibit price movements or not being able to liquidate assets before they plunge in value.

Multichain Support

Enterprises capitalizing off the crypto markets also need access to a broad range of assets deployed across multiple chains. The industry is presently witnessing innovation across several blockchain networks possessing dedicated developer and token communities. With use cases on various chains gaining adoption, many tokens are surging in value. Enterprises obviously want to extend support to them and allow their users to trade in those assets on their applications.

Custodians supporting such emerging chains and the tokens operating within their ecosystems are needed to reach the vastness of Web3. Turning to custodians who support limited assets diminishes the opportunities that enterprises can benefit from.

Licensing and Regulation Oriented

As jurisdictions worldwide develop comprehensive digital asset regulations and legislation, custodians must administer policies and infrastructure to comply. They must acquire the needed licensing and go-ahead from relevant regulators. Regulatory enforcers in Abu Dhabi, Hong Kong, Singapore, and Europe, among others, have already made their requirements clear to custodians.

Getting licensed by them is no easy task. Regulators require custodians to leave no stone unturned in protecting their clients’ value and assets. Furthermore, regulations push custodians to function in ways that preserve the integrity of the markets.

Thus, possessing regulatory licensing plays an enormous part in knowing which custodians are trustworthy and reliable. In fact, licensed custodians can reduce the headaches that enterprises face while traversing the evolving regulatory landscape. For instance, regulated custodians only list the assets away from regulatory crosshairs, enabling enterprises to interact with the safe ones. Thus, staying away from violating securities and commodities laws becomes easy. With so many digital assets emerging and taking off, dealing with the wrong ones can bring unwanted troubles.

Cost Efficiency

Using top-of-the-line custodial solutions does not have to be an expensive affair. Enterprises can shop around for different custodians and analyze their prices for the services relevant to their needs. Custodians provide various pricing structures based on differing factors, including the size of clients’ businesses, assets under management, transactions processed, wallets created, and integration offered in their solutions.

These features can range from simply storing assets to offering software tools that connect client assets to a broad range of utilities like smart contracts, DEXs, liquidity pools, and more. Ergo, enterprises can decide on solutions that will benefit them the most and compare prices accordingly.

The Right Digital Asset Custodian Compliments Enterprise Operations

Choosing a digital asset custodian does not have to be a difficult task. Several trusted custodians providing reliable custodial services and solutions at sensible prices exist. Nevertheless, enterprises must verify multiple aspects of how they function and what they offer. The point is to identify those who can handle assets safely and provide solutions that simplify asset usage, making enterprise operations smooth and scalable. With that, crypto-native ventures and financial institutions adopting digital assets in their portfolios can take advantage of the crypto industry’s rapid innovation.