Cryptocurrency holders refer to asset storage. Yet strictly speaking, these crypto wallets store access codes and not assets themselves. Here we shine some light on the world of crypto custody.
Cryptocurrency storage and wallet solutions are categorized into two categories based on their accessibility. If the storage is accessible via Internet, we call it “hot storage.” If the funds in the wallet are stored offline and are not accessible online, it is called “cold storage.” Cold storage is beneficial in holding large volumes of funds. This is where independent parties that handle this task for other companies come into play. Independent parties that provide storage, insurance and security solutions to store large quantities of tokens are called crypto custody solutions or crypto custodians.
Crypto custody solutions use a combination of hot and cold storage to store funds for institutional investors, exchanges and hedge funds. These custody solutions do not earn interest as these companies are not allowed to lend the deposit to other customers. However, custody solutions will charge a fee for storing and insuring your funds.
Coinbase and Gemini are two of the biggest names that operate both crypto exchange and custody services for investors. But traditional investors are not sleeping, as experienced institutional custodians like Kingdom Trust and Fidelity Investments have already gained a head start in the race. Xapo, which is known as one of the oldest Bitcoin wallets, also provides custody solutions. It purportedly holds as much as 7% of all circulating bitcoins in its Swiss-based vault.
Forgetting or misplacing a private key is a disaster in the cryptocurrency world. There have been several instances when institutions have lost funds stored in a wallet due to loss of private keys, hacks or funds being transferred to an inaccessible wallet. Custody solutions ensure that assets are never lost due to any manmade or natural accident. Custody takes full responsibility for recovering the loss in case the funds are lost. With increasing institutional investor interest of the cryptocurrency space, the need for custody can be expected to increase with time.
The other important driver for crypto custodian solutions is regulation. As cryptocurrencies become increasingly regulated and treated as assets, commodities or even securities by some regulatory bodies, institutions are required to store holdings with a “qualified custodian.” The US SEC has made it clear as a part of the Dodd-Frank Act that any institutional investor with assets of more than US$ 150,000 must ensure that its funds operate under a qualified custodian.
Germany has passed a law allowing existing financial institutions to offer cryptocurrency handling services, including custody. The legislation came into force on January 1, 2020. While the country does not permit the formation of new entities for crypto custody purposes, the law has created considerable interest in offering crypto services among banks.
France’s regulator, Autorité des marches financiers (AMF) requires, that crypto custodians and any firm dealing with fiat-to-crypto or crypto-to-fiat services register for anti-money laundering (AML) and combating the financing of terrorism (CFT) reasons. A notice on the AMF Website reads, “If you provide services of digital asset custody and/or buying or selling digital assets for legal tender in France, you must register with the AMF. To do so, you must have an establishment in France. The registration procedure is mandatory. The AMF will check that you comply with the regulations on Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT).” The country passed a new crypto law on December 18.
Despite these regulatory advances, it must be said that security requirements for custody solutions remain unclear. Legal uncertainties regarding cryptocurrencies abound. Fortunately, players in the crypto custody services space are on the case, and have earned accolades as experts and as a bridge between cryptocurrency markets and institutional investors. If the current trend continues, this class of investment has excellent chances of becoming mainstream.
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