Crypto Asset Custody
A world apart from traditional finance.
What is first-party custody and why does it matter?
In crypto, you have a concept called first-party custody, which is to say that you own your own private keys. In this arrangement, you are responsible for recording, storing and keeping your crypto assets safe. In exchange for this safe-keeping, responsibility comes the benefit of control, authority, 24/7/365 access, faster transaction times, lower to potentially no fees, and anonymity. For anyone with more than one wallet, this is no easy task. More on this later.
Meanwhile, in traditional finance, there is no such thing as first-party custody (any longer) because a custodian, such as TDAmeritrade or Fidelity, holds your stocks, bonds, and cash. This is called third-party custody. Here, the party holds centralized record books on your behalf, interacting with brokers and clearinghouses to prove orderly settlement, storage, and safekeeping of your assets. In exchange, custodians charge fees for their services, gain rights to hypothecate or otherwise profit off of holding your securities and maintain authority to freeze or restrict.
Decentralized blockchain protocols and their native crypto assets have advantages over traditional, centralized financial systems due to their ability to operate securely, without a single point of failure and in their ability to facilitate trustless, peer-to-peer transactions at any time, year-round. Non-custodial crypto asset wallets give users complete control over their assets, by allowing only users access to their private keys and no other centralized entity. And the structure delivers financial independence to people and companies in areas where government entities control banks and lenders. Want financial freedom, a borderless and instantaneous settlement for many forms of transactions? We do. And judging from the global growth of the blockchain native ecosystem so does everyone else. That’s why first-party custody matters.
The responsibility of first-party custody!
If I lose my private key, do I lose my asset? In many cases, Yes. Keeping track of private key information, passphrases and seed data is important. It is one of the most critical aspects of crypto wealth management. Self-custody requires some organization and ultimately new and modern tools to help simplify things.
An example of early (and arguably the best) wallet security is Bitcoin. Bitcoin wallets cannot recover user accounts once the private key is lost, which means keeping track of multiple keys and wallets is a serious issue and often requires time and a meticulous patience.
With every crypto asset wallet comes the responsibility to initiate and validate every transaction, which can also require additional security measures, including more private key data. To make it truly complicated, there are hundreds of coins and tokens, each with their own wallet technology, keys, passphrases and idiosyncratic setup instructions. Btw, a passphrase is for decrypting a wallet file, but that needs to be kept safe too!
In short, you need to be confident in how you back up your keys and make multiple (encrypted) backups on of all your private keys. The modern technology conundrum is summarized as such;the convenience we seek is the security vulnerability we create.
One way to solve the problems of storing your crypto assets is to use a hardware wallet (“cold storage”). Popular HWWs include; Ledger, Trezor and KeepKey. Cold storage is the safest way to store your crypto assets, away from web-based wallets (software wallets and exchange wallets) with potential connectivity to malicious online activity or subject to attacks or scams. Hardware wallets are not connected to an exchange, which makes them more safe, but also less accessible when you want to trade. To provide a final level of security, air-gapping (a sexy phrase for unplugging the hardware wallet from your computer USB port) will eliminate any threat of offline malicious activity such as viruses and other attacks through your local computer operating system, if ever corrupted. HWWs require a PIN or key, which must be kept safe.
The crypto-based solution protects and empowers PEOPLE.
The future is quickly approaching where we see commercial and compliant solutions to support first-party custody activities. These solutions will provide the necessary tools to give the asset ownership benefit and control back to the client/user/YOU in financial services. There are well-respected development teams, particularly working within Ethereum’s smart contract ecosystem, working on Regulatory sandboxes as we speak. There are asset insurance companies working on crypto asset custody protection solutions as we speak. There are also SaaS-based software developers working on improving the user experience to reduce the hurdles of adoption. We are proud to be involved in this early development stage and excited to share some revolutionary new SaaS-based solutions to help manage the way critical private wallet information is stored and managed for the empowerment of the user.
We believe, through the deployment of middleware software, API technology, smart contracts, and other programming tools, the solutions are both necessary and achievable to expand the ecosystem for the betterment of all users on a permission-less basis. Achieving this without the need of private key information is paramount to privacy and thus long-term alignment with the greatest benefit of crypto assets, the direct custody model.
The skinny summary
We will undoubtedly see rent-seeking third-parties attempt centralized asset control of the crypto market, especially as the market evolves to include more institutions, some of which have regulatory requirements for third-party custody (such as pensions, foundations, and endowments). We may even see providers roll-out third-party custody solutions that offer a menu of risk-based activities and commiserate pricing, in an attempt to mimic the ultimate benefits of self-custody (first-party). While this is a move in the right direction, the end result centralizes your for data and final control to another third-party while charging a premium for the same rent-seeking activities.
We believe this new first-party custody model makes so much sense, that over time, the regtech solutions born from these early days will eventually grow to govern traditional asset classes such as stocks based on the demands of the modern client after seeing the results within crypto asset markets. This would make sense as financial behemoths such as Goldman Sachs, BlackRock and Fidelity are just a few of the firms working on big plans around trading, mining and settlement solutions for both crypto assets as well as blockchain registered traditional assets (security tokens and settlement utility tokens).
Expect a decentralized custody future.
In short, crypto asset custody (self or first-party) delivers a modern and highly valuable model which empowers the owner, reduces centralized asset risk, removes rent seeking expenses and greatly improves capital markets efficiency. Decentralized asset custody is today’s crypto asset status quo and possibly the preferred asset infrastructure of the future.
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