The Ultimate Guide To Digital Asset Custody đź§
By now you’ve probably heard: “Not your keys, not your crypto”
But why is controlling your keys so important?
Being in control of your crypto keys ensures that you have full ownership and control over your digital assets. When you hold your private keys, you can access your assets directly on the blockchain without needing to rely on any third party. Giving you the ability to independently manage, transfer, and secure your cryptocurrencies.
By not being in control of your keys, there are several risks you are exposing yourself to:
- Security breaches: Centralized platforms and exchanges can be targets for hackers and cybercriminals. If the platform suffers a security breach, your assets could be stolen. This has happened in the past with high-profile exchange hacks, leading to significant losses for users. Some notable hacks: in 2019 Binance lost 7,000 Bitcoin, Kucoin was hacked for $281 Million in 2020, and in 2019 Cryptopia lost $15.5 Million and went insolvent.
- Platform insolvency: If a centralized platform or exchange becomes insolvent, there is a risk that users may lose their assets. This can happen due to hacks, excessive risk, fraud, and other factors. Some notable insolvencies: FTX, Mt. Gox, Celsius, and Voyager.
- Regulatory actions: Centralized platforms and exchanges are subject to regulatory actions and oversight. If the platform is shut down or restricted by regulators, you may lose access to your assets, at least temporarily.
- Mismanagement: Centralized platforms and exchanges are operated by human teams, which can make mistakes or mismanage the platform, potentially leading to the loss of user assets. The most notable failure in management is FTX, which lent out customer deposits to its hedge fund Alameda and lost Billions in leverage trading.
- Lack of control: When your digital assets are stored on a centralized platform or exchange, you don’t have direct control over your private keys. This means you’re trusting a third party to manage your assets, and you may not be able to access your assets if the platform experiences downtime or other technical issues.
- Privacy concerns: Centralized platforms and exchanges often require users to provide personal information and identity verification processes (KYC/AML) to comply with regulations. Leading to reduced privacy, as personal information and transaction history may be stored by the platform.
In other words, by not holding your keys… you could be allowing this guy to get his hands on YOUR money:
There is a simple way to mitigate this risk… control your keys.
We will explore the popular solutions for crypto asset custody: non-custodial, third-party custodial services, self-custody via multi-sig, and MPC (Multi-Party Computation) Wallets.
Non-Custodial
A non-custodial wallet or service does not hold or control users’ private keys. Instead, users either hold their keys or interact with a decentralized system (such as a smart contract) that manages their assets. In some cases, non-custodial services may involve cryptographic techniques that allow users to access their assets without the service ever having access to the private keys. Non-custodial wallets can be software-based, browser extensions, or even integrated into decentralized applications.
Pros:
- Users still have a degree of control over their assets
- No reliance on a centralized entity to manage keys and assets
- Reduced risk of loss due to platform hacks or mismanagement
Cons:
- Users must still take responsibility for securing their private keys
- May offer fewer features compared to custodial services
- The level of control and security can vary depending on the specific non-custodial solution
Non-custodial wallets are suitable for users who prioritize security, control, and privacy. It’s ideal for “hodling” crypto assets, as well as for users who prefer not to expose themselves to centralized counterparty risk.
Types of Non-custodial wallets: Ledger, Metamask, etc.
Third-Party Custodial Services
Third-party custodial services are specialized companies that securely store and manage cryptocurrency assets on behalf of users or institutions. They cater to institutional investors, high-net-worth individuals, and others who require a higher level of security, compliance, and professional management for their crypto holdings.
Pros:
- Advanced security measures and protocols
- Insurance coverage for user assets
- Regulatory compliance
- Professional asset management
Cons:
- Trust in third-party service
- Fees for account maintenance and services
- Limited privacy due to KYC/AML requirements
- Limited control over private keys
Third-party custodial services are suitable for users who prioritize security, professional management, regulatory compliance, and insurance coverage. They are particularly relevant for institutional investors, high-net-worth individuals, or those who may not have the technical expertise or time to manage their assets securely.
Self Custody via Multi-Sig
Self-Custodial Multi-signature (multi-sig) wallets are a type of cryptocurrency wallet that requires multiple signatures (private keys) to authorize transactions and the user doesn’t give up the keys. They add an extra layer of security by distributing control of the assets among multiple parties, which can be individuals or entities.
Pros:
- High security due to multiple signatures
- Enforced rules/policies within organizations
- Built-in backup mechanism
- Trustless agreements and escrow services
Cons:
- Higher complexity
- Requires coordination among parties
- Limited support and compatibility
Self-Custodial Multi-sig wallets are for users who prioritize security, access control, and redundancy. They are particularly suitable for organizations, businesses, or partnerships that require multiple approvals for transactions, or for individuals who want an additional layer of security for their crypto assets.
MPC (Multi-Party Computation) Wallets
An MPC wallet is a type of cryptocurrency wallet that uses advanced cryptographic techniques to secure private keys and transactions. The main idea behind MPC wallets is to distribute the responsibility of managing private keys among multiple parties, making it extremely difficult for a single entity to compromise the wallet’s security.
In an MPC wallet, the private key is split into multiple shares, with each share held by a different party. These parties can be individuals, organizations, or even different servers within a single organization. To perform a transaction, a predefined threshold number of shares must collaborate, ensuring that no single party has full control over the wallet’s funds.
Pros of MPC wallets:
- Enhanced security: The distributed nature of private key management reduces the risk of a single point of failure, making it more challenging for hackers to compromise the wallet.
- Flexibility: MPC wallets can be designed with varying levels of redundancy and security, allowing users to balance convenience with security based on their specific needs.
- Recovery options: Since private keys are split into shares, MPC wallets can provide more robust recovery mechanisms if a share is lost or a party becomes unresponsive.
Cons of MPC wallets:
- Complexity: MPC wallets use advanced cryptographic techniques, which may be more challenging for users to understand and set up than traditional wallets.
- Increased coordination: Performing transactions with an MPC wallet requires collaboration between multiple parties, which could be slower and more cumbersome than using a single-party wallet.
- Trust in participants: MPC wallets rely on the assumption that the parties holding the key shares will act honestly and securely. This requires a certain level of trust in the participants, which may not be suitable for all users.
Overall, MPC wallets offer a secure and flexible option for managing cryptocurrency assets, particularly for users who prioritize security and are willing to navigate the complexities associated with multi-party key management.
Velvet.Capital does not currently offer MPC wallet custody, however, we may in the future provide MPC Wallet integrations.
Velvet Vaults
Velvet.Capital offers a unique vault system for its products, with each product having a separate vault created upon product inception. But the most important thing is Velvet.Capital never takes custody of user funds. So your funds stay your funds.
Take a deep dive into our tech & audit reports here: https://docs.velvet.capital/technology
Fund Managers on Velvet.Capital can choose from three custody options:
- Non-Custodial Vault: The underlying assets are stored in a smart contract vault, no one (not Velvet or the portfolio creator) has keys from the vault. The funds can be taken out only via the redemption module.
- Self-Custody via Multisig: The underlying assets are stored in a Gnosis Safe vault (Gnosis is an industry-leading provider of multi-sig vaults). The keys can be held by the portfolio creator who will choose the owners + threshold when creating the safe (default) or transferred to the end clients (e.g., in the case of individual high-value users)
- Third-party Custody: The underlying assets are stored with an external custodian, which has its own security guidelines and recovery mechanisms.
The purpose of Velvet Vaults is to provide a flexible solution that caters to a range of user requirements, preferences, and risk tolerances. The three options offered by Velvet allow clients to choose the level of control and security that best suits their needs.
If you are a fund manager and want to discuss in further detail the custody of your assets please visit our institutional investor website: https://velvet.capital/institutional
Velvet Does It Better
Because there is no one-size-fits-all solution for crypto asset custody. Each option has its pros and cons, and the choice depends on individual preferences, risk tolerance, and the specific needs of the user or organization. By understanding the differences between non-custodial, third-party custodial services, and self-custodial multi-sig, you can make a more informed decision about the best solution for securely managing and storing your cryptocurrency assets.
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Originally published at https://velvet.capital.
