Crypto Custody: The Role of Bitcoin Custodians in Institutional Digital Asset Adoption
January 30, 2024
For the digital asset market, the next big milestone is widespread institutional adoption. This goal cannot be achieved without crypto custody service providers.
In this guide, we will break down crypto custody by defining what it is and the role it plays in institutional digital asset adoption.
What is Crypto Custody?
Crypto custody is a term that describes the process of safely storing a digital asset’s private keys. It entails managing and securing these cryptographic keys using different methods to protect them from theft and loss.
You can think of a private key as the physical “key” to the “padlock” where your digital assets are stored. Cryptocurrencies are stored on the blockchain, and they can only be accessed with a wallet’s private key.
Therefore, anyone with access to this private key has custody over the associated crypto assets. Moreover, a custodian has control over the assets under their management.
In TradFi (traditional finance), investors transfer the custody of their holdings to third-party financial institutions like banks. This system operates under the assumption that the custodian can be trusted to safeguard all the financial assets under its management. However, there’s no guarantee that financial institutions will live up to this expectation. For this reason, even in traditional financial markets, it’s recommended that you bank with an insured institution.
To solve TradFi’s sometimes unreliable trust system, blockchain technology has introduced a trustless intermediary-free approach to finance. This allows people to have total control over their assets. At its core, the new world of Web3 is self-custodial. It gives users the possibility to store their assets self-sovereignly. If they wish not to do so, third-party crypto custody services are also available.
Types of Crypto Custody: Self-Custodial vs. Custodial
Crypto custody can be self-custodial or custodial, depending on who is managing and securing the private keys.
As the name suggests, self-custodial means personally securing and managing your assets’ private keys. This form of crypto custody transfers all the power and responsibility to the crypto asset holder.
That means the owner gets to enjoy the freedom of handling their assets as they wish while bearing the obligation to protect them from loss and theft, which means proper security measures need to be implemented.
Self-custody options include a cold wallet for long-term storage, using a secure internet connection when operating a hot wallet, backing up your private key, and storing it in a safe place where a family member can access it in case anything unexpected happens to you.
Executing these actions effectively is crucial, as the loss or theft of crypto assets under self-custody is permanent and cannot easily be reversed. There is no customer support hotline to call and if not purposely set up, there is no insurance coverage to turn to.
The custodial form of crypto custody entails surrendering the security and management of your private keys to a third-party custodian. This option is suitable for individuals who do not want to be responsible for protecting their assets. It is also the preferred method of securing crypto assets for institutional investors.
The most common third-party crypto custodians are centralized crypto exchanges (CEXs), which mainly cater to retail investors. Digital asset managers and custodial banks are also third-party crypto custody service providers that mostly serve institutional investors as they are more tightly regulated than exchanges.
Third-party crypto custody services may include insurance coverage that protects assets from theft or loss, which acts as an additional security layer.
The Rise of Qualified Bitcoin Custodians
Given increased institutional interest, the number of qualified Bitcoin custodians has risen in the past five years.
As crypto market capitalization has grown over the years, traditional investors have sought to tap into this high-performing industry (Bitcoin was one of the top-performing assets of 2023, surpassing gold, S&P 500, NASDAQ, and other traditional assets), forcing hedge funds, asset managers, banks, and other financial institutions to create digital asset products for their clients.
These institutions need qualified, regulated and licensed custodians to safely manage their clients’ assets. As a result, more and more companies are introducing crypto custody services to meet this demand.
The rise of qualified Bitcoin custodians has also been propelled by the fact that since mid-2020, the US has permitted banks to provide crypto custody services.
Going forward, the crypto custodial services market is forecasted to grow by a CAGR of 23.65% from 2023 to 2028. This growth will take the market size from the current $447.9 billion to over $1 trillion by 2028.
Examples of Popular Bitcoin Custody Service Providers
Let’s take a look at a handful of leading crypto custodians.
BitGo, a trust company founded in 2013, operates as a qualified crypto custodian regulated in South Dakota, New York, Germany, and Switzerland. The company reported assets under custody (AUC) worth more than $64 billion in 2021.
BitGo holds the private keys of individual and institutional investors in cold storage, which features bank-grade security. It secures more than 700 digital assets and charges a service fee of 1%. Furthermore, assets in custody are insured at up to $250 million against theft and loss.
Coinbase Custody is a qualified crypto custodian established in 2012. It secures private keys for institutional investors using a vault storage solution that combines consensus computation, strict controls, and physical security.
Coinbase Custody supports over 400 crypto assets and manages assets valued at $128 billion. Moreover, the company insures the assets under its management by up to $320 million and charges a service fee of 0.1%.
The company is licensed by the New York Department of Financial Services (NYDFS) to provide crypto custody services.
Coinbase Custody has become a prominent player in the crypto custody market over the years, with most of the current spot Bitcoin ETF applicants choosing it as their custodian of choice.
Gemini Custody is a crypto custody provider targeting high net worth individuals and institutional investors. It leverages cold storage, multi-signature technology, physical security, role-based governance protocols, and biometric access controls to safeguard investors’ assets.
The custodian supports over 100 crypto assets and charges a service fee of 0.4%. It also offers insurance coverage of up to $75 million of assets in custody.
Gemini Custody, which has more than $30 billion in assets under management, was launched in 2019 and is licensed by NYDFS.
Fidelity Digital Assets
Fidelity Digital Assets is a subsidiary of the asset manager, Fidelity Investments, a giant in the TradFi space. It focuses on crypto custody, trading, and asset management. The Bitcoin custodian uses cold storage and a multi-tier approval structure to secure clients’ BTC holdings. Besides Bitcoin, Fidelity Digital Assets also provides custody services for ETH.
Institutional investors that custody their assets with Fidelity Digital Assets pay a service charge of 1%. However, the crypto custodian does not offer insurance coverage. The firm has not revealed the value of assets it has under custody.
Fidelity Digital Assets launched its crypto custody operations in 2018 and is licensed by NYDFS and the UK’s Financial Conduct Authority. .
Why Qualified Crypto Custodians Are So Important for Institutional Bitcoin Adoption
Meet Regulatory Requirements
Regulation stands as a primary concern hindering institutional investors from embracing crypto assets. Institutional investors are typically cautious because they have to maintain a high degree of integrity for their clients to retain their trust.
Fortunately, the crypto sector is slowly but steadily beginning to get more regulatory clarity and, as we have seen, countries like the US are providing crypto custody licenses that enable institutional investors to store their clients’ private keys with regulated custodians.
Over time, these regulated crypto custody service providers will help boost the institutional adoption of Bitcoin and other crypto assets.
Many people have lost millions of dollars by storing their digital assets with custodians that went under due to cyber hacks or mismanagement.
However, with qualified crypto custodians, the risk of asset mismanagement is reduced thanks to more stringent regulatory oversight. Also, the risk of loss from cyberattacks is minimized because these professional players offer insurance coverage. This level of increased security in the space is highly valuable to institutional investors who appreciate a safe and controlled environment.
Convenience And Ease
Because qualified crypto custodians operate similarly to banks, institutional investors will find them easy and convenient to use.
Technical aspects of crypto custody are left to the service provider, lessening the burden for institutional investors who may not have the time to familiarize themselves with all the ins and outs of crypto and blockchain technology.
Such a level of convenience can help make institutional investors less intimidated by crypto assets.
The Bottom Line
Crypto custody is a key factor institutional investors consider when deciding whether to enter the digital assets space. Therefore, institutional digital asset adoption is likely to grow as the crypto custody market becomes more widely regulated and thus safer.
Crypto custody has evolved dramatically over recent years and is no longer dominated by crypto-native companies. Financial services companies like Fidelity, BNY Mellon, and Citibank have entered the scene, kick-starting the long-awaited institutional adoption of crypto.