What is Custody?

Custody is a service offered by professionals for the holding and maintenance of valuable assets. Traditionally this has been common among high net worth individuals and institutions. Custody services aren't common among everyday consumers because generally banks act as custodians to their assets: people can store the few valuables they have in a bank account or safety deposit box. While this culture of custody worked in the traditional finance realm, the new era of peer-to-peer finance — where consumers own their assets and are thus liable for them — begs a new way of conceiving custody.

What is Self-Custody?

Self-custody is the new wave in the institutional and High-Net-Worth-Individual (HNW) realm of peer-to-peer finance. This is because managing private keys of accounts upwards of a million dollars usually will not be left to single individuals to maintain on a hard or stick drive.

What are Custodians?

One of the only widely-compliant custody solutions on the market right now is Coinbase Custody. Coinbase Custody is a service that provides insurance, hierarchical control, segregated cold storage, SLAs on fund transfers, and 24/7 customer service. Coinbase works in collaboration with an SEC-registered broker-dealer and a FINRA-compliant brokerage firm to be fully compliant as a custody service provider.

While custody with the likes of Coinbase may be the best solution for high net worth individuals, this service is unavailable for typical retail investors. Moreover, institutions have grown to be skeptical of Coinbase Custody because the idea of custody of an asset typically entails disintermediating the asset from the market.

Many hedge funds await big investment houses like Goldman Sachs and ICE to expand and mature their custody desk services, so that custody of their assets is handled outside of the hands of cryptocurrency businesses. Institutions have also awaited the approval of cryptocurrency exchange-traded products (ETPs) which could turn out to be a powerful liquidity and custody solution to the market. Meanwhile, many filings have been denied by the SEC, and it is unclear which the SEC will approve and when.

How do Exchanges handle custody?

Exchanges take custody of assets that speculators own. It's apparent that traders are comfortable holding their funds on exchanges — as some of the largest exchanges hold a total of over 4% of Bitcoin's circulating supply. However, exchanges have not proven themselves to be bulletproof custodians in the past. Mt. Gox's hack in 2014, Bitfinex's hack in 2016, and Coincheck's hack in 2018 showed us that exchanges are not exactly what one would call risk-free.

Holding assets on exchanges is common among retail investors. Institutions with a lot of capital typically open up corporate accounts on multiple exchanges for more liquid trading. Exchanges like Poloniex, Kraken, OKex, and Huobi have opened doors to institutions where they provide more customized service and custody options.

How do Wallets handle Custody?

Wallets are means of storing public and private key pairs that identify and give access to cryptocurrency on the blockchain. Wallets include both hot wallets and cold storage wallets.

Hot wallets are connected to the internet. Where this wallet is stored presents a potential point of failure — if a malicious actor gets hold of the wallet, they could steal a users funds.

Cold wallets are offline and isolated, such as a hardware wallet. Hardware wallets are more secure but more complicated for the average user. Executing a transaction on a hardware wallet requires that one confirms the transaction using a button on a dedicated physical device. To protect individuals from losing funds if they lose their device, each hardware wallet uses a seed phrase. This is a set of words that can be used to regain access to a wallet without having to have that device. While hardware wallets are relatively secure and safe, the seed phrase is a central point of failure to the security of one's funds.

We've established a few things so far. Hot wallets present a single point of failure wherever the private access key is stored. Cold storage presents a single point of failure wherever the private key or seed phrase to restore the account is stored. Exchanges store funds in their wallets which could be compromised at any time. Professional digital custody solutions are not yet where institutions quite need them to be, and are unavailable to average investors.

How does Vault12 handle Custody?

So how do we establish a universal and secure means of digital custody that does not include a central point of failure? The way that we at Vault12 do so is by decentralizing storage of access points themselves — private keys and seed phrases — breaking them up into shares that are useless on their own, but then are combined to reconstruct these keys. This isn't a solution that would replace paper or hardware wallets per se, but rather would be an extra layer of security on top.

In other words, we spread these central points of failure out, to make the storage of access keys to cryptocurrency safer, more secure, and more practical. Instead of storing your private keys on a server, or on a fragile memory disk — your keys are split up and stored on a mesh of devices around the world — completely resistant to targeted attacks and unfortunate occurrences.