A Beginner's Guide to Different Types of Crypto Custody
As we discussed before, you never truly own your cryptocurrency and NFT investments until you take custody of your wallet's private keys. Now, let's tackle the "types crypto custody" and find out who currently holds your wallet's private keys.
The Types of Crypto Custody
1. Third Party Custody
Third party custody is when someone else holds the private keys of your cryptocurrency wallet - most of the times this happens when we leave our cryptocurrencies on centralized exchanges. Yes, when you create an exchange wallet technically the crypto isn't yours yet. ( That's why you don't remember writing down a 12 or 24 word seed phrase when creating an exchange wallet, because they take custody of your private keys. )
This is very convenient since you don't have the responsibility of safely storing your own private keys, but this convenience may come with some risks.
- Exchanges are always targeted by hacking groups cause of the sheer volume of cryptocurrency investments left on exchanges on a daily basis ( talk about big pay day )
- Leaving your private keys on an exchange means that your withdrawals may be suspended anytime, for any reason. Not to mention that this issue almost always happens when there is an immediate need for an emergency withdrawal of a specific token...
- Exchanges are run by *drum roll please* human beings, very corruptible human beings that can runaway with everyone's money - like the infamous Africrypt exchange, who's founders disappeared into thin air taking $3.6 Billion worth of Bitcoin with them in the process.
2. Joint Custody
Joint custody is when you are not the only person holding the private keys to a cryptocurrency wallet. This not commonly done due to the inherent corruptibility of human nature. ( you could literally lose all your investments due to a fight or if someone just runs away with all wallet's funds ) but for the right reasons like pooling funds to invest or develop, joint custody using multi-signature wallet, can be done.
Multi-signature Wallet
A Multi signature wallet is a configurable cryptocurrency wallet that has several private keys. These wallets can be configured to only send transactions once a custom set of conditions have been met.
For example: The multi-signature cryptocurrency wallet will only send a transaction if 3 out of 5 private key holders approve.
3. Self Custody
Self custody is when you take the responsibility of holding the private key ( usually in the form of a seed or recovery phrase ) of a cryptocurrency wallet. In short, you take custody of your keys, and holding your own private key means that you alone have the power to withdraw coins and tokens from the cryptocurrency wallet associated with your private key.
There are two types of self custodial wallets:
- Hot Wallets
Hot wallets are fairly secure, you owning your private keys is enough assurance that your investments in these wallets cannot be withdrawn without your consent. But by being constantly connected to the internet, your wallet will still be constantly exposed to hackers!
- Hardware Wallets
A hardware wallet is a self custodial cryptocurrency wallet that is disconnected from the internet or "air gapped". A hardware wallet is a physical device used to store your private keys, and manually approve blockchain transactions.
When you use a hardware wallet, you can rest assured that no one can take control of your private key unless they have access to your physical device. Examples of hardware wallets available in the Philippines are: Ledger, Trezor, and Safepal.
What if my phone or computer is infected with a virus?
As we discussed a while ago, hardware wallets are "air gapped", when a hardware wallet is connected to your PC ( during transaction sending ) all the transaction signing takes place on the hardware wallet itself, which means your private keys will not be exposed to any attackers or viruses on you computer.
What if someone takes my hardware wallet?
Even if your hardware wallet gets taken from you, it will require your 8 digit PIN code to operate, and after only 3 failed attempts your hardware wallet will restore to factory settings and erase your wallet accounts.
What if I forget my PIN code?
Take is easy! This is when taking care of your seed phrase saves the day. When you accidentally reset your hardware wallet, getting your crypto back will be very easy. Just set up your hardware wallet, and on the first step it will ask you to either "create new wallet" or "recover old wallet" in your case just choose to recover your old wallet and input your seed phrase, then *poof* you get your investments back!
Takeaways
- Self custody is the custody type for you if you want to get true and absolute control over your privates keys, cryptocurrency withdrawals, and censorship resistance.
- Hardware wallets are the safest, and most hack-proof self custodial wallets. These are the wallets for you if you want to take control of your private keys, and have the best web 3 security at the same time.
- Joint custody is best for pooled investment funds and DAOs
Third Party custody is best for convenient and fast transaction signing and sending.
To summarize : Cryptocurrency custody refers to the secure storage of digital assets. As the popularity of cryptocurrency continues to grow, it's important for investors to understand the different types of crypto custody available and choose the one that best suits their needs.
Self-custody refers to the storage of cryptocurrency by the owner. This type of custody is the most secure, as the owner is fully responsible for the safety of their assets. With self-custody, there is no need to trust a third-party with your private keys, which are the codes that give you access to your digital assets.
However, self-custody can be challenging for those who are new to cryptocurrency or who are not tech-savvy. Storing your digital assets securely requires a good understanding of cybersecurity and the use of secure hardware wallets or software wallets. Additionally, there is no insurance available to protect your assets in the event of a security breach.
Exchange-Based Custody
Exchange-based custody refers to the storage of cryptocurrency on a cryptocurrency exchange. This type of custody is the easiest and most convenient, as it allows you to store your assets and trade them in one place. Many exchanges offer built-in wallets for storing your digital assets, which can be easily accessed through your account on the exchange.
However, exchange-based custody is also the least secure type of custody. Exchanges have been the target of numerous hacks, which have resulted in the loss of billions of dollars worth of cryptocurrency. Additionally, many exchanges are not insured, so there is no protection for your assets in the event of a security breach.
Institutional Custody
Institutional custody refers to the storage of cryptocurrency by a trusted third-party, such as a bank, financial institution, or asset manager. This type of custody is designed for institutions, such as hedge funds, that need to securely store large amounts of digital assets. Institutional custody offers a high level of security and insurance, as well as features such as cold storage, multi-signature protection, and regular audits.
However, institutional custody can be expensive and is typically only available to institutions with large amounts of assets. Additionally, there is a risk of losing access to your assets if the third-party goes out of business or experiences a security breach.
Conclusion
In conclusion, the type of crypto custody you choose will depend on your individual needs and risk tolerance. Self-custody is the most secure, but it requires a good understanding of cybersecurity and the use of secure hardware or software wallets. Exchange-based custody is the easiest and most convenient, but it is also the least secure. Institutional custody is designed for institutions and offers a high level of security, but it can be expensive. When choosing a type of crypto custody, it's important to carefully consider your individual needs and risk tolerance, and to do your research to ensure that you choose the best option for you.
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