The technologically driven world we live in is changing nearly everything in our daily lives, including the way we store our money. In the traditional system, most people store their money in a bank account. However, what most people don’t realize when they put these funds into an account at the bank is that they don’t control this money per se anymore.
You see, the money placed in a bank account now technically enables the bank to lend out the money. Indeed they can loan out as much 10x whatever money is deposited.
Cryptocurrency is breaking down this traditional system of banking. When you invest in cryptocurrency, the crypto coins or tokens are stored in a crypto wallet. While stored in your crypto wallet, no one can do anything with your coins or tokens without your private key. This ability to self custody your funds is one of the primary reasons cryptocurrencies have value.
Read on to learn more about crypto custody wallets, to find out what types of crypto custody are available, and to discover what type of crypto custody wallet is the best fit for you and your goals.
What Is Crypto Custody?
Before diving into crypto custody, the first thing to understand is how crypto wallets work. Every crypto wallet is made up of two components, a private key, and a public key.
- Public Key – An address that consists of a jumble of numbers and letters that you use to send your crypto tokens and coins to.
- Private Key – A password, or seed phrase of 12-24 words, that is viewable only to the owner of the crypto wallet. The private key or seed phrase is needed to send any crypto coins or tokens out of the wallet.
Essentially, crypto custody has to do with who holds the private key of a crypto wallet. There are three main types of crypto custody, including:
- self custody,
- joint custody, and
- third-party custody.
Of course, each type of crypto custody has its own set of pros and cons.
With self custody crypto wallets, you are the only person with the seed phrase or private key necessary to send coins or tokens out of the wallet, ensuring that you are the only individual in control of your wallet.
There are also two different types of self custody wallets you can utilize, including hot wallets and cold wallets.
- Hot Wallets – Crypto wallets that are continuously connected to the internet. These types of wallets include web wallets like MyEtherWallet, browser extension wallets like Metamask, desktop wallets like Exodus, and mobile wallets like Coinomi. With these wallets being connected to the internet at all times, there is always the potential that they could be hacked through cyber attacks.
- Cold Wallets – In comparison to hot wallets, cold wallets are more secure as they are completely disconnected from any network. Cold wallets are essentially just hardware wallets where no one can get into the wallet without having both the physical device that it is on and the pin to get into it.
Ultimately, the biggest pro associated with self custody wallets is that you are always in control of your crypto coins and tokens at all times. In comparison, the biggest con is the responsibility that comes with self custody wallets. If you ever send your crypto to the wrong address, there is no refund, and you simply lose those coins or tokens forever. If you ever lose your seed phrase, you will have a difficult if not impossible time trying to recover your crypto wallet and coins and tokens it holds.
Another type of crypto custody wallet is the joint custody wallet. With this type of wallet, you are not the only person who holds the private key to your crypto wallet. Joint custody can be done in a variety of ways, with the most basic being simply sharing your private key with someone you trust.
Setting up joint custody wallets is rarely advised, as you risk the chance of someone else running off with your funds should they decide the price is right. However, there are legitimate reasons to set up a joint custody wallet or share a wallet among trusted individuals. The most common type of joint custody wallet is the multi-signature or multisig wallet.
- Multi-Signature Wallet – A wallet that has multiple private keys that must be unlocked before funds can be transferred out of it. These types of wallets can be set up with multiple types of configurations. An example would be a wallet that has five different keyholders and a stipulation that three out of the five keyholders must put in their seed phrase in order for any crypto coins or tokens to leave the wallet.
Ultimately, the biggest pro associated with joint custody wallets is that it makes it possible to share the responsibility of the wallet with other individuals. If you would somehow lose access to your seed phrase or private key, there would be multiple other parties to help recover the wallet to prevent funds from being lost entirely.
In comparison, the biggest con to joint custody wallets is that you have to rely on other individuals to hold up their end of the deal and not sell or trade funds without your knowledge or consent. Therefore, it is essential to set up joint custody wallets with individuals you can trust.
The final type of crypto custody wallet is the third-party custody wallet. With third-party custody wallets, someone else holds the private key to your wallet. There are two main types of third-party custody wallets, including informal third-party crypto custody and formal third-party crypto custody.
- Informal Third Party Crypto Custody – In informal third-party crypto custody arrangements you hold your coins and tokens with a centralized cryptocurrency exchange like Coinbase, Binance, or Gemini. This means these institutions hold the private key to your wallet, and just like with banks, the crypto you hold on these exchanges is owned by the institution, not by you. There is a great deal of risk associated with holding money on these exchanges as they are at greater risk for being hacked as they are usually made up of hot wallets that are always connected to the internet.
- Formal Third Party Crypto Custody – Informal third-party crypto custody arrangements, there is much more security provided to users. Interestingly enough, most of the largest formal third-party crypto custodians are subsidiaries of popular crypto exchanges such as Coinbase Custody and Gemini Custody. With formal third-party crypto custody, your coins and tokens are arguably as safe as they are in self custody. However, you are not left to shoulder all of the responsibility in this arrangement.
Ultimately, the biggest pro associated with third-party custody wallets is that you do not have to carry the responsibility of remembering or holding onto any private keys.
In comparison, the biggest con to third-party custody wallets is that you give up control of your funds, and with informal third-party crypto custody wallets, your funds are also at a higher risk of being hacked or lost altogether.
What Type of Crypto Custody Wallet Is Right for You?
Deciding which type of crypto custody wallet is right for you will largely be based on how much crypto you own and what your goals are. For most individuals with a moderate amount of crypto, that of which consists of less than $1 million, a self custody wallet is almost always the best choice.