Custody is a financial institution’s legal capacity to keep and preserve financial assets for its clients to avoid asset theft or loss.
What Is Custody?
In the financial world, custody can be termed as a safeguarding service provided by a financial institution for a customer’s securities. The institution that provides custody is known as a custodian which gathers dividends, interest, and profits from security sales for a fee and redistributes funds according to the customer’s instructions.
Custody has evolved from a personal relationship to a face-to-face encounter with a highly controlled institution. This gave birth to a new degree of financial complexity, further separating the secretive realm of banking from daily life.
Custodians that accept client funds now commit not just to retain the funds on behalf of the customer, but also to utilize the assets to lend them out for their gains.
Custodians play an important role in the financial ecosystem, from onboarding newbies to offering advanced trading tools to seasoned users. At the institutional level, there is an increase in the number of firms that handle asset storage and management, and some are also insured to repay their clients in the event of a financial loss.
Assets can be held in both digital and physical form by custodians. Custodial businesses are often very big and respected entities (like major banks) since they are in charge of preserving assets for a large number of customers that amount to millions or billions of dollars in most cases.
In the blockchain world, custodial solutions are usually provided by a third-party crypto exchange that holds the private keys of its cryptocurrency users in addition to the crypto assets, such as Bitcoin and Ethereum.
The custody of the cryptocurrencies is completely in control of the crypto exchanges that employ security solutions to keep the digital assets of their users safe from theft or unpredictable losses. In case of a hack or theft, the custodian (crypto exchange) is fully responsible for refunding their users.
A great example of this was the Binance hack of 2019, one of the major crypto hacks in history, where $40 million was stolen from its online wallets. In a reaction to this hack, the CEO of the world’s largest exchange, Changpeng ‘CZ’ Zhao announced full refunds to the victims.
Custodians of crypto assets, such as Bitcoin, Ethereum, Cardano, and Terra, are known as crypto custody providers. Cryptocurrency custodians offer services to both institutions and individuals who wish to store and safeguard their digital assets in a user-friendly, secure, and compliant custodian platform.
Cryptocurrency custodians are a great way to store digital currencies, however, caution must still be practiced by users against any major hack that may take their funds away forever. According to experienced crypto investors, a major part of digital currency holdings should be held in cold storage if users aren’t actively using it or don’t plan to use them in the near future. This practice is important to remain safe from hacking activities that may take place on a custodian platform.