What is crypto custody and why is it important?

May 19, 2022

A major topic in the world of crypto is custody. Bitcoiners talk about it in sometimes heated terms, countless companies offer different solutions for it, and your relationship to it is something to decide even before you make your first Bitcoin transaction. Yet knowing what custody means is also something many in the crypto community take as a given. Luckily, this short guide to crypto custody will shed some light on this need-to-know crypto topic from the ground up. We'll lay out what custody is, why it's important for your crypto, and even the different types of custody you'll encounter in the crypto space. All this will help you make the decision that's right for you when it comes to getting started with crypto.

What is custody?

Just like with children, criminals, or valuables, custody means who has control over something. A parent has custody of their children, the police may have a criminal in custody, or a bank may provide safe custody for your jewelry in a safe deposit box. So when it comes to Bitcoin and altcoins, a simple shorthand for custody is who controls your coins.

But surprise: it's actually a bit more complicated than that. Since your bitcoins only exist as bits of code engraved unchangeably on the blockchain – and the blockchain is controlled by all its participants around the world – it's not really useful to talk about who owns the coins themselves. Instead, we need to take a step back and talk about keys.

As you'll recall from Invity's explainer on keys, every time you start working with crypto you'll create a set of one private key and one public key. Your unique private key is like your online banking password, your front door key, or an all-access backstage pass: it identifies you as the owner of certain coins, lets you check your "balance", and importantly allows you to send your coins anywhere you wish. (This is why you should never, ever share your private key!) A mathematically related public key, on the other hand, lets you receive funds and makes sure they go to you and you alone.

Since your keys are the actual, well, keys to controlling your coins, crypto custody means having control over your keys and therefore your coins. This is why you'll often hear the catchphrase "Not your keys, not your coins" – it sums up the situation quite neatly.

Bitcoin advocate and author Andreas Antonopoulos explains the importance of having custody of your own keys.

What types of crypto custody are there?

So we've established that keys are the information you need to keep custody of – but how to do that? There are a number of different options all with their own upsides but some with real downsides as well.

(Don't) keep it on an exchange

One place many people start with crypto is on large multinational custodial exchanges. You're probably familiar with these: Coinbase, Binance, Kraken, and many others besides. These options tout themselves as super easy to get started with and easy to use, and they're typically not wrong in that respect – you make an account and you're usually off to the races to buy and trade crypto, pretty much from anywhere you can log in. But this simplicity usually hides a not-so-secret vulnerability: custody.

When using the most basic form of these custodial exchanges, you may or may not make a wallet (more on this in the next section). But more importantly, when you buy and trade coins, they may not be transferred to this wallet. More often the coins you "buy" are simply allocated to your account. In other words, "your" coins are simply added to a giant spreadsheet next to your name while the exchange holds custody of your coins for you – in their wallet, with their keys.

This may seem like an okay trade-off for convenience...until you start looking at the fine print. A perfect example of this came just a few weeks ago in some updated legal filings by Coinbase.

Excerpt from Coinbase's 10Q document. Source: @sophiamzaller via Twitter.
Excerpt from Coinbase's 10Q document. Source: @sophiamzaller via Twitter.

Cutting through the legalese, this essentially means that if you leave your coins in an exchange's hands and the exchange collapses (or is hacked, as happens rather frequently), your assets are gone too and you won't be made whole. Bye-bye investment.

This is why Invity only connects our users to noncustodial exchanges. These services let you buy or exchange crypto "direct to custody": your coins are sent to the wallet of your choosing and are never held on an exchange.

Get 👏 your 👏 own 👏 wallet 👏

We've got a full-length explainer on Bitcoin wallets, but the short version is that wallets both protect and let you use your own keys. This is what the crypto community usually refers to as "self-custody".

While there are many crypto wallets in the world, they typically fall under two main categories: hot and cold. Hot wallets are usually apps where, after downloading to your phone, you can create the keys you need. These are great for convenience, for example if you're looking for a free way to start stacking sats or you want to be able to spend Bitcoin when out and about. Even here, though, you need to take care: these wallets are "hot" because they're constantly or frequently connected to your phone's internet connection. This leaves your keys – and therefore your coins – vulnerable to intruders from the web, no matter how unlikely that threat may be. This is why it's a good idea to use a hot wallet just like a wallet where you keep your folding money: only carry around as much Bitcoin as you're willing to lose, and transfer some pocket money whenever you think you'll need it.

For long-term, larger crypto investments, the only way to go is a cold wallet. Cold wallets, also called hardware wallets, are standalone gadgets that secure your keys offline: they're only active when you plug them into your computer and unlock them with a few layers of security. You can think of these like your bank account, except that you are your own bank: you keep your device safe, you know your PIN, and so you are the only person to have custody over your keys and coins. Hardware wallets aren't free, but the security they provide is more than worth the cost; in fact, a general rule is that once your crypto portfolio is around ten times as much as a hardware wallet, you should invest in a hardware wallet.

The Trezor Model T hardware crypto wallet by Trezor.
The Trezor Model T hardware crypto wallet by Trezor.

We recommend that anyone interested in a hardware wallet go for a Trezor, the first and widely recognized as the most secure wallet on the market. Full disclosure, Invity and Trezor are part of the same holding group of companies. This is a real benefit: Invity's network of noncustodial exchanges is fully integrated into Trezor hardware wallets, meaning any coins you purchase will be sent directly to cold storage. What's more, our companies work together every day to ensure the highest levels of both usability and security for every crypto user, whether you have a Trezor or not.

Want to get your hands on your very first hardware wallet? The Trezor Starter Packcomes with all you need to get started fast – including a voucher to make your first transaction even easier!

Hey big spender: third-party custody

Self-custody in a hardware wallet is usually the final word for average consumers who want to secure their keys and coins. However, we would be remiss if we didn't also cover solutions for more boutique clients. For crypto investors who are dealing with huge amounts of crypto – we're talking multiple bitcoins, minimum – or who are high profile, there are third-party solutions who secure and manage investments on an institutional scale. Aside from having added resources, oversight, and dedicated security professionals, these third parties also usually insure these large investments against theft or loss. If you fall into this category, however, you're probably not reading this. But you never know – you could get there one day if you stack enough sats!

So let's briefly summarize. Crypto custody means having personal control over your keys and therefore your coins. Keeping your coins off exchanges and putting them into self-custody in a wallet is the best way to protect your investment. And choosing a cold storage hardware wallet is the best way to protect your keys. There you have it – custody in one paragraph!

Ready to take custody of your finances and be your own bank with Bitcoin? Check out our Beginner's Guide to Crypto to see how to get started today!

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