Choosing the Right Custody Solution for Your Business: The Differences Between Qualified Custodians and Self-Custody

Choosing a solution for the secure custody and management of digital assets is one of the most critical decisions faced by any individual or institution in the crypto and Web3 markets. Amidst increased government crackdowns, such as the recent SEC ruling proposing to expand and enhance the role of qualified custodians, it is especially important to understand the differences in crypto custody solutions, and know who adheres to the latest rules and regulations imposed by the U.S. government.

The primary consideration when securing crypto holdings is whether to use a self-custody solution offered by a technology provider, or to work with a custodian more akin to traditional financial services.

Below, we’ll explore some of the critical differences between self-custody and qualified custodians, as they are often conflated. Let’s start with some definitions:

• A qualified custodian is (typically) a regulated financial services provider that holds and manages cryptocurrencies, stablecoins and NFTs on behalf of the customer. The custodian may offer value-added services such as staking or execution.
• A custody technology services provider is a technology company that enables the customer to directly manage their own funds (i.e., self-custody).

Both models are commonly seen in digital asset markets. In addition to regulatory requirements from the recent SEC qualified custodian proposal for Registered Investment Advisors (“RIAs”) it is important for institutions to consider how aspects such as security and insurance will factor into whether a self-custody or custody technology service provider will make better sense for their business.

Security Considerations

There are various security concerns that need to be addressed when managing digital assets, including:

• Risks associated with the physical storage of private keys
• Cybersecurity threats
• Collusion
• Operational risks

In contrast to self-custody options, a qualified custodian assumes and manages the majority of these security exposures. This assumption considerably reduces risk for the customer. Here at Aegis Trust, we give our customers peace of mind by securing their assets with multiple layers of security.

• We protect the private keys of our clients via secure multi-party computation (MPC) technology. This means that the key shares are distributed to multiple physical locations, ensuring no single hack can compromise the assets.
• We use hardware authentication to overlay all transactions from our cold wallet to combat remote attacks.
• To protect against collusion, all transactions must be initiated by the client (Aegis cannot initiate transactions) and they are subject to preset, system-enforced trade approval processes on both the client and Aegis sides.
• Our global operations teams are trained and certified. They are physically located in the United States and Asia, and strive to complete all cold wallet transactions within 1-2 hours (industry standard is 48 hours).

In the case of custody technology providers, all or most of the security management is left up to the end user. Customers must take on all of the security risks, which in digital assets often means exposing the gross value of the portfolio. Managing this security risk appropriately is often very expensive, as it requires access to appropriate infrastructure, sophisticated processes and expertise.

A portion of the private keys may be held by the custody technology provider, however, they will not take on the associated liabilities for protecting these assets. This means responsibility for the backup and recovery of lost private keys often lands on the end user, adding increased complexity, costs and security risks, and potentially burdening them with needing yet another vendor to fulfill these responsibilities.

Insurance Considerations

Insurance is another factor to consider when choosing between self-custody solutions or qualified custodians. There are two types of insurance typically offered in digital asset (and many other) markets:

• Specie insurance provides protection for valuable assets in physical locations, including in storage and in transit. When in cold storage, cryptocurrency is considered to be in a secure location — which makes it available for specie insurance. This type of insurance is able to cover cryptocurrencies with much larger value and is less expensive than crime insurance.
• Crime insurance indemnifies against losses stemming from cryptocurrency theft. A crime insurance policy reimburses asset holders for the loss of the digital assets stored in hot wallets.

Assumption of liability is critical when considering digital asset insurance.

Specie insurance is typically provided to the party that is liable for the assets. In the case of Aegis as a qualified custodian, the client retains the title for the assets at all times, however, the responsibility to return the assets to the client sits with us.

This allows Aegis to take out a specie insurance policy that covers virtually any digital asset held and managed for our clients, including cryptocurrencies, stablecoins and NFTs and any type of tokenized assets. This type of insurance can scale significantly and quickly based on the assets held on the platform.

Given that custody technology providers don’t manage client assets or assume liability, they are typically only able to offer crime insurance. While certainly better than no coverage, the higher cost makes it uneconomical to insure the platform assets in full. End user customers could of course look at direct insurance policies, however, the process will be onerous, slow and operationally intensive.

Regulation Considerations

In recent news, the SEC proposed a rule to require registered investment advisors (RIA) to keep their customers’ money and securities with a qualified custodian. As new rules and regulations evolve, it is important for investors to research the latest regulatory requirements imposed by the SEC and ensure the chosen custody solution adheres to them. Taking into account that there are only a handful of companies that hold the title of “qualified custodian” (including Aegis Trust, which is regulated by South Dakota Division of Banking), may be paramount to avoiding legal issues and hefty fines.

Qualified Custodians Assume Liability and Reduce Customer Risk

Self-custody using custody technology solutions offers a number of benefits to clients looking to manage their own assets. They are often flexible and relatively simple to integrate and manage, at least on the surface.

However, choosing to safeguard your assets with a qualified custodian such as Aegis offers greater benefits when it comes to security and insurance. The custodian assumes the majority of the complex risks associated with the management of digital assets.

Here at Aegis, we have spent considerable efforts implementing secure and regulatory and insurance approved infrastructure to manage these risks effectively. This is coupled with solid coverage and economic benefits awarded by specie insurance. Together, we believe that this provides our customers true peace of mind for the integrity and safety of their assets.