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  • Ben Dickens

Understanding Bitcoin Custody: How to Safeguard Your Digital Assets


Bitcoin has achieved several significant milestones when measured in Australian dollars, highlighting its remarkable growth and stability. The most recent surge took Bitcoin's price to just over $98,000, marking a substantial increase from its previous all-time high in November 2021. This surge demonstrates the ongoing demand and interest in Bitcoin as a store of value and a hedge against inflation. It is important to note that this price surge is not a one-time event but rather a reflection of the growing recognition of Bitcoin's potential as a long-term investment. 

 

To safely acquire Bitcoin as a store-of-value asset, it is crucial to understand the process and take the necessary precautions. Firstly, it is important to ensure that you are acquiring genuine Bitcoin at the correct price. To achieve this, it is recommended to use reputable and trustworthy sources, such as established exchanges or platforms that have a proven history of security and transparency. These platforms typically have measures in place to protect users' assets and prevent fraudulent activities. One common way to gain exposure to Bitcoin's price movement is through investment vehicles such as MicroStrategy, Bitcoin ETFs, or trusts like GBTC (Grayscale Bitcoin Trust). These options allow investors to indirectly invest in Bitcoin without directly owning and storing the cryptocurrency themselves. However, it is important to note that each of these investment vehicles has its own set of risks and considerations.

 

Once you possess Bitcoin, the crucial question arises: how do you safely store it, or what is known as "custody" in the cryptocurrency world?

 

Securing private keys is fundamental to owning bitcoin. As the ecosystem matures, collaborative custody is gaining traction for its ability to eliminate single points of failure. There are various custodial models, broadly categorised into two major types of arrangements. Firstly, there's custodianship via a third party, where a custodian holds the keys to secure your Bitcoin stack, rather than you retain direct control. The second option is self-custody, where you (potentially in collaboration with others) maintain control over the keys securing your Bitcoin stack.

 

When it comes to custodying Bitcoin, there are several options available to users. Each method has its own advantages and considerations, so it is important to understand the different approaches. In this article, we will delve into some of the types of custodial arrangements. It is important to note that individual circumstances vary, and what works for one person may not suit another, and vice versa.

 

 

It is essential to emphasise that this blog does not offer specific advice, and we strongly recommend considering professional guidance.

 

With this disclaimer in mind, let us dive into several types of custody. These are presented without any particular order or suggestion of hierarchy.

 

 

TYPES OF CUSTODY

When considering the myriad options for safeguarding Bitcoin holdings, various custody solutions cater to unique needs and preferences. Institutional custody stands as a prominent choice, tailored primarily for institutional investors or high-net-worth individuals. These specialised custodians excel in securely storing significant amounts of Bitcoin, often complemented by services such as insurance coverage and auditing to instil confidence in their clients.

 

Alternatively, custodial wallets present another approach, where a third party assumes responsibility for holding the private keys on behalf of the user. This category encompasses exchanges and other service providers. While custodial wallets offer convenience and user-friendly interfaces, they also entail counterparty risk. Users must place trust in the security practices of the custodian, which could potentially expose them to vulnerabilities.

 

A Exchange Custodian

An exchange custodian is a business that provides customers with the capability to buy and sell Bitcoin, along with potentially other digital currencies. In the realm of cryptocurrency, a custodial exchange operates by retaining custody of a customer's Bitcoin holdings as well as the private key associated with the customer's digital wallet.

 

In simpler terms, when you use a custodial exchange, your Bitcoin is held by the exchange itself, and the exchange is tasked with securely managing your private key whenever you engage in transactions involving your Bitcoin.

 

 

B Professional Manager

Engaging a professional manager to hold your Bitcoin involves utilising the services of a crypto custodian, which is a financial institution specialising in securely storing digital assets for investors.

 

Institutional investors often mandate the storage of their securities and assets with qualified custodians, making the emergence of crypto custody providers pivotal in facilitating the institutionalisation of Bitcoin.

 

Professional and institutional investors typically opt to delegate the management of their private keys to mitigate the risk of fund loss stemming from theft, operational errors, or technical mishaps. Within a collaborative custody framework, a 'key agent' is an entity designated specifically to secure and operate one of the multiple keys involved.

 

Key agency, though not a new concept, has gained traction over the years, with companies like Unchained, Coincover, Kingdom Trust, BitGo, Nunchuk, and Casa serving as collaborators rather than custodians in their clients' custody endeavours.

 

 

C Collaborative Custody Arrangements

Collaborative custody is a concept that involves multiple parties sharing the responsibility of custody for Bitcoin. In this approach, the ownership of the Bitcoin is not held by a single entity, but rather it is distributed among multiple parties. This means that each party has a stake in the security and protection of the Bitcoin, and they work together to ensure its safekeeping. Collaborative custody is distinct from other methods of Bitcoin custody, such as self-custody, where individuals hold their own private keys and manage their own Bitcoin, or trusted third-party custody, where individuals or organisations entrust their Bitcoin to a centralised entity for safekeeping.

 

Collaborative custody offers several advantages. Firstly, it allows for greater security by spreading the risk across multiple parties. This reduces the likelihood of a single point of failure, making it more resilient to potential attacks or breaches. Secondly, it promotes transparency and accountability, as each party has a personal stake in maintaining the integrity of the Bitcoin. Finally, collaborative custody can facilitate the creation of decentralised financial systems, where multiple parties work together to manage and secure the Bitcoin, ensuring that no single entity has control over the network.

 

D Self Custody

Self-custody is a practice of holding and managing your digital assets on your own, without needing to entrust them to a third-party custodian. This means that you choose not to use a third party, and instead will manage your private key personally. One common method of self-custody is where users take full control of their private keys. This can be achieved through several types of wallets, such as hardware wallets, mobile wallets, or desktop wallets. Hardware wallets like the Cold Card or Trezor offer an additional layer of security by keeping the private keys offline. Mobile wallets like Blue Wallet provide convenience and accessibility, while desktop wallets like Electrum offer more control and customisation options. Self-custody empowers individuals to have complete ownership and control over their digital assets, enhancing security and privacy. 

 

It is important to acknowledge that self-custody is widely regarded as the most secure option for Bitcoin storage. By opting for self-custody, users retain complete control over their private keys, significantly reducing the risk of hacks or theft associated with third-party custodians. However, self-custody also entails the responsibility of ensuring the security of one's own keys. This includes implementing proper backup and storage measures to safeguard against the loss or theft of private keys. While self-custody provides the highest level of security and autonomy, it necessitates an initiative-taking approach to security on the part of the user.

 

 

In the next section, we will delve into several types of wallets and explore their features and functionalities to help you choose the most suitable option for your self-custody needs.

 

 

TYPES OF WALLETS

 

In the realm of Bitcoin custody, the distinction between hot wallets and cold wallets revolves around their connectivity to the internet. Hot wallets maintain an online connection and are engineered for quick accessibility and user convenience. Typically, they are software-based wallets accessible through devices like computers, smartphones, or tablets. Hot wallets suit frequent transactions and everyday usage. However, their constant online presence renders them more vulnerable to security breaches.

 

Due to their internet connectivity, hot wallets face increased exposure to hacking attempts and malware attacks. Thus, employing robust security measures such as strong passwords, two-factor authentication, and regular software updates is essential when using a hot wallet.

 

Conversely, cold wallets, also termed hardware wallets or offline wallets, are crafted to store Bitcoin offline, detached from the internet. These physical devices securely house the private keys essential for accessing and managing Bitcoin funds. Offering a heightened level of security, cold wallets are impervious to online threats, making them ideal for long-term storage and safeguarding substantial Bitcoin holdings. However, they may be less convenient for frequent transactions, as initiating transactions requires connecting the cold wallet to a computer or smartphone.

 

Hot wallets offer easy accessibility but carry elevated security risks due to their online nature. On the contrary, cold wallets provide superior security by storing Bitcoin offline, albeit with reduced convenience for frequent transactions. The decision between hot and cold wallets hinges on an individual's specific requirements and the amount of Bitcoin they intend to store or transact with.

 

Wallet Type

Description

Pros

Cons

Hot Wallet

Software-based, connected to the internet.

Convenient for daily transactions.

Vulnerable to hacks.

Cold Storage / Hardware Wallet (Single-Sig)

Hardware-based, offline storage.

High security, ideal for long-term storage.

Less convenient for frequent transactions.

Cold Storage (Single-Sig with Passphrase)

Hardware-based with an added passphrase.

Enhanced security.

Requires remembering the passphrase.

Cold Storage (Multi-Signature)

Involves multiple private keys for authorisation.

Robust security, shared control.

Complexity and coordination among signatories.

Cold Storage (Collaborative Custody)

Multi-signature with additional layers of security.

High security, shared responsibility.

Requires careful management among custodians.

 

 

The choice of custody method depends on individual preferences and risk tolerance. It is important for users to carefully evaluate the pros and cons of each approach and choose the one that aligns with their needs and priorities. We are one of Australia's first Bitcoin lawyers, and we offer services to assist individuals and businesses in navigating the legal aspects of Bitcoin transactions and custody. If you require legal guidance or assistance in getting started with Bitcoin custody, please feel free to reach out to us for personalised support.

 

The information provided in this blog article is for educational purposes only. It does not constitute financial, investment, or legal advice. The content is intended to offer general insights and perspectives on Bitcoin custody and related topics. Readers are encouraged to conduct their own research and seek professional advice before making any financial or legal decisions regarding Bitcoin or other cryptocurrencies.

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