Digital assets have risen to the top again this year, with the market cap of VDAs rising to over $2.5 trillion and only expected to go up further. While the market remained constricted due to a bear cycle spanning over a year, the digital asset industry still made significant moves.
Institutional investors became increasingly favourable about adopting this asset class, with a 2023 survey finding that four out of ten institutions have exposure to digital assets.
The institutional interest represents nothing less than digital assets going mainstream. The full-scale adoption of the asset class has begun and will only snowball in the coming years. Nevertheless, fears surrounding these assets have always been high. In 2023, about $1.7 billion was stolen from centralized platforms, DeFi applications, and individuals. While trends suggest that the amount of funds stolen has dropped, it is still crucial for the industry to weave robustness into the fabric of its existence.
The high levels of exploits in the digital asset space combined with bad actors manipulating the industry to their whims, like Sam-Bankman Fried and the FTX debacle he caused, keep mainstream players from accepting digital assets with open arms. If the digital asset industry’s adoption has grown despite that, it only shows the innovative offerings it brings to the table. Now imagine the unstoppable acceptance they will witness if the industry is as secure as the TradFi system.
Digital Assets Help Secure the Digital Asset Landscape
Digital asset custodians are emerging as solutions to safeguard everyone gaining exposure to these assets, including institutions, enterprises, and end-users. Like TradFi (Traditional Financial) custodians, digital asset custodians are third-party companies safeguarding client assets. In TradFi, regulated custodians hold, manage, and store assets, like cash, bonds, and securities, for financial institutions and service providers.
Custodians in the digital asset realm provide the same kind of services but differently than their TradFi counterparts due to the inherent uniqueness of this asset class. Digital assets, including digital currency, RWAs (Real World Assets), and security tokens, utilize cryptographic encryption that ties them to their users’ wallets. Digital asset custodians secure the private keys of these wallets, which act as decryption mechanisms to transact digital currency out of the wallets. So, bad actors gaining access to users’ private keys result in hacks and thefts, which custodians offer protection from by robustly managing the private keys.
Digital asset custodians integrate sophisticated storage technologies and practices to safeguard client private keys during storage and transacting. By extension, the assets entrusted by clients to the custodians remain protected. Regulations governing Virtual Digital Assets (VDAs) are emerging worldwide, mandatorily pushing entities operating with large sums of digital assets to turn to licensed third-party custodians for safeguarding. It is like how TradFi entities are required to rely on custodians if they manage a certain amount of assets by valuation for obvious safety reasons.
Digital asset custodians are being considered the cornerstone of the digital asset industry, with regulators recognizing them as the driving force behind the safety needed to protect their jurisdictional financial systems. Otherwise, scams, thefts, crime, and venture mismanagement can wreak tremendous havoc within national digital asset ecosystems and even their financial systems.
The Benefits Provided by Digital Asset Custodians
Custodians will provide the necessary checks and balances for their clients to manage their digital assets securely. For starters, custodians prevent a major red flag in the digital asset industry: the commingling of end-user and enterprise funds, as practised by several exchanges, including FTX. Custodians segregate end-user and exchange/enterprise funds adequately, preventing the latter from unfairly and illegally leveraging end-user funds for selfish profits.
Moreover, custodians like Liminal and other regulated setups utilize MultiSig (Multi Signature) and MPC Wallet (Multi-Party Computation) enabled wallets to ensure enhanced security over private key storage. Essentially, multiple keys for the former and key shards for the latter are needed to initiate transactions, preventing internal or external bad actors from stealing the wallets.
The information required to transact funds from these wallets is scattered across numerous individuals/entities, making it nearly impossible to launch successful hacks. Also, custodians practise asset segregation measures, utilizing cold and hot wallets in synergy to balance secureness with efficiency.
They store asset bulks in impenetrable HSM (Hardware Security Modules) based wallets that remain away from networks, thereby preventing hackers from connecting to them. The needed liquidity for regular business operations is left in the hot wallet, probably around 10% of the total assets in custody at any time, to reduce the gravity of hacks in case they occur.
Even then, those turning to custodians can stay worry-free because regulated digital asset custodians come insured. Insurance providers cover fund loss incidents related to the custodians. Custody users can reclaim their assets even after unfortunate hacks.
As if all that was not enough, custodians make it convenient for businesses and investors to transact and settle their assets. Handling the complexities of digital wallets, especially full-fledged wallet infrastructures like the ones managed by custodians, is hard to operate in-house. By outsourcing complex asset management, entities can streamline their core business operations while alleviating asset management headaches.
Furthermore, custodians ensure the integrity of jurisdictional and global financial systems by setting up frameworks and technologies to prevent the flow of funds derived from or supporting illicit activity. Custodians implement KYC (Know Your Customer), AML (Anti-Money Laundering), and CFT (Countering the Financing of Terrorism) protocols to ensure compliance with the Travel Rule and related regulations.
They help ward off illicit funds that way. These protocols also ensure institutions remain protected from assets etched with criminal activity, preventing authorities from freezing their funds and halting business operations.
Custodians Will Be Essential to Shaping a Safe Digital Asset Ecosystem
Leveraging third-party digital asset custodians is highly beneficial for institutions dealing with digital assets and Web3 native businesses. These benefits are necessary for the safe functioning of the digital asset ecosystem. Regulators now require entities to partner with registered custodians like Liminal Custody in their jurisdictions. The custodian is licensed in multiple countries, making its recent regulatory go-ahead in the UAE the latest development in offering custody services to emerging digital asset markets securely and conveniently.