Custodianship is frequently talked about in the blockchain and cryptocurrency space; whether it’s a cryptocurrency exchanges’ hot wallet getting hacked, or talk regarding why you should own your private keys, you have most likely heard the word “custodian” or “custodianship” thrown around in the blockchain and cryptocurrency industry.
A custodian is a party that safeguards your money; you can be your own custodian, or someone else can be the custody of your assets. In the blockchain and cryptocurrency industry, there are different methods of custody, each solution with unique advantages and disadvantages, that make each method an ideal solution depending on your situation as an investor.
There are paper wallets, hardware wallets, cold-storage wallets, hot wallets, and most likely many more, each providing a custody feature or advantage unique to its type. Each of these wallets generally falls into one of two buckets that define custody: cold and hot storage solutions
What are cold and hot wallets?
Cold and hot wallets are the most common way individuals store their cryptocurrency. A hot wallet is a wallet connected to the internet at all times, typically operated by a third-party–like a cryptocurrency exchange or broker–who owns your private keys for you (think Bittrex and Coinbase). The third party gives you 100% access, but not direct control (because you don’t own your private keys), of your cryptocurrency holdings.
On the other hand, a cold-storage wallet is a wallet that is kept offline at all times (think Ledgers or BitGo). A cold wallet only goes online to update itself regarding the current state of the blockchain; there are several different types of cold storage wallets, from secure server warehouses–where your private keys are held in a vault of sorts at a secure location –to hardware wallets, like a USB where you can store your cryptocurrency, there are numerous types of cold-storage custody solutions.
Which custody solution is best?
Given that there are several different ways to store your cryptocurrency, and many different custodians and methods of custodianship that you can opt to use, you might be wondering: is it better to use a hot or cold wallet?
More often than not, the answer to that question is that it is better to use a cold-storage wallet. However, both hot and cold wallets have advantages and disadvantages which make them ideal custody methods depending on what you set out to accomplish in the blockchain and cryptocurrency space–let’s take a closer look.
To begin with, a hot-wallet is typically operated by a third-party, for example, nearly every cryptocurrency exchange gives their users a hot wallet, a wallet that represents the amount of funds that they have access to as a user. That being said, the user does not have direct control of their funds if they use a hot wallet, instead, all interaction with their wallet and funds happens through the third party provider.
Unfortunately, hot wallets run off of an exchanges server, and in the rare–but possible– instance that the server is breached, hacked, or taken offline, then the funds in the hot wallet can be stolen, altered, or become inaccessible.
In addition, parties that run hot wallets like cryptocurrency exchanges (Binance, Bittrex, Gemini) and cryptocurrency brokers (Coinbase) typically require the user to sign up for an account, undergoing KYC and AML in the process. However, when these processes take place, an individual usually has to provide the custodian with personal identification information, something many advocates of cryptography and blockchain technologies would say is against the ethos of the tech.
That being said, because a hot wallet is on an exchanges server, it is a convenient place for your funds to be if you trade actively. Most exchanges require a Bitcoin transaction to have six confirmations before it is considered final and tradable, and during the time it takes to wait for six confirmations, the price of the cryptocurrency you are interested in trading could change drastically. That is why having your funds on an exchange or marketplaces’ hot wallet can be a more efficient and liquid option for those who trade cryptocurrency frequently.
As mentioned before, cold wallets–in their various forms–provide users with better security than hot wallets, however, cold wallets are a bit more involved than hot wallets.
A cold wallet user is responsible for remembering their private key and seed–the 12-word passphrase that proves and gives the users ownership and control over their funds. Using a cold wallet also requires individuals to either download a desktop wallet, go out and purchase a specialized hardware wallet or a USB where they can store their funds, or maybe print a piece of paper with a QR code that allows them to store and send cryptocurrency. For institutions and large holders of digital assets, there are a few other cold storage solutions like secret severs in undisclosed locations; this method of cold storage is similar to a vault at a bank. Access to these accounts are highly restricted, typically offline, and often times insured.
As you can see, there are a few more steps involved when opting for cold storage custody, however, the increase in security and power that a cold-storage wallet owner has makes these additional steps worth it.
Because a cold storage user owns their private keys, the user truly owns their underlying digital asset and has full ownership of their funds, meaning that the balance that represents their wallet address on the blockchain will represent the number of digital assets physically located at that the users wallet address.
Second, when digital assets are physically stored in an offline wallet address, it is a lot harder–nearly impossible–for a third party to hack, breach, or alter your funds–unless human error occurs or your private keys are stolen.
On the downside, cold storage wallets are not very liquid. Like mentioned earlier, if you want to sell some of your crypto, you will most likely do so through a cryptocurrency exchange or a broker (if you don’t go the route of an over the counter or decentralized exchange).
But when you go these routes, you will need to transfer your cold-stored funds to a hot location before you can liquidate your assets. Most of these exchanges and brokers require your transaction to undergo six confirmations before it is considered official and becomes tradable; six transactions on the Bitcoin network takes about an hour–and in that time, the price of the cryptocurrency you were looking to trade can fluctuate and the trading opportunity you were looking to take advantage of could disappear.
But if you are looking to hold your cryptocurrency for the long term, or would like the maximum security and privacy for your wealth, then a cold-storage wallet might be for you.
Which custody solution is right for me?
At the end of the day, picking the right custody solution for your cryptocurrency is a personal decision. If you are an individual who will need quick access and high liquidity regarding their funds so that they can take advantage of trading opportunities at the maximum speeds possible–then you might find that a hot wallet better suits your needs.
If you are a privacy and security freak, or maybe you invested for the long term and do not need your funds to be highly liquid, then you would most likely find it in your favor to store your funds in one of the more secure, cold-wallet options.
But remember, each wallet has its unique advantages and disadvantages that make it ideal for different types of investors and traders in different situations. That is why it is important to Do Your Own Research and learn about the features and limitations of each kind of custody solution to see which is best for you. But hopefully, we gave you enough information to begin or continue your research!
How does Amplify intend to secure customer funds?
At Amplify, we take our fiduciary responsibilities seriously. After all, if you’re going to be trading on our platforms, you’ll need to first feel confident that your funds are safe and secure. That’s why at Amplify, we employ a combination of hot wallets that are needed to cover daily transactions, and cold storage, which covers the majority of our assets under management. Each day, or as needed, we will push funds from our hot wallets to our cold storage solution. Even more, our cold storage will be insured, giving our clients comfort that no matter what, we have their back.
Our goal is to help set the standard for responsible behavior in the digital asset marketplace. We hope more exchanges will follow suit and if not, you’ll always be able to leave them for us 🙂