The importance of Bitcoin custody, Bitcoin holdings in centralized exchanges

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The importance of Bitcoin custody

The importance of Bitcoin custody

Bitcoin is a decentralized cryptocurrency, the first of its kind, and is widely considered digital gold for its ability to store value. With industry expert predictions cheering Bitcoin prices to reach astronomical amounts, users and investors must prepare and execute a good custody plan.

Bitcoin (BTC) remains a hot topic of discussion with growing institutional interest and multiple spot BTC ETFs approved, allowing traditional investment firms to offer Bitcoin to their clients.

Users own Bitcoin or obtain exposure to this asset class in multiple ways, from investing in ETFs to holding them via centralized exchanges or exploring self-custody options either directly or via institutions or third parties.

Individuals need to choose the right custody solution that best suits their custodial risk appetite along with their investment and regulatory profile. They broadly have the following options when it comes to holding their Bitcoin:

Bitcoin holdings in centralized exchanges

Centralized exchanges are considered a gateway into cryptocurrencies for retail investors, and it’s no surprise that some users might consider them a convenient option to hold their Bitcoin.

Reputable centralized exchanges like Coinbase and Kraken operate to high standards owing to their jurisdictions and regulatory and legal compliance. Retail users drawn to cryptocurrencies tend to start their journeys by opening their first accounts on centralized exchanges.

These institutions can onboard users after necessary Know Your Customer (KYC) checks and offer easy on-ramp solutions to facilitate cryptocurrency purchases via fiat currencies. The users who appreciate the centralized exchange experience can potentially leave their Bitcoin holdings on their exchange accounts, making the chosen crypto exchange their default custody provider.

The option does have some downsides, and users should become familiar with the risks of this approach, which can include the complete loss of assets due to hacking or exchange insolvency.

Bitcoin self-custody options

Bitcoin self-custody represents scenarios where users take full accountability and ownership of the BTC they own, which comes with its own pros and cons. The critical aspect of self-custody is safeguarding the private key that controls user wallets.

For sophisticated users who believe in the popular maxim of “not your keys, not your crypto” within the cryptocurrency ecosystem and are willing to put in some extra effort to set up self-custodial options, here are some potential approaches:

Private hot wallets

Private hot wallets range from mobile to desktop solutions where users can set up a wallet and safeguard the private key to control assets within that wallet. These are usually termed hot wallets as they stay connected to the internet and can interact with multiple decentralized applications (DApps) to perform regular transactions. However, it’s not wise to store a significant amount of BTC in hot wallets.

Private hardware wallets

Hardware wallets are usually considered cold wallets, as they only interact with external applications when required. Security-conscious users can benefit greatly from using a hardware wallet as a cold storage solution for their Bitcoin. Cold storage wallets potentially help users avoid malicious contracts, hacks or social engineering attempts.

Bitcoin self-custody security measures

Users who opt for self-custodial options must ensure best practices are followed to safeguard their assets.

Private key storage

For users with private wallets, their private key is the only way to control assets tied to their address. They must protect it at all costs and avoid exposing it to unknown parties. As a private key record is essential, it should not be stored by users on their devices or computers as plain text, as this exposes them in the event of a security breach.

Paper wallets offer a simple start for secure key storage, but consider durable metal solutions for ultimate protection. These specialize in engraving users’ private keys or seed phrases onto fire-and-flood-resistant metal, ensuring your crypto assets are protected for the long haul.

Multisig wallets

Multisignature wallets offer an additional layer of protection where multiple individuals would need to sign a transaction to move any Bitcoin within the underlying wallets. These are standard measures in cryptocurrency project treasuries or decentralized autonomous organizations DAOs to protect against a single wallet or individual compromise. Still, they can be adopted by security-conscious retail users who can draft in families and friends to provide an additional layer of safety.

Custodial institutions and third parties

For organizations and high-net-worth individuals (HNWIs), relying on reputable third parties to safeguard their assets is a sensible approach that would meet many of their regulatory and compliance commitments.

Custodial services for digital assets mirror existing stocks, precious metals and art models.

Reputable institutions like Coinbase and BitGo offer digital assets custody solutions. These entities are certified as custodial institutions under the laws and regulations of their incorporated jurisdictions. They adhere to very high standards in terms of security measures, insurance, audits and compliance that would satisfy the requirements of institutional investors and HNWIs.

These custodial solutions have a gamut of physical security, cold storage, operational security workflows and access controls to safeguard the Bitcoin entrusted to them. They can also regularly provide users with clear reporting and holdings status to maintain high transparency levels.

Ownership, jurisdiction and tax efficient structures

Ownership jurisdiction and holding structures can significantly impact one’s cryptocurrency custody choices. Considering these factors alongside the technical aspects of custody is essential to ensure your assets are secure and legally compliant.

Global institutions holding Bitcoin are sometimes complex legal entities when it comes to their jurisdictions and holding companies. Similarly, family offices or HNWIs can opt to hold BTC via holding companies or trusts in different jurisdictions, which would impact the potential custodial solutions available to them.

These structures are predominantly driven by privacy and tax efficiency benefits; however, users must ensure that their chosen custody options are legal and compliant by seeking appropriate advice from financial and legal experts.

Source: Cointelegraph.com