How to Enhance Security and Reduce Development Costs by Integrating with Custodians

Digital assets are disrupting the financial system through and through. They are no longer instruments people turn to for making a quick buck; digital assets serve real-world utility and are highly efficient. Some would say they are better than their TradFi counterparts, and they would not be wrong.

There is a reason why the asset class is witnessing increasing usage even through the rough conditions the current bear market presents. Retail and institutional interest is at the highest it has ever been. However, the interest is not limited to those wanting to interact regularly with digital assets. Bad actors look to constantly pull fast ones to make the most out of digital assets.

The Crypto Industry's Woes with Safe Asset Storage

Crypto-native businesses like exchanges are the biggest victims of such exploits. For instance, in frightful news reported in early October 2023, Upbit, a South Korean crypto exchange, witnessed 159,061 hacking attempts this year. However, none of those attempts penetrated its defense. Nevertheless, the question is how long until they do?

Some of the biggest exchanges with decent security measures still witness exploits leading to losses in the millions due to software bugs, wallet hacks, key leakage, and other vulnerabilities.

Such exploits also extend to enterprises beyond exchanges dealing with digital assets. Stake.com, the popular digital asset gambling platform, witnessed a $41 million hack in September 2023, as hackers managed to siphon out various tokens from its hot wallets connected to the Ethereum and Binance Smart Chain networks.

The availability of enormous amounts of value concentrated within enterprise wallets makes exploiting them very luring to attackers, and the lack of adequate protection implemented for the wallets makes exploits attainable. Well, that has been the case so far.

Just Like TradFi, Custodians Can Protect Crypto Enterprises

Mainstream finance has already dealt with issues like asset theft and misappropriation of funds from financial companies. Therefore, regulators worldwide enacted laws mandating these companies to outsource their custody-related processes to third-party custodians to reduce the risks of misuse, theft, and loss of assets belonging to investors. The crypto industry, still in its early stages of evolution, witnesses the same difficulties faced by TradFi decades ago due to enterprises indulging in the self-custody of user assets.

Digital asset custodians, like Liminal, Bitgo, and Copper, are now offering enterprise-level security akin to traditional financial custodians. These custodians securely hold assets, mirroring the level of protection seen in traditional finance for securities. This robust infrastructure is tailored for crypto-native institutions, ensuring bank-grade asset security.

Crypto enterprises storing digital assets on behalf of their users in their custody while being involved in other verticals have always presented conflicts. The infamous FTX saga involving its decision-makers blatantly using user assets for their own gain through risky lending and investing practices was only possible because it stored user assets. Users lost billions of dollars of assets when the exchange declared insolvency.

Similarly, asset theft is a significant threat to both users and enterprises, with users losing their assets forever and enterprises having their reputations tarnished. Digital assets are highly susceptible to attacks irrespective of them being on-chain or off-chain. Exchanges and enterprises are subjected to exploits since they cannot match security mechanisms and practices implemented by institutional-grade custodians simply because their focus is to build for consumers, not for security.

Furthermore, developing and operating institutional-grade custody solutions is expensive, and small and medium-sized enterprises cannot afford to set them up. Also, directing resources to keep their custody verticals robust becomes an afterthought when they operate other verticals that generate higher profits. To that end, jurisdictions setting the trend in creating digital asset frameworks mandate enterprises to rely on custodians to store end-user assets. Enterprises in jurisdictions that are yet to impose digital asset guidelines are already utilizing digital asset custodians to offer enhanced safety to their users.

How Digital Asset Custodians Offer Needed Security

Digital asset custodians offer a layer of segregation while storing value, ending the conflicts faced by enterprises and averting FTX-like incidents. Moreover, the superior asset and data security infrastructure boasted by custodians keeps attackers at bay. Custodians follow needed protocols to segregate digital assets within hot and cold wallets, leaving most of the funds they safeguard within cold wallets whose private keys are stored offline discreetly. Their hot wallets handling immediate liquidity requirements get fortified securely enough to prevent bad actors from accessing their contents.

The best part of turning to reliable custodians is that the funds they store for enterprises are insured. Getting insured is no easy task. Only those custodians meeting high-level security standards and are regulation-oriented are backed by insurance providers – especially in the digital asset space. Ergo, enterprises can remain confident about their users retrieving their funds even when sophisticated hacks wreak havoc on the custodians they trust. The insurance will also help if custodians face bankruptcy, ensuring that users can claim the assets stored by the custodians.

Additionally, users can be sure of maintaining access to their funds even if the enterprises they employ for their trading and investing purposes go bankrupt. The funds remain away from the enterprises, thus allowing their clients to redeem their deposits fully from custodians. In fact, custodians also keep track of the activity their enterprise customers are involved in. Any red flags are immediately reported to the authorities as mandated by regulations, which helps create accountability in the digital asset ecosystem, keeping investor value safe and sound.

Custodians are becoming integral to regulating digital asset activity as enterprises turn to them, resulting in most of the digital assets in the crypto ecosystem flowing through them. Regulators can use custodians to track fund flows to prevent laundering efforts and implement controls to prevent financial instability. The benefits of relying on custodians are endless, and those enterprises employing their services emanate trust and reliability.

Relying on Custodians Nullifies the High Development Costs Associated with Creating Non-Custodial Solutions

As the importance of third-party custodianship becomes apparent, enterprises will gain more than security- and compliance-related benefits. Delegating the task to custodians is financially more viable than developing full-fledged native custody-related processes and systems. Building institutional-grade custody infrastructure is expensive, requiring extended investment, time, and effort. Moreover, operating the infrastructure requires competent personnel working sophisticated processes to ensure assets are stored and settled appropriately, always in line with regulatory requirements.

Third-party digital custodians offer their services at affordable prices to enterprises while taking care of all the essentials, enabling them to access secure custody without breaking their banks. As added benefits, custodians can accommodate the growing needs of enterprises as they grow, making scaling convenient. Custodians also adapt to changing regulations quickly since many enterprises depend on their services, extending compliance to enterprise customers. Altering asset custody processes while scaling and with changing regulations is tough, cost- and implementation-wise, for custody implementations erected by enterprises for their own needs. Partnering with established digital asset custodians is thus a no-brainer.

Integrating Third-Party Custodians Is Becoming Industry Standard for Crypto Enterprises

The importance of crypto enterprises integrating third-party custodians cannot be understated. As digital assets are becoming investment choices for a growing number of institutional and retail investors, the checks present in TradFi are required for the crypto ecosystem. With the bar for enterprise operations increasing, partnering with well-known, regulated custodians to leave no gaps in safeguarding end-user assets is a must. Nevertheless, evolving regulations will require enterprises to shift their asset storage tasks to custodians if they are not doing so already.

Turning to third-party custodians is the best way for enterprises dealing with digital assets to offer the highest safety standards for their users. Doing so will also build and maintain the reputations of enterprises and save them from legal troubles.