Custody is a commonly used term in financial services and refers to the holding and safekeeping of assets, such as dollars or gold. Crypto custody is about holding cryptographic keys (which you can think of as passwords that unlock crypto wallets), and is typically handled through “cold” or “hot” wallets.
Cold wallets are used to custody cryptographic keys offline in a physically secure location that can’t be accessed through the internet. Hardware wallets (such as USB devices where users store their private keys) are the most popular cold storage method. Stealing from a cold wallet would require physical possession of the device, as well as any PINs or passwords required to access the funds. The downside of cold wallets is that processing transactions takes more time. Cold wallets need to be powered on and accessing funds and processing transactions are manually initiated.
Hot wallets are used to custody cryptographic keys online, enabling transactions to be executed automatically through secure algorithms with no delay. Since hot wallets are always connected to the internet, they’re easy to use, and people often rely on them to trade or make purchases with cryptocurrencies. The downside of being online is that hot wallets are more vulnerable to hacks and theft than cold wallets.
Many companies, like Paxos, use a combination of hot and cold wallets to help keep customer assets safe while ensuring that transactions can happen instantaneously. The majority of customers’ funds are held in cold wallets, while day-to-day trading activity happens via hot wallets. This boils down to basic, intuitive principles for money management. You wouldn’t walk around with a sizable portion of your net worth in large bills in your wallet; you keep it safe in a bank and only take out the cash you need for groceries and everyday transactions.
Nick Robnett is the Director of Customer Success at Paxos. Connect with him today!