In the context of finance, custody refers to the holding of assets on behalf of a client by an institution. Asset holders use a custodial service to mitigate security risks such as theft or loss.
Understanding the term
The custodian or the institution that provides the custodial service tends to differ from banks, as they do not leverage the assets they hold to their own ends. As compensation, the custodian charges a fee for the safekeeping of assets. In the context of cryptocurrencies, custodians are third parties that hold the private keys to a user’s funds. They are also the only authority that can actually send and receive user funds.
There is no ownership at the protocol level, but the owner of the cryptocurrency owns it in the legal sense. To provide a better user experience, almost all exchanges employ a custodial approach. Custodial cryptocurrency solutions are safer for the novice or inexperienced users that are unfamiliar with public and private keys. However, this also exposes users to counterparty risk in case the custodian gets compromised or shuts down.
Custodians play a vital role in the cryptocurrency ecosystem in onboarding newcomers. They are in charge of the user’s private keys and access to cryptocurrency tokens.