The US SEC walks you through how to custody cryptocurrency assets

Note: On December 12, the U.S. SEC issued an official statement to retail investors on the basics of cryptocurrency custody, helping retail investors decide how to hold crypto assets in the best way. Gold Finance translation:

The U.S. SEC Investor Education and Assistance Office released this investor notice to help retail investors understand how to hold crypto assets. This notice outlines the types of crypto asset custody and provides some tips and questions to help you decide how to hold crypto assets in the best way.

1. What is crypto asset custody?

Crypto asset “custody” refers to the way and place you store and access your crypto assets. You typically access crypto assets through a device or computer program called a crypto wallet. Crypto wallets themselves do not store crypto assets; instead, they store your crypto asset “private keys” or passwords.

Crypto assets. Crypto assets refer to assets generated, issued, and/or transferred using blockchain or similar distributed ledger technology networks, including assets called “tokens,” “digital assets,” “virtual currencies,” and “cryptocurrencies.” Investors should understand that the characteristics and design of crypto assets, as well as the distributed ledger or blockchain technology used for issuance and/or transfer, may vary significantly. In other words, different crypto assets may bring different returns or risks.

When creating a crypto wallet, the following two keys or passwords are generated:

1. Private key. The private key is a randomly generated alphanumeric password used to authorize transactions of crypto assets. It’s like your crypto wallet password. Once created, the private key cannot be changed or replaced. If you lose your private key, you will permanently lose access to the crypto assets in your wallet.
2. Public key. The public key is another code used to verify transactions and allow others to send crypto assets to your wallet. The public key cannot access the private key in your wallet, nor can it authorize transactions. It’s like your crypto wallet email address.

These keys collectively prove your ownership of crypto assets and grant you the rights to send, receive, or use crypto assets.

2. Hot wallets and cold wallets

There are many types of cryptocurrency wallets, and retail investors hold these wallets in various ways. Crypto wallets are mainly divided into two categories: “hot wallets” and “cold wallets.” A hot wallet is a cryptocurrency wallet connected to the internet, which can be a desktop application, mobile app, or web application. Hot wallets allow you to conveniently access and trade crypto assets but also expose your crypto assets to network threats.

Cold wallets usually refer to physical devices not connected to the internet, such as USB drives, external hard drives, or even paper. For crypto asset transactions, cold wallets are generally less convenient than hot wallets. However, because cold wallets are not connected to the internet, they are usually more resistant to online threats. Nonetheless, physical devices of cold wallets can still be lost, damaged, or stolen, leading to permanent loss of your crypto assets.

Protect your seed phrase! Many crypto wallets generate a “seed phrase,” also called a recovery phrase, backup seed phrase, or memorization phrase. A seed phrase is a series of random words that can help you recover your wallet if you lose your wallet or private key, or if the hardware or software of your wallet is damaged. Keep your seed phrase in a secure place and do not share it with anyone.

3. Self-custody and third-party custody

You also need to decide whether to self-custody your crypto assets (self-managed) or entrust a third party to manage them (third-party custody). Both self-custody and third-party custody offer hot wallets and cold wallets options.

Self-custody:

Using self-custody, you have full control over your crypto assets and are responsible for managing all your crypto wallets’ private keys. This means you have complete control over access to your crypto private keys, but also bear full responsibility for their security. If your crypto wallet is lost, stolen, damaged, or hacked, you may permanently lose access to your crypto assets.

Key questions when choosing a self-custody crypto asset plan

• Can you easily set up and maintain your crypto wallet? Setting up and maintaining a crypto wallet may require some technical knowledge. Make sure you are capable of handling all technical aspects involved.
• Do you want full responsibility for your crypto assets? With self-custody, you can fully control your crypto assets. You need to securely store your private keys and seed phrase. If these keys or seed phrase are lost or stolen, you may lose access to your crypto assets.
• What type of crypto wallet do you want to use? As mentioned above, you can use hot wallets or cold wallets to store your crypto assets. Carefully consider your convenience and security needs when choosing the most suitable wallet type.
• How much does a crypto wallet cost? Physical cold wallets usually need to be purchased, while hot wallets are often free initially. However, transactions using wallets typically incur fees. Be sure to understand these costs before choosing a wallet or making transactions.

Third-party custody:

Through third-party custody, you can choose professional custody institutions or service providers to hold your crypto assets. Third-party custody providers include cryptocurrency exchanges and specialized crypto asset custody service providers. They manage and control access to your crypto asset private keys. The accounts holding your private keys may be cold wallets, hot wallets, or a combination of both. If the third-party custody provider is hacked, goes bankrupt, or ceases operations, you may lose access to your crypto assets.

Key questions when choosing a third-party custody provider

• Have you researched the background of the custody provider? Take time to thoroughly investigate any third-party custody provider. Search online for complaints or issues. Understand how the provider is regulated. Although the regulatory framework for the crypto industry is still developing, some regulation exists.
• What types of crypto assets does the provider allow me to hold? Each provider may support different types of crypto assets. Confirm that the provider allows you to hold the types of crypto assets you wish to.
• What happens if the provider goes bankrupt? Find out whether the provider offers insurance for lost or stolen crypto assets, and understand their terms and conditions.
• How does the provider store and protect your crypto assets? Ask how they safeguard your crypto assets and private keys, and who has access. Do they store your assets in their own facilities or outsource storage? Do they use hot wallets, cold wallets, or other methods? What types of wallets do they primarily use, and how do they determine where your assets are stored? Also, inquire about the physical and network security protocols they employ to protect your assets.
• How does the provider use your crypto assets? Some providers may use your crypto assets as collateral for their own purposes (e.g., lending). This is sometimes called “re-hypothecation.” To reduce costs, some providers may pool client assets rather than holding them separately. Understand whether your provider employs any of these practices and whether your consent is required.
• What privacy protections does the provider offer? Look for providers that can protect your sensitive personal information (such as your name, address, social security number, and the types of crypto assets you own or trade). Ask if they sell client data to third parties and whether your consent is needed.
• What account fees does the provider charge? Ask about annual asset management fees (charged based on your crypto asset value), transaction fees (costs for using or trading crypto assets), transfer fees (costs to transfer your assets outside the provider), and account opening/closing fees.

4. General tips for protecting crypto assets

1. Carefully research and choose any third-party custody provider.
2. Never disclose your private keys or seed phrase.
3. Protect your crypto asset privacy. Do not share the amount or types of crypto assets you own with anyone.
4. Beware of crypto phishing scams.
5. Use strong passwords and multi-factor authentication for all online crypto accounts.