Behind the Vault: How Custodial Infrastructure Powers Crypto and Stablecoin Payments

As cryptocurrency and stablecoin payments continue to gain popularity in the world of digital transactions, many businesses are beginning to explore the potential benefits of accepting cryptocurrency payments. However, while the advantages of integrating cryptocurrencies into business models are well-understood by most small business owners and treasury departments in larger enterprises, there remains a key area of uncertainty: how to manage and secure the cryptocurrency once it is received. This aspect of cryptocurrency payments is referred to as custodial infrastructure, which addresses the safekeeping and management of crypto assets. Since stablecoins are crypto tokens that operate on blockchain networks, their custody follows the same fundamental principles as other cryptocurrencies.

What is Custody in the Cryptocurrency Industry?

In traditional finance, custody refers to the services provided by institutions, such as banks, that manage and safeguard assets like cash or securities. In the cryptocurrency world, custody similarly refers to the various methods used to protect and secure digital assets. Since cryptocurrencies exist on decentralized and distributed blockchain networks, custody in this context focuses on securing the private keys that grant access to these assets. Let’s explore the different types of crypto custody and how each impacts the transaction cycle.

Self-Managed Custody: Full Control but High Responsibility

The first type of crypto custody is self-managed custody, where the business takes direct control over the storage, security, and management of its cryptocurrency assets. In this arrangement, the merchant owns the cryptocurrency and has the ability to exchange or trade it at will. Managing self-custody involves the creation and secure storage of private keys and wallets, requiring the business to handle the entire security process independently.

A major advantage of self-managed custody is the autonomy it provides. The business retains full control over its assets, offering flexibility and the opportunity to implement its own security protocols. Additionally, self-managed custody eliminates the need for third-party custodians, potentially saving on custodial fees. This model also aligns with the core principles of decentralization that underlie the philosophy of cryptocurrencies, which is especially appealing for businesses that prioritize transparency and independence.

However, the responsibility of managing the assets also comes with challenges. The technical complexity of safeguarding private keys and wallets requires specialized knowledge and expertise. If not properly secured, assets are at risk of theft or loss. There is also no recourse for recovering lost keys, which can result in irreversible access loss to the crypto assets. Businesses must also be mindful of varying cryptocurrency regulations across jurisdictions, which may add an extra layer of complexity to self-managed custody.

Third-Party Custody: Professional Security with Trade-Offs

The second type of custody is third-party custody, where businesses entrust their cryptocurrency assets to an independent, qualified custodian. These custodians specialize in the secure management of digital assets, providing enhanced security and professional management for their clients. Third-party custodians can include centralized cryptocurrency platforms or specialized custodial banks, which may be regulated in certain jurisdictions.

One of the most significant advantages of third-party custody is advanced security. Custodians are dedicated to safeguarding their clients' assets and employ cutting-edge security measures such as multi-signature wallets, cold storage, and encryption. Many custodians also offer insurance to protect clients from theft or hacking incidents, further enhancing the protection of digital assets.

Third-party custody also provides convenience. By outsourcing the responsibility of managing crypto assets, businesses can focus on their core operations without the burden of managing security measures. Additionally, many custodians offer a range of additional services, including trading, staking, and lending, which could further benefit businesses looking for more comprehensive financial solutions.

However, third-party custody comes with its own set of challenges. The most obvious disadvantage is the cost of the service. Third-party custodians charge fees for their services, which can add up, particularly for businesses with smaller cryptocurrency holdings. Furthermore, businesses relying on a third party also face counterparty risk: if the custodian is compromised or fails, there is a risk of losing the assets. This loss of control is another downside, as businesses may experience delays or restrictions on withdrawing their assets, especially during market volatility. Lastly, the reliance on a few major custodians creates centralization risks, where a breach in the security of one custodian can affect many clients in the cryptocurrency ecosystem.

Hybrid Custody: A Balanced Approach

For businesses that find themselves torn between the benefits and drawbacks of self-managed and third-party custody, hybrid custody offers a balanced approach. Hybrid custody divides control over the assets between the business and a service provider, often through technologies like multisignature wallets and secure multiparty computation (SMPC).

Multisignature technology allows multiple parties to control a cryptocurrency wallet. For example, a wallet may require at least two out of three private keys to approve a transaction. This approach reduces the risk of a single point of failure, as no single entity has full control over the assets. Hybrid multisig custody solutions are often used by centralized platforms or businesses with multiple stakeholders.

Alternatively, secure multiparty computation operates entirely off-chain and enables multiple parties to securely contribute to the signing of a transaction without revealing their private inputs. This method enhances privacy and security by preventing any party from gaining knowledge of the others’ contributions. Hybrid custody solutions combine the benefits of both self-managed and third-party custodians, ensuring robust security while retaining a degree of control over the assets.

What’s Next: Major Payment Providers Drive Innovation in Stablecoin Custody

The custodial landscape is also being reshaped by increased involvement from major financial and payment companies, signaling growing confidence in the stablecoin and crypto ecosystem. Industry leaders like Stripe, Visa, and Mastercard have recently made strategic acquisitions and formed partnerships with companies focused on stablecoin infrastructure. Stripe acquired Bridge, a startup specializing in stablecoin orchestration, while Visa partnered with the same company and BVNK to explore stablecoin-based settlement and card issuance. Mastercard has also entered the space by collaborating with MoonPay, following MoonPay’s acquisition of stablecoin-focused infrastructure firm Iron. These moves are expected to introduce new custody models and integrated solutions, offering businesses more seamless and secure ways to manage digital assets within familiar financial platforms.

Conclusion: Choosing the Right Custody Solution

The decision to choose self-managed, third-party, or hybrid custody largely depends on a business's resources, expertise, and risk tolerance. While self-managed custody offers control and potential savings, it also demands a high level of technical expertise and carries the risk of loss or theft. Third-party custody provides professional security and convenience but comes with fees and counterparty risks. Hybrid custody offers a middle ground, combining some of the advantages of both approaches while mitigating certain risks.

If you are a business still unsure about the most suitable custody solution or how to implement and manage it, a quick and effective way to gain the necessary knowledge is by enrolling in the eLearning course Cryptocurrency Payments for Businesses from reMonetary. This course offers an end-to-end perspective, covering topics such as the benefits of cryptocurrencies and stablecoins, the conversion process and settlement options, the role of exchanges, a comprehensive overview of the transaction cycle, and the business model and cost structure of a crypto PSP. By the end, you’ll have a solid understanding of the crypto PSP landscape, enabling you to make informed, strategic decisions for your organization.

For businesses with more complex use cases or those seeking personalized guidance from a leading consulting firm in the digital transformation space, please feel free to contact me.

In the next article, we will explore another important aspect of cryptocurrency acceptance: the various settlement options available to businesses integrating cryptocurrency payments into their operations.