Self-Custody vs. Third-Party Custody: Weighing the Risks and Benefits

Self-custody is a fundamental aspect of digital asset ownership. It allows investors to fully control their holdings without relying on third parties. However, with complete control comes the need for careful security practices. Even experienced investors have lost access to their assets due to theft, misplaced keys, or unexpected technical failures. Weighing the advantages and risks of self-custody is crucial for making informed decisions about digital asset security.

In this post, we’ll examine the responsibilities that come with self-custody, common security challenges, and alternative approaches to asset storage. While many prefer to manage their own keys, others choose different solutions to manage risk and ensure long-term accessibility. Understanding the range of custody options available can help owners make informed decisions about how they can construct a model to maximize the security of their digital assets.

Note: The information provided in this blog is intended for educational and informational purposes only and should not be construed as financial, legal, tax, or other professional advice or opinion from Tetra or its employees. It is not a substitute for advice from a qualified professional. You are solely responsible for your decisions and actions based on this information.

The Appeal of Self-Custody

Self-custody is a foundational principle in the digital asset space, built on the idea that financial sovereignty should be in the hands of individuals rather than intermediaries. The phrase “not your keys, not your coins” has become a defining mantra, underscoring the importance of holding private keys directly.

For many, self-custody is not just about asset security; it represents a shift toward greater financial autonomy and flexibility. Here are some of the reasons why investors choose self-custody.

Ownership & Financial Independence

Self-custody ensures that you are the sole owner of your digital assets, free from reliance on third-party platforms or financial institutions. There are no intermediaries to impose withdrawal limits, freeze accounts, or be vulnerable to failures.

Beyond ownership, self-custody also represents economic freedom; the ability to store and transact wealth independently of traditional financial institutions. Investors are not subject to institutional policies, restrictions, or fees, giving them the flexibility to manage their assets on their terms. That said, with financial independence comes added responsibility. Individuals managing their own assets are also responsible for understanding and complying with legal, regulatory, and tax obligations, which differ across different jurisdictions and can rapidly become cumbersome.

Censorship Resistance & Unrestricted Access

Blockchain technology enables censorship resistance by enabling transactions to be processed and recorded on a decentralized network without requiring approval from a central authority. This reduces the risk of transactions being blocked or restricted by financial institutions or other intermediaries. 

This principle is most fully realized when transacting peer-to-peer or through decentralized exchanges (DEXs), where users maintain full custody of their assets and there is no intermediary to delay or deny a transaction. By contrast, when transactions are made through centralized exchanges or OTC desks, some aspects of censorship resistance may be reduced, as those intermediaries can still restrict access or impose limitations, even if the underlying assets are self-custodied, given the laws and regulations to which they must comply 

With self-custody, owners also retain uninterrupted access to their assets, with no imposed withdrawal limits or dependency on third-party processing. This level of control is especially valuable during periods of uncertainty or financial instability, whether perceived or actual. 

Portability and Global Accessibility

Unlike traditional financial systems, self-custodied digital assets can be accessed from anywhere in the world. As long as the private keys are secure, holdings can be restored on any compatible platform, allowing seamless cross-border movement of assets. This level of portability is especially relevant in countries where formal banking infrastructure is limited or underdeveloped or in the context of heightened geopolitical risks. In such environments, peer-to-peer transactions, often conducted with just a mobile phone and an internet connection, can serve as a functional alternative to traditional financial services. 

This accessibility also points to the broader potential of digital assets as global payment networks. By removing friction from cross-border transactions and reducing dependency on legacy intermediaries, self-custody enables more open, efficient, and inclusive forms of commerce. Whether facilitating trade across jurisdictions or supporting communities in underserved regions, self-custodied digital assets can empower individuals and businesses to participate in the global economy in ways that traditional systems cannot. The Bank for International Settlement (BIS), the Financial Stability Board (FSB) and academia, amongst others, have widely documented this use case along with potential limitations/gaps to consider for many years already.

Security (When Done Correctly) 

When properly managed, self-custody provides strong security against exchange failures, platform breaches, and third-party risks. Solutions such as hardware wallets and multi-signature setups add extra layers of protection. However, securing private keys requires strict discipline, as loss or theft can result in permanent loss of access.

The Risks of Self-Custody

While self-custody offers control, it also places the full burden of security on the individual. Managing private keys is not as simple as storing a password; once lost or compromised, recovery is nearly impossible. Even the most experienced investors have made costly mistakes.

Common Risks of Self-Custody:

Human Error: Misplacing a private key, forgetting a seed phrase, or failing to properly back up credentials can lead to irreversible loss. A single mistake can result in assets becoming inaccessible forever.

Hacking and Theft: Cybercriminals continuously target individuals with phishing attacks, malware, and sophisticated social engineering tactics. Storing private keys digitally or in easily accessible locations increases the risk of compromise.

Estate Planning Challenges: Unlike traditional financial accounts, digital assets under self-custody do not have built-in inheritance mechanisms. Without a clear plan, assets may become permanently lost if the owner is unable to access them.

A highly secure setup—such as air-gapped cold storage with complex recovery procedures—can significantly reduce risk but may also make accessing funds more cumbersome. Many investors struggle to find the right balance between usability and security, as overly complex setups can lead to mistakes, while overly convenient ones may introduce vulnerabilities.

Self-custody is only as strong as the security measures in place. Without diligent key management and contingency planning, even the best-intentioned self-custody approach can fail. 

Exploring Other Custody Options

Beyond self-custody, there are two other common approaches to digital asset storage: exchange-hosted wallets and third-party custody solutions.

Exchange-hosted wallets allow users to access their assets through an online platform while the exchange retains control of the private keys. This setup offers convenience, especially for frequent traders, as it streamlines access to markets. It can, however, introduce additional risks or different manifestations of the same risks. Centralized exchanges (CEXs) have been targets for hacks and security breaches, and users can be exposed to counterparty risk; the possibility that the exchange could fail or mishandle assets. In response to these concerns, some exchanges have begun to adopt third-party custody solutions to help restore user trust and enhance overall security – whether mandated through a jurisdictions’s regulation, such as in Canada, or voluntarily.

This shift reflects a broader industry trend: custody technology must constantly evolve to stay ahead as digital asset threats grow more sophisticated, including those involving state-sponsored actors. High-profile incidents of loss and theft have underscored the importance of robust, transparent custody practices. Investors now demand greater accountability, spurring a push for increased regulation and oversight. In this context, qualified custodians play a critical role.

What is a Qualified Custodian?

While some exchanges and crypto service providers claim to “custody” assets or offer “institutional-grade” custody, there’s a meaningful difference between a custodian and a qualified custodian. The distinction lies in regulatory compliance.

In Canada, the Canadian Securities Administrators (CSA), through National Instrument NI 31-103, sets out clear parameters for entities to meet the qualified custody status. In the U.S., the SEC’s 2023 guidance defines qualified custodians as institutions that are not only regulated but also required to maintain segregated accounts and adhere to strict standards of asset protection.

Why does this distinction matter? Simply put, regulated investors are only permitted to deposit assets with custodians approved by their regulators. In jurisdictions like Canada and the U.S., this regulatory requirement means that without qualified custodians, institutional investors are effectively barred from participating in the market. Not all countries have implemented these standards, making it critical for investors to evaluate the credibility and legal standing of any custody provider before engaging with them.

One such example of a qualified custodian is Tetra Trust Company, the first Canadian Trust with a special license to custody digital assets. Unlike exchanges that primarily focus on trading and execution, Tetra Trust prioritizes secure storage, regulatory compliance, and risk mitigation. It also offers “custody-plus” solutions—enhanced service models that extend beyond storage to support broader institutional needs, all within a framework that meets the highest regulatory standards. For institutional investors, high-net-worth individuals, and businesses, working with a qualified custodian offers a level of security, accountability, and operational assurance that can be difficult to replicate independently.

Deep Dive: What Sets Qualified Custodians Apart?

As digital asset markets continue to evolve, so does the infrastructure designed to protect them. Qualified custodians offer more than just secure storage; they provide regulatory oversight and a purposely-built compliance framework for safeguarding assets, reducing operational risks, and ensuring long-term accessibility.

Regulatory Oversight and Industry Assurance

Qualified custodians operate under strict regulatory standards and help fill the gap in areas where digital asset regulation is still developing. In fast-moving sectors like DeFi, staking, and tokenized securities, custodians play a key role in not only aligning evolving asset classes with existing regulatory frameworks, but setting the standards as they implement supporting services for their clients. By doing so, they help investors navigate an increasingly complex landscape while ensuring oversight, compliance and audit readiness.

To support this, custodians often undergo a range of independent audits and assessments such as financial statement audits, AML effectiveness reviews, penetration testing, proof-of-reserves reports, and more. While not all of these are legally mandated or globally standardized, they are becoming growing norms in a maturing industry, providing additional transparency and accountability. Certifications like SOC 1, SOC 2 Type 2, and ISAE 3000 further demonstrate adherence to robust operational and security controls.

Security Measures

Institutional-grade custodians implement advanced security infrastructure that is difficult to replicate at the individual level. This typically includes hardware security modules (HSMs) governed by multi-party computation (MPC) or multi-signature protocols, encryption, air-gapped cold storage, and redundant backup systems, all designed to safeguard digital assets from external and internal threats.

Mitigating Social Engineering Risks

Unlike individuals, custodians enforce strict identity verification protocols and internal control procedures that reduce the risk of phishing, fraud, and other forms of social engineering. These safeguards are not only implemented operationally but are also subject to third-party audit validation, providing another layer of defence and accountability.

Insurance as an Added Layer of Protection

In the event of an adverse incident, many qualified custodians carry insurance policies that offer a degree of financial protection. However, it’s important to note that insurance coverage in the digital asset space is still evolving, and standards around insurable risks and coverage amounts have not yet been fully established. Investors should review a custodian’s policy terms carefully and assess whether additional coverage is necessary for their specific needs.

Expanded Services and Tools

As the market matures, custody providers are expanding their offerings beyond asset storage. Many now support staking, lending, trading integration, and API connectivity, offering added functionality for institutions managing more complex digital asset strategies. These “custody-plus” solutions reflect the broader shift toward infrastructure that supports both security and operational utility.

Succession and Accessibility Planning

Qualified custodians also help address long-term considerations that self-custody cannot easily solve, such as succession planning and recovery mechanisms. In the event of unforeseen circumstances, custodians provide structured processes to ensure that assets can be securely accessed by designated heirs or trustees, preserving continuity and control.

Conclusion: Custody is not one-size-fits-all

There is no one-size-fits-all solution for digital asset custody. Instead, investors operate along a spectrum of custody options, each offering a different balance of control, security, oversight, and functionality.

At one end lies self-custody, where individuals retain full ownership and control over their assets. Layers of security, such as cold storage, multi-signature wallets, and hardware devices, can be added to strengthen protection. While this model offers autonomy and financial sovereignty, it also requires discipline, technical know-how, and a strong understanding of contingency planning.

Further along the spectrum are third-party custody services, offering enhanced security measures and varying degrees of operational support. These options appeal to investors who prefer to offload some of the responsibility for key management and infrastructure security while still maintaining some degree of asset control.

At the far end of the spectrum sit qualified custodians—regulated entities that combine institutional-grade infrastructure with comprehensive governance, compliance, and audit frameworks. These custodians provide robust protections, independent assurance through third-party audits, and integration with broader financial and estate planning needs, all while maintaining key control. For many institutional investors and high-net-worth individuals, these layers of oversight and risk mitigation are not just a preference—they are a requirement.

Rather than choosing a single method, many investors find value in a blended approach that aligns with their unique risk profiles, investment goals, and operational preferences. This often includes:

• Hot wallets for everyday use and active trading
• Cold wallets for long-term self-custody
• Custodial solutions for secure storage, compliance, and succession planning

Key considerations to address whenever assessing custody strategy, include:

• Segmentation of Holdings: Custody methods diversification based on asset purpose, risk exposure and regulatory requirements
• Risk Exposure and Tolerance: Clear understanding of existing risks, including internal level of technical knowledge and different levels of security measures and responsibilities that come with different custody options. 
• Estate and Business Planning: Ensuring your custody model supports long-term access, transferability, and continuity.

As the digital asset space matures, so too will the standards and expectations surrounding custody. Staying informed, adaptable, and proactive in your custody decisions is key to ensuring that your assets remain secure, accessible, and future-ready.

References

1. PwC. Crypto custody: Risks and controls from an auditor’s perspective. https://www.pwc.com/gx/en/financial-services/pdf/crypto-custody.pdf
2. U.S. Securities and Exchange Commission (SEC). 2023 Proposed Rule Amendments to Safeguarding Advisory Client Assets. https://www.sec.gov/rules/proposed/2023/ia-6240.pdf
3. Canadian Securities Administrators (CSA). Regulatory requirements for qualified custodians in Canada. https://www.securities-administrators.ca/
4. Tetra Trust Company. Canada’s Digital Asset Custody Solution. https://tetratrust.com
5. Tetra Trust Company. SOC 2 Type 2 Compliance Announcement. https://tetratrust.com/securing-your-trust-our-drive-to-achieving-soc-2-type-2-compliance/
6. BlockZero. Digital Assets Custody – An Evolving Landscape. https://www.blockzero.ca/post/digital-assets-custody-an-evolving-landscape
7. American Institute of Certified Public Accountants (AICPA). SOC 1 & SOC 2 Standards. https://www.aicpa.org
8. International Federation of Accountants (IFAC). ISAE 3000 Standard for Assurance Engagements. https://www.ifac.org
9. Future of Finance. Digital Asset Custody: The Future looks like the Past. https://futureoffinance.biz/wp-content/uploads/2023/07/Digital-Asset-Custody-The-Future-Looks-Like-The-Past.pdf
10. AIMA. Digital Asset Custody: An AIMA Industry Guide. https://www.aima.org/sound-practices/industry-guides/digital-asset-custody-guide.html