Custody and segregation, explained for allocators

This is an educational piece about how custody and segregation of digital assets work in general market practice, and about the questions an allocator can usefully ask a manager or a custodian. It describes general practice only. It does not describe the operating arrangements of MidSquare Capital or of any other named firm. MidSquare Capital is an authorised financial services provider (FSP no. 53511), approved by the Financial Sector Conduct Authority as a Category II and IIA discretionary investment manager, and is licensed as a crypto asset service provider. Nothing here is advice, an offer or an invitation to invest.

Custody of a digital asset is control of a key

A digital asset is recorded on a ledger, and the ability to move it comes from a private key that authorises a transfer. Custody in this market therefore means control of keys rather than possession of a certificate or an entry in a register held by a transfer agent. Three arrangements are common. In self custody the owner controls the keys directly. In third party custody a custodian controls the keys under a written mandate and moves assets only on instruction. Where a balance sits on a trading venue, the venue controls the keys and the account holder has a claim on the venue rather than an asset it holds itself. The three arrangements differ in who can move the asset, and that is the distinction an allocator should hold on to.

Segregation is the separation of client assets from the firm holding them

Segregation means that assets belonging to clients are kept apart from the assets of the firm that holds them, and are identified as belonging to clients in that firm's records. It has a legal dimension and an operational one. Legally, segregation is what supports the position that client assets are not available to the creditors of the holding firm if that firm fails. Operationally, it is the difference between assets sitting in accounts or wallets identified to a client and assets pooled in a general balance. Practice ranges from a wallet dedicated to a single client, through an omnibus wallet with client level records behind it, to no separation at all. Those are materially different arrangements and they are often described in the same language.

Segregation addresses some risks and leaves others untouched

Segregation is aimed at two things: the misappropriation of client assets by the firm holding them, and the treatment of those assets if that firm becomes insolvent. It does not reduce market risk, it does not prevent operational error, and it does not by itself protect against the theft of a key. An allocator that treats segregation as a general safety property has read more into it than it carries. The useful question is narrower: which specific risk does this arrangement address, and what evidence exists that it works as described.

Key storage is a trade off between availability and exposure

General practice separates keys by how quickly they can sign a transaction. Keys held on systems connected to a network can sign quickly and are exposed to anything that reaches those systems. Keys held offline are far harder to reach and correspondingly slower to use. Most institutional arrangements run tiers, holding a small working balance where it can be moved quickly and the greater part where it cannot. Two techniques are widely used to remove any single point of compromise: multiple signature schemes, in which a transfer requires several independent keys, and multi party computation, in which a single signature is produced from key shares that are never brought together. Both change the question from who holds the key to how many independent parties must agree.

Governance decides who can actually move an asset

Key storage describes where a key lives. Governance describes the conditions under which it is used. The controls an allocator will meet in general practice include approval quorums, so that no one person can authorise a transfer; withdrawal address allowlists, so that assets can only be sent to addresses registered in advance; delays between the registration of a new address and its first use; and separation of the people who instruct a transfer from the people who approve it. These controls are the part of a custody arrangement most likely to be described briefly in a marketing document and at length in an operations manual, and the operations manual is the one worth reading.

Independent verification is what turns a description into evidence

An arrangement described by the firm that operates it is a description. Independent verification is what makes it evidence. In general practice an allocator will encounter reports by an independent auditor on the design and operating effectiveness of a service organisation's controls, for example a report prepared under the International Standard on Assurance Engagements 3402 or a Service Organization Control report. It will also encounter reconciliations between recorded client balances and the balances observable on the underlying ledger, sometimes published as a proof of reserves. A proof of reserves shows assets. It does not show liabilities, so on its own it does not establish that a firm holds enough to meet its obligations, and it should be read alongside an auditor's work rather than instead of it.

Questions an allocator can usefully ask

• Who controls the keys to the assets, and under what written mandate.
• Are client assets separated from the assets of the firm holding them, and separated in records, in accounts or in both.
• Is a client identified to its own wallet, or held in an omnibus arrangement with records behind it.
• What proportion of assets sits in keys able to sign immediately, and what governs that proportion.
• How many independent approvals does a transfer require, and can any single person complete one.
• Are withdrawal addresses registered in advance, and what delay applies to a new address.
• What independent assurance exists over these controls, how recent is it, and what did it qualify.
• What happens to client assets if the custodian fails, and on what legal analysis.

What custody arrangements do not do

A sound custody arrangement reduces the chance that assets are lost or taken. It does not change what those assets are worth. Digital assets are volatile and an investment in them carries significant risk, including the possible loss of the amount invested. Returns are not guaranteed, and past performance is not a reliable indicator of future returns. Custody is one of several operational questions an investment committee should ask, and it is not a substitute for the investment question.

MidSquare Capital sets out its approach to investing on the strategies page. Market conditions are discussed in Market commentary, August 2026. Enquiries about the operating arrangements of MidSquare Capital are handled through the contact page rather than on a public page.