As decentralized finance (DeFi) gains traction among institutional investors, fund managers are under pressure to navigate a new category of exposure: DeFi custody risk. Without a traditional custodian, and with asset control often tied to smart contracts and private keys, managers face legal and operational challenges that are frequently underestimated.
Custody Risk is a Growing Regulatory Concern
As institutional capital enters DeFi, regulators across Asia and Europe are sharpening scrutiny around custody practices. In Singapore, the Monetary Authority of Singapore (MAS) now mandates that crypto service providers:
- Segregate client assets
- Store at least 90% of assets in cold wallets
- Maintain strong internal controls over access and transfers
Fund managers operating in DeFi, however, often engage with smart contracts that don’t meet conventional custody standards. In the absence of a licensed custodian, regulators now hold the fund directly accountable
Key Categories of Custody Risk in DeFi
- Smart Contract Risk: Bugs, logic errors, or unaudited code controlling user funds
- Key Management Risk: Private key loss, inadequate multisig design, or collusion
- Governance Risk: Admin key centralization, DAO takeovers, or malicious upgrades
- Third-Party Interface Risk: Compromised wallets, web UIs, or transaction signing tools
- Reputational Risk: Investor backlash following a protocol loss linked to custody missteps
How Insurance Can Help Fund Managers Mitigate Custody Risk
While technical due diligence is critical, insurance can play an increasingly important role in reducing the financial impact of custody failures:
- Crime Insurance – Protects against theft or fraud involving insiders, external attackers, or collusion—especially in cases involving multisig wallets or protocol-level governance roles.
- Specie Insurance – Covers loss or theft of private keys, cold wallets, and other physical or digital custody infrastructure.
- Investment Management Insurance (IMI)– Provides professional liability coverage for fund managers, including exposure to claims tied to custody decisions, DeFi protocol failures, or investor losses.
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