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.
While DeFi offers innovation and yield, it also introduces a persistent structural challenge: custody.
In traditional finance, licensed custodians are responsible for safeguarding client assets. In DeFi, however, custody is often fragmented—distributed across protocols, wallets, and governance mechanisms. Without a central authority or liability buffer, fund managers become directly accountable for protecting assets.
This decentralized structure has created one of the most overlooked vulnerabilities in digital asset management today.
When Protocols Fail, Fund Managers Are Left Exposed
Custody failures in DeFi can stem from a range of issues—code exploits, admin key misuse, front-end compromises, or governance breakdowns. While the root cause is often technical, the responsibility ultimately falls on the fund interacting with the protocol.
Real-World Impact: When Custody Breaks Down, Losses Escalate
Case 1: BadgerDAO Interface Exploit (2021)
In December 2021, attackers compromised BadgerDAO’s front end, injecting malicious scripts that tricked users into authorizing unauthorized transactions. More than $120 million in assets were drained, including funds from institutional vaults.
Key Lesson: Even if the smart contract is secure, off-chain components—like the user interface—can create critical vulnerabilities. Without third-party custodians, the fund becomes the de facto custodian.
Case 2: Curve Finance Vyper Exploit (2023)
In mid-2023, a vulnerability in legacy Vyper compiler code led to over $60 million in stolen assets. Liquidity providers who had deposited into affected Curve pools found themselves suddenly exposed to a critical coding flaw.
Key Lesson: Depositing into a protocol is a custodial act. Once assets are committed to a smart contract, managers assume the consequences of underlying protocol risk, even if that risk is downstream and indirect.
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.
How Continuum Supports DeFi Fund Managers
At Continuum, we work with digital asset funds, VC-backed crypto vehicles, and on-chain strategy platforms to identify, assess, and insure custody-related exposures. Our support includes:
Tailored insurance program design aligned with fund structure and custody model – we can work with existing custody providers.
Risk reviews of key management setups, smart contract interactions, and protocol dependencies
Coverage gap analysis, ensuring DeFi risks are not excluded from traditional PI or D&O policies
Claims support in the event of loss arising from exploits, protocol breaches, or wallet compromise
DeFi doesn’t eliminate risk—it redistributes it. As fund managers navigate this evolving ecosystem, custody risk must be treated as a core operational exposure—not a peripheral technical issue.
Get in touch to learn how Continuum can help structure insurance solutions that scale with your fund’s DeFi strategy.
