How to nail crypto-custody
Hedge fund manager Kyle Samani was quoted in Bloomberg earlier this year saying, "There are a lot of investors where custodianship is the final barrier" for getting into the crypto market. Samani, along with many others, are convinced by the potential of digital currencies, but unwilling to dive in without being absolutely sure their funds are secure.
We agree. In order for crypto-currency to take a larger share of the world economy, problems around custody need to be solved. There have been far too many security incidents that have had the effect of punishing people for innovation. Many investors won't move meaningful portions of their assets until they can be sure of those assets' viability.
I do believe we are on the verge of a tipping point in the market. Longstanding interest in custody is turning into full scale investment as companies large and small look to under the space. The last quarter have seen reports that Goldman Sachs, Northern Trust and Nomura are considering entering the space.
Coindesk called this a $20 billion market earlier in the year. The actual number could be much higher.
From my background in banking and the past year I have spent looking into the state of the crypto markets, I know that not all custody options are created equal.
I have come to believe that there are three requirements that institutions will need to offer crypto-custody services that are viable for a meaningful proportion of today’s investors.
Get regulatory approval
Certainty is a currency in custody. The institutional landscape has been held back as governments from Japan to France have made evolving and sometimes contradictory statements about how cryptocurrencies will be regulated. For a crypto custody solution to be viable, I believe it needs to be done in the context of a comprehensive regulatory solution.
Thankfully we are now reaching a point where a few vanguard jurisdictions are reaching this milestone. Both Bermuda and Mauritius have enacted fintech frameworks that contain within them guidelines for managing crypto assets. They will soon be joined by several OCED countries such as Korea, which are developing ways to manage and handle assets. While the regulatory landscape will continue to evolve, operating at least under some guidelines will give investors more confidence in a custody solution.
Offer both hot and cold storage
These temperature-based terms do not have any climate-based meaning. Rather "cold" digital wallets are not connected to the Internet and therefore immune to any sort of interference. Not all wallets can be cold, obviously, as many people have digital assets for the purpose of trading or complete commerce. Any viable custody solution will mix cold and hot storage, depending on the immediate access needs. The system will also be seamless, so risk is not introduced as customers switch from short to long term storage.
Balance trusted solutions with new ideas
The right custody solutions will be a marriage of the consistency of traditional custody services along with innovative thinking appropriate for a new asset class. I believe this will reward players who do treat custody as first and foremost a financial product - this is not strictly the realm of technology speculation. This means people who understand how crypto assets will work inside a larger portfolio.
In order for crypto to see continued institutional investment these assets will need to live alongside bonds, stocks and real estate investments.
At the same time, the demands of crypto investors require doing more than just copying and pasting a solution that has worked for other asset classes. There's innovation required to move at the speed and through the complex web that is blockchain-backed assets.
This year has been a transformational one for many parts of the digital asset industry. While the price of several cryptocurrencies has fluctuated, the market for digital token investment has soared as public awareness grows ever deeper about the promise and potential of what is to come. Custody will be one of the first major applications of digital assets in a traditional banking and finance function. By this time next year, there will be millions if not billions of dollars in digital asset stored in digital custody.
When custody is nailed it will open the door for even greater crypto investment.