The sad state of institutional crypto custody — and why it remains a significant barrier to future blockchain adoption
In February 2018, Ouriel Ohayon wrote a great article about the sad state of crypto custody from a technology and retail user perspective. In this article, we’ll explore why there’s a similar sad state of affairs from an institutional point of view.
This year, many established banks and exchanges have sought to show that they too have an adoption strategy for digital assets. Despite the murmurings of the current crypto bear market, outright rejections of blockchain technology have generally decreased (with a few vocal exceptions).
There is growing acceptance that digital asset technology has multiple use-cases, each with significant potential value.
However, as we wrote last month, a lack of clear and consistent regulation presents an ongoing barrier to further adoption of digital assets, especially among institutional investors.
This barrier and resulting lack of infrastructure is felt in many different ways. These include the dearth of banking services available to blockchain organisations; a limited market for crypto-related insurance underwriting; and a lack of robust custodial solutions from the trusted names in that field.
It’s worth exploring the latter lack of custodial solutions in more detail. As an area that is crucial to accelerating adoption, at first sight it appears that demand is growing.
For example, one lead indicator — Google Trends search volumes for crypto custody — is up by 212% on 2017 levels so far this year. However, as we will see, the situation is more complex.
What is Custody?
SEC rules require most institutional investors to maintain their assets with a third-party “qualified custodian”. Given that the definition of a digital currency versus a digital security is still being determined in many places, it hasn’t been immediately and universally clear which digital assets require qualified custody and which do not.
Erring on the side of safety is undoubtedly the wisest play. Given the amount of risk currently in the digital asset system, it’s good practice and a necessary step for the industry to fully embrace regulated custody solutions for institutionally managed digital assets.
What are the emerging Custody solutions?
- Coinbase
Both new and established digital asset custody options are emerging. The US-headquartered Coinbase, a top-30 crypto exchange by volume, set out its strategy to attract institutional investment in January.
It then launched its first Custody service in July, for institutions with a minimum digital asset deposits of $5m. In October, Coinbase Custody was approved by the NYDFS to provide qualified custody services for BTC, ETH, LTC, XRP, ETC and BCH.
2. Bit Go
In September, the wallet Bit Go, also received approval for a regulated custodial solution for more than 75 coins and tokens. The company created their own solution after previously discounting a different route into the space via a purchase of existing qualified custodian Kingdom Trust.
3. Others
Other hats have being thrown into the ring from some surprising names. In May, global investment bank Nomura announced the creation of Komainu, a joint digital asset custody venture with Ledger and Global Advisor. Indeed Pascal Gauthier, CEO of Ledger recently predicted 2019 would be the year of custodianship in crypto.
Bloomberg reported this Summer that Goldman Sachs was also considering a digital asset custody solution. It subsequently invested in a BitGo funding round, suggesting it has chosen a partnership option ahead of a self-build route.
4. Fidelity
In October, Fidelity, the world’s fourth-largest asset manager, which oversees $7.2 trillion of assets, announced it would establish Fidelity Digital Asset Services to “offer enterprise-quality custody and trade execution services for digital assets…to sophisticated institutional investors such as hedge funds, family offices and market intermediaries.”
This provided a minor landmark in the crypto adoption journey as Fidelity has 27 million existing customers — including 13,000 institutions.
Chief Investment Officers looking to securely store their digital assets with a reputable name will take more notice of a move by such a well-recognised player. Fidelity’s white paper on custody neatly outlines their positioning and benefits to institutions.
Fidelity’s custody solution currently only covers BTC, but Tom Jessop, Head of Fidelity Digital Assets, recently stated at a conference that “there is demand for the next four or five [crypto assets] in rank of market cap order. So we will be looking at that.”
As with most new technologies, once the first major player brings a new offer to the market, their main competitors will generally be rushing to catch-up — even if this happens in secret until they’re ready to launch.
Where Are The Big 4 of Custody?
BNY Mellon, JPMorgan, Citigroup and State Street are the names to watch next when it comes to the diversification of established qualified custody. They are responsible for more than half of the custody industry and had a combined $114 trillion in assets in custody and administration at the end of Q2 2018.
We can expect many of these firms to launch their own digital asset solutions in the next 12–24 months in response to client demand.
However, it’s interesting to note that while client interest may be here, tangible demand has yet to arrive.
At a recent conference, a State Street exec Jay Biancamano was quoted as saying that while he saw “very high level of [client] interest” in crypto assets there was “no urgency” as “currently none of our clients are looking for us to house these assets in custody”.
State Street seems keen to ensure it’s viewed as “ready” for institutional investment — as soon as the other pieces of the jigsaw, including regulatory approval, fall into place and clients are ready to put their money where their mouths are.
When and how will institutional crypto custody finally improve?
Exchanges, wallets, banks and established custody providers are in the process of creating institution-grade custody solutions for digital assets.
While this will ultimately facilitate greater institutional investment, there remain many challenges to overcome (from a technological and regulatory point of view) — as Finoa noted in a recent article.
State Street’s Biancamano has stated that the future of custody isn’t “just about the current cryptocurrency; it’s also about tokenization and digitalization of traditional assets too.”
This is an important distinction. Digital assets don’t just represent a new type of asset, they may also redefine and even replace many existing assets.
Just as the fabric and functionality of traditional assets will be impacted by their digitalization, so too will their associated custody requirement. It’s been clear for several years that the custody industry faces huge technological change even if the arrival of this change is not yet clear. Some believe DLT will render many current processes effectively obsolete.
Of course such change will not happen overnight. Custody providers who provide the most trusted and frictionless solutions will bring competitive advantage and organic growth to what has now become a low-margin, low-growth industry. Institutional investors may find it easiest to procure their digital custody solutions from the same organisations (and during the same negotiations) as their traditional ones.
But mastering the technology for this to happen requires foresight and long-term strategic investment.
If the traditional custodians are not ready, we’ll see challenger brands more familiar with the technology quickly eating into the market share of this multi-trillion dollar marketplace and fuelling a new phase of growth.
As a result, it’s likely we will see the nascent arms race between new and established custody players escalate in 2019.
This should provide further momentum to the digital asset industry and go a long way to improving the current state of institutional crypto custody.
Want to read more?
Also in this series:
· Institutional crypto adoption: why we must embrace regulation to tackle risk
· Other institutional barriers to crypto adoption (forthcoming)
·The impending boom in alternative data for crypto investments (forthcoming)
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