Can a Decentralized Custody Infrastructure Help Stabilize Markets?
A real world solution for a crypto problem or a crypto solution for a crypto problem?
On the 10th of June 2018, two days prior to the Trump-Kim summit in Singapore, Coinrail, a relatively small cryptocurrency exchange in South Korea had been hacked. Markets tumbled for both Bitcoin and Altcoins by more than 10%.
According to Coinmarketcap.com, the number of tracked cryptocurrencies has almost reached 1700. What is interesting though is how the Pareto Principle has failed to work by a huge factor on the value distribution of the digital asset market. 80% of the network value is represented by a mere 0.8% of crypto assets.
What does this mean?
If getting a stake in the real world markets was complex, dipping your feet in crypto feels like moving mountains for the uninitiated. From the possibility of losing your funds to hackers to not understanding how the digital assets are correlated to each other and to your base currency: a lot could go wrong. For starters, you may think to entrust all these issues to a third party that perhaps also provides support with proper portfolio building solutions, however the relative privacy that the coins possess, create a valid ground for an issue that other asset classes do not have.
That is the possibility of your funds being stolen from your accounts held with third party custodians without you even noticing it and the immediate encashment of the looted funds without the complications of being hunted down by any authority in the world, despite the numerous attempts to do so.
Regardless of the numerous decentralized exchanges that have been created over the last year, we still are unable to unplug ourselves from the addictive services of the now “too big to fail” centralized crypto exchanges. When acquiring crypto assets or deciding to build a diversified portfolio, there are two options possible:
- To buy the digital asset and keep it on the exchange to maximize the efficiency
- To buy the digital asset and send it to a wallet under your control, effectively accepting a trade off between efficiency and safety
The second option would be feasible only if the portfolio in question is constituted by a few digital assets.
What if the assets you would like to own follow different protocols?
Currently, when we hold our Digital Assets on a centralized exchange, we are handing over the right to own our funds to a centralized third party. We get in exchange an IOU from the exchange, a promise to give us back our assets upon request. Obviously all this is predicated on the hope that the probability of the exchange getting hacked is infinitesimal. Otherwise, since all these exchanges are capitalized very lightly, their IOUs will not be worth much.
Understandably, institutional investors are skeptical about these structures and about investing their client’s money in Digital Assets when every year for the past 4 years (since crypto had started to become mainstream and deliver extravagant returns in 2014) there has been one major hack that made it to the headlines.
As more money gets poured into the ecosystem, the incentive for hackers to plan more sophisticated attacks also increases. Despite the numerous past thefts and the promising technological improvements that followed, the likelihood of a cyber-threat not only has not waned but, in our opinion, has actually increased together with the increase in interest and capitalization.
In addition to this and surprise regulatory announcements, the uncertainty created by the insecurity of the custodial solutions have severely turned off institutional investors, which traditionally maintain a high risk aversion in relation to the protection of clients’ assets. To this end, the first foray into solving this issue has been made by Nomura in joint venture with Ledger and other players.
It is expected that more traditional financial institutions will attempt to provide a viable custody solution which surely enough is a profitable line of business with very little downside as large existing customers, enthusiastic about the space, have waited patiently to finally get some exposure to it.
Granting the admirable goodwill from big players to solve this head-scratching issue, which if solved would at least legitimize the potential belief that cryptocurrencies are a store of value in a mostly inflationary global economy, we need to recognize that these shall be considered imperfect solutions as they still qualify as attempts to generate fiat solutions for crypto related issues. To explain it with an analogy, let us bring back to memory how Wikipedia has supplanted Encarta (created by Microsoft), which had the ingenious idea (at the time…) to have encyclopedic knowledge burned on disc. The mistake that Encarta ran into was purely based on a consideration of efficiency over actual knowledge, which interestingly enough, is more valuable and accurate if reviewed on a decentralized platform such as Wikipedia. In other words, what today’s traditional players are doing in crypto is inculcating each their version of custody to users, which will carry a brand and reputation. In any case, today Wikipedia has emerged victorious and Encarta forgotten.
It has been estimated that there is a colossal US$ 256 trillion worth of assets today. These include gold, real estate and stocks. What this also means is that there is a great potential for the tokenization process to scale and accelerate to include all real-world asset classes. We can imagine that the technology will allow traditionally considered illiquid assets to become easily exchangeable in the market and eventually finding a correlation with the real world economics as the tokenization process covers more and more assets.
If this will be the case, it is time to ask ourselves whether we would want to still keep our tokenized real asset at a third party custody solution. While the monumental leap towards the implementation of a trustless network and the coveted disintermediation of financial institutions is being celebrated, we need to embrace and acknowledge the issues that cryptographic assets bring forward together with its advantages.
The period of immense interest that followed the price run-up in Q4 2017 has also coincided with many great projects being revealed waiting to be developed. And in order to allow a thriving and sustainable ecosystem, it is of utmost importance to convince ourselves that besides volatility, a reliable and trustless custody infrastructure is also needed as the crypto community’s trust is being tested. It is also not untrue that the biggest market swings have historically closely followed the announcements of security breaches into supposedly trusted third parties. One thing is crystal clear, the market will not grow up if it does not know how to protect itself first.
About DEXTF Protocol
DEXTF’s on-chain asset management protocol will allow the creation, management and trading of digital-native funds units, connecting investors, arbitrageurs and portfolio managers in a way that has never been done before. Working to bring the biggest crypto investment funds on DEXTF protocol and to eliminate the need of a third party custody service.