Every week crypto news outlets publish stories about exchanges that have been compromised or hacked, and how crypto investors have had their funds stolen or lost. While the funds many investors keep in banks and other regulated financial institutions are insured against loss or theft, funds on crypto exchanges or in crypto wallets are not insured. If crypto funds are lost or stolen, there is little hope for recovery.
Many turn to crypto investments as a way to free themselves from central financial institutions. Investors who are tired of paying fees to banks and allowing banks to make money off of their assets turn to cryptocurrencies instead. However, safeguarding one’s crypto assets is not an easy thing to do.
With cryptocurrencies, the responsibility of safeguarding your digital currency is entirely up to you. There are some inherent safeguards to cryptocurrencies. In addition to being encrypted, the owner of the coin possesses an alphanumeric passcode as well as a 12-word or 24-word passphrase. It is the owner’s responsibility to keep both the passcode and the passphrase safe. There are many options for this, but each with its own weak points. You can keep the information on a cold wallet, which consists of a hardware wallet that has the ability to connect to your computer through a USB drive and to exchanges through the internet. When not in active use, the cold wallet is disconnected from the internet and the computer and is therefore protected against theft. However, such a device can be lost, stolen, or broken. Passcodes and passphrases can be printed out and stored in a safety deposit box, vault, or other safe space. These pieces of paper can also be lost, stolen, or destroyed.
With all of these considerations to explore when deciding on the best way to protect your cryptocurrency assets, it is no wonder that many institutional investors have looked to custodial services as a solution.
How Custodians Can Protect Your Assets
“Custodians” are regulated financial institutions that hold assets on behalf of client investors in order to protect client’s assets from theft and loss. In addition to providing secure storage for assets, custodians often provide additional services, such as a platform for trading securities. Custodians play a major role for institutional investors of traditional assets, such as gold. Because companies that offer custodial services hold a large amount of assets, they are required to be registered as a financial institution. In the United States, these companies must register with the Security and Exchange Commission (SEC).
The SEC currently requires investors with assets totaling over $150,000 to store their funds with a qualified custodian as part of the Dodd Frank Act. The Act defines a qualified custodian to be institutions such as a bank, registered broker-dealer, foreign financial institution, or saving association. Institutional investors of mainstream investments, such as gold or securities, have trusted their funds to custodial service providers such as JP Morgan, Northern Trust, and BNY Mellon.
Until it was acquired by BitGo, Kingdom Trust was the largest custodial service provider for crypto assets. Currently, there is a lack of custodial service providers for crypto assets. This may be due to the lack of certainty regarding regulations of crypto assets. However, after the SEC opened their guidelines to include crypto assets, many financial institutions have submitted applications to provide services in a regulated manner to crypto investors, such as brokerage licenses and custodial services.
Bringing New Investors to the Crypto Market
The introduction of established crypto custody providers may be the entranceway for investors who have not yet entered the crypto market. Custody service providers, especially ones that are already trusted in the mainstream financial industry, can help investors feel that their crypto investments are safe in a way wallet providers and crypto exchanges cannot. Exchanges are often targeted by hackers, or may shut down causing all funds on the exchange to be lost.
Due to the fragmented nature of the cryptocurrency market, wallets are often unable to support multiple types of cryptocurrencies. Investors who have portfolios which include multiple cryptocurrencies need multiple wallets. This increases the number of passcodes that must be remembered and protected. Wallets also force investors to accept a trade-off between convenience (liquidity) and security. Wallets that are more secure are those that are offline. These types of cold storage options make it difficult to immediately trade the crypto assets, as they must first be connected to the internet and then placed on an exchange. Those that are considered hot storage options are connected to the internet at all times. These options are more exposed to attack by hackers or other entities.
Current options for custodial services.
As of July 2018, Coinbase began offering crypto custodial services for institutional investors in the US and Europe. In preparation for this new service, Coinbase acquired Venovate Marketplace, Keystone Capital Corp., and Digital Wealth LLC. Coinbase’s custodial service is provided by Coinbase Custody, a subsidiary of the parent company. Until Coinbase secures a license from the SEC, it will use its partner, Electronic Transaction Clearing, as the SEC-registered broker-dealer for its custodial services.
The crypto custody service offered by Coinbase Custody is expensive, with set up fees costing $100,000 and a minimum balance of $10 million being required. Additional fees and long waiting times to remove assets from cold storage make it clear that this service is aimed at institutional investors.
Currently, Coinbase Custody only supports Bitcoin, Ethereum, Litecoin, and Bitcoin Cash. In addition to supporting more cryptocurrencies, Coinbase Custody plans on expanding to offer crypto custodial services to Asian investors.
Ledger, a French crypto wallet startup, will also offer crypto custody services. By the end of 2019, Ledger plans to support 100 cryptocurrencies with its wallet. The company believes that this move will also support the entrance of new institutional investors, such as hedge funds, to the crypto market.
Crypto Custody Provider Hopefuls
Many companies have begun to look into providing crypto custody services. Financial institutions that have made a name for themselves offering custodial services for Wall Street assets, such as JPMorgan Chase and Goldman Sachs, have begun to work on developing custodial service offerings for crypto assets. Goldman Sachs is exploring the possibility of providing a range of crypto services, including trading options.
Normura Holdings Inc., an investment bank, has partnered with Global Advisors and Ledger, two crypto firms. Their partnership created Komainu, a crypto custody consortium. Private testing of the consortium will start over the summer of 2018 and the launch of Komainu is schedule to take place by the end of that year.
Other crypto custody service providers include Robinhood, Square and Circle. These providers are still developing their services and continue to work to gain widespread recognition. BitGo has already applied to gain recognition as a state-chartered trust company in South Dakota, USA, and is waiting for approval from the SEC.
In the Asain market, Fusang Investment Office is scheduled to launch the Fusang Vault in late 2018. The Fusang Vault will provide crypto custody services in Hong Kong. Currently, Fusang Vault is developing a system of cyber insurance coverage to protect clients’ crypto assets.
Conclusion
Cryptocurrencies and crypto assets are difficult to protect, as they are purely digital assets with many vulnerabilities. They are hard to track, vulnerable to hackers, and once stolen or lost, incredibly difficult to recover. These vulnerabilities keep institutional investors from entering the crypto market. Crypto custody providers may break down this barrier and bring in a new wave of investors to the crypto market. The cost of custodial crypto services is expected to lower once more companies offer the service and market competition increases. While there are still those that see the crypto market as not developed enough to support crypto custody providers, there are others who see the entrance of mainstream financial institutions as a significant step forward in the goal of cryptocurrencies gaining acceptance.
