How to solve the custody problem on crypto-exchanges
LGO Markets is the first cryptocurrency exchange designed to cater for the needs of institutional investors.
What is custody
In the traditional financial world, custody is the service by which a custodian safekeeps its clients’ assets and manages the update of their balances according to their trading history
For instance, on the stock market, when A buys 100 shares of Apple stock to B, A and B don’t meet and transact directly (B giving 100 paper certificates to A against 100 times the price of a share in dollars). Rather, they both have a custodian, which takes care of managing their accounts in Apple stock and dollars, and updates their respective balances with the new transaction.
Custodians in the traditional financial world have a huge responsibility, as they hold billions of dollars worth of securities and other assets on behalf of their clients. These assets are either stored in electronic or physical form. Because of this responsibility, custodians are generally large and reputable firms.
Problems with current crypto-exchanges
Cryptocurrency exchanges actually need 2 kinds of custody: Fiat custody and Crypto custody.
Fiat Custody
There are only a handful of crypto-exchanges in the world that accept real fiat deposits and withdrawals — and as such offer a fiat custody service. All of these exchanges have some or all of the following attributes: lengthy onboarding process, high fees, and delays of up to a week for buying bitcoins with fiat in conjunction with an unknown and sometimes evidently unfair execution price (see our article on price manipulation).
As a matter of fact, fiat custody is one of the blocking issues when it comes to institutional investors getting in the cryptocurrency market. No institution will rationally transfer large amounts of fiat currencies to any of the current leading exchanges, solely because of fiat custody. Institutions need to know where and how their money is stored as well as what guarantees and which insurances are put on these funds. These guarantees will be given by banks which already provide them in the financial industry, and unlikely by the banks which currently operate with cryptocurrency exchanges.
Fiat Custodians have been in business for dozens if not hundreds of years, and have a high reputation and experience. Unfortunately, the cryptocurrency market doesn’t take advantage of their experience.
Crypto Custody
Crypto custody is a new and important problem which is tied to the technical specifications of the market. Cryptocurrencies are completely digital which makes them prone to theft and hacks, as the current storing technology is not up to speed (see this article on the Parity multisig wallet hack).
Storing Cryptocurrencies: what does it exactly mean?
Cryptocurrencies are stored on their respective blockchain. There’s no way to “move them” out of it, they remain there forever.
However, to have access to Bitcoins for instance, one needs a private and a public key. The public key is the “identity” of the address on the network — this is the key which has to be given to someone in order to receive bitcoins. The private key is essentially a password, used to access and transfer bitcoins from one’s wallet to another.
These keys are series of hexadecimal characters which investors have to store properly. If your private key gets lost or stolen, then you lose your bitcoins without ever being able to retrieve them. A cryptocurrency custodian stores and protects these 2 keys.
Most of the current exchanges work in the following way:
They have a master wallet — think of an address on a blockchain with the cumulative amount of cryptos owned by the exchanges’ users. When users send cryptos to their account on an exchange, they actually send them to the exchange’s wallet, which in turn virtually “credits” the user with the amount of cryptos she sent. In this configuration, the users’ cryptos are not stored in their own blockchain address but rather on that of the exchange.
The counterparty risk is maximal here, as users don’t have any guarantees on the cryptos they have, other than the information given by the exchange. The risk of a “crypto bank run” — in which every user would try to transfer their cryptos out of their exchange accounts — is high, as no one can check that the sum of the users balances actually matches the cryptos custodied by the exchange. Very few exchanges offer a real crypto-custody service.
LGO Solution
Fiat Custody
Through the partnership with traditional brokers, LGO Markets’ users will have accounts at established fiat custodians in which they’ll be able to deposit fiat currency. This is a game changer in the cryptocurrency exchange industry, in which fiat money is usually deposited in tier 2 or 3 bank and where large deposits are slow and difficult to make.
Thanks to its partnership with renowned brokers, LGO will offer cash custody with top-tier banks, offering institutional investors a compliant and first class service.
Crypto Custody
LGO is building its own crypto custody infrastructure, in order to give users the highest level of safety and accessibility to their crypto holdings. LGO has designed a multisignature wallet where the exchange and the client will both hold one key, and where the third one will by stored on an HSM (Hardware Security Module, also called cold wallets) in a bank vault. The wallet is said to be a 2-of-3 multisignature wallet, as 2 out of the 3 keys are necessary to access the funds on the wallet.
This will allow LGO Markets’ users to have a full access to their cryptocurrencies, as well as a guarantee of their safety.
More importantly, the custody of cryptocurrencies will be completely separated from the exchange. This way, LGO Markets users’ funds will be secure in case of a hack or a theft on the exchange — such as the one which happened on Mt. Gox in 2013.
LGO Markets e will be the first cryptocurrency exchange to provide a fiat and crypto custody service complying with institutional investors needs.
About LGO
LGO is a demonstrably fair and premium exchange for institutional investors. It incorporates a decentralized ledger within its proprietary centralized platform in order to guarantee the inalterability, temporality and transparency of the order book and ensure a fair trading environment.
If you like what you read, please don’t forget to like and share the post !
