It was not until 2017 that crypto came under the spotlight with an unprecedented performance – the top 20 crypto index returned over 5,000% during the year, and even though the markets have slowed down since, the crypto space has achieved an asset-class status and is being keenly explored by institutional players, who can very well bring on the next stage of market growth and maturation.
However, the useability of crypto assets, and in particular, their security, leave much to be desired, and present a major hurdle towards large-scale institutional involvement. Be it university endowments, hedge funds or banks, unlike their forays into traditional markets and investment vehicles, the crypto space does not provide safeguarding that can be implemented simply and reliably – hence, the need for custody solutions.
What are Crypto Custody Solutions and Why are they Needed?
Like any other custody solution, crypto custody is a service which assures the safekeeping of digital assets, such as Bitcoin, Ether and so on. These digital assets, due to their very nature, are prone to cyber attacks, including online hacks and other methods employed by bad actors to obtain the alphanumeric private keys used to access and transfer digital currency funds.
Since most digital currencies lack centralized infrastructures, there is no record of ownership, and the coins themselves behave like bearer-assets, where whoever possesses them, effectively has complete ownership. This means if a cryptocurrency wallet managed by a large-scale hedge fund is compromised due to any security lapse, the hacker can essentially seize complete control of the assets.
Such a risk can only be mitigated by robust custody practices, such as the effective use of hot and cold wallets (hot wallets are accessible online while cold wallets are stored offline to prevent cyber attacks) and the safekeeping of private keys. However, when it comes to handling large amounts in crypto, the risk often overshadows viability.
This is where third-party, institutional-grade crypto custody solutions come into play.
The Current State of Institutional Crypto Custody Solutions
Coinbase has been very active in catering to institutional clients, with a dedicated platform, Coinbase Prime, and a custody solution, Coinbase Custody. The company’s custody solution requires a minimum of $10 million in holding, and utilizes a mix of hot and cold storage. BitGo is another company providing institutional-grade custody services, and is among the pioneers in the space.
Meanwhile, we have, more traditional players such as Fidelity, whose custody solution is now live with around five clients, as they take a steadier approach towards the nascent technology.
The need for institutional solutions is also felt by companies seeking to introduce financial instruments linked with digital assets, such as Bakkt, which is a subsidiary of Intercontinental Exchange (ICE), which also owns the New York Stock Exchange (NYSE).
This week, ICE announced its acquisition of a custody solution provider, the Digital Asset Custody Company (DACC), and with this purchase, the exchange will be seeking the status of a qualified custodian. Once that happens, Bakkt’s plan to launch Bitcoin futures will have one less hurdle.
Apart from the standard hot and cold wallets approach towards custody, other avenues are also being explored by companies such as IBM, which are focusing on cloud-based secure storage solutions that bridge the best of security and accessibility. These solutions are used increasingly in Hardware Security Modules or HSMs, which are being developed by the likes of Crypto Storage AG, and an initiative, the Komainu Project, involving hardware wallet manufacturer Ledger.
Presently, just as blockchain technology is evolving, so are the solutions designed around digital assets. However, developments made by prominent names further attest that cryptocurrencies are poised to be a key part of future economy and financial markets.
While no one can truly predict when certain market developments will take place, such as the inflow of institutional investors, the space can be prepared for them ahead of time, and the development of key services like crypto insurance and custody is a major step towards that preparation.