May 2019
The lack of certainty regarding national regulators’ treatment of digital assets is often cited as the main reason for the cautious approach of asset managers towards digital assets. However, the reality is that, apart from the uncertainty surrounding the regulatory framework, it seems that the lack of safe, qualified custody is also a significant barrier preventing institutional investors from joining the crypto market in greater numbers. This seems poised to change as their interest is growing and solutions are being developed by major, trustworthy players.
What’s really at stake is ensuring the safekeeping of private keys and crypto-addresses while allowing third-party access to pertinent information stored on the wallet to provide relevant services, such as, asset servicing, delivery versus payment, audit, fund administration, etc.
Securing digital assets on the Internet is a much more far-reaching issue than just capital markets operation. The skyrocketing growth of cybercrimes in recent years is pushing this matter to the forefront of concerns among executives and citizens. In 2017 in the US alone, 1,579 data breaches were recorded—a 50% growth compared to the previous year. Given this, a major strategic challenge for every firm across the world is ensuring the security of their data, which has become one of their key assets.
In the digital asset world, custody is often used in the sense of safekeeping, without including the additional services that traditional bank custodians provide to clients. Given the sensitivity and importance of the crypto wallet private key and the numerous reported hacks and thefts of coins, this aspect of the value chain is of great strategic importance to the development of the industry. There are two main methods of safekeeping:
The majority of crypto funds have turned to cold storage as it is the only fully secure solution for safekeeping assets. There are currently three main types of cold storage safekeeping solution providers:
Not surprisingly the market has been dominated by crypto-asset specialists and Fintechs, that obviously had a first mover advantage. However, the situation is likely to change, and traditional players, such as Fidelity which has announced the launch of a crypto-custody service for March 2019, are likely to enter the space sooner than later.
The challenges in the custody of digital assets are not only the concerns around the security of the private key and transaction addresses, but also how to allow third parties, such as regulators and fund administrators, to receive the pertinent information without compromising the safety of assets.
In the traditional capital markets infrastructure, transactions are conducted through an exchange of messages that updates relevant ledgers at banks, CSDs, and so on. In the digital world, it’s either the asset itself or the contract right to demand delivery of an off-blockchain asset represented by the token that is transferred over the network. But it’s important to acknowledge that the token itself is nothing more than just a data storage space and a line of code. Hence, if compact enough to be included within the token storage capability, any data could be represented. The digital asset infrastructure is, in fact, a network to exchange sensitive and valuable data through a secure and immutable decentralized and distributed network of ledgers. As such, the digital assets infrastructure allows the transfer of any type of asset over Internet Protocol. In our hyper-connected society, in which future business models of firms are reliant on their ability to collect, manipulate, analyze and enrich data, digital assets could be the instruments that are most suited to respond to future market needs.
The views expressed herein are those of the authors only and may not reflect the views of BNY Mellon. This does not constitute Asset Servicing advice, or any other business or legal advice, and it should not be relied upon as such.