Global Custodian Securities@Sibos 2019 - Page 10

[ D I G I TA L A S S E T S ] CUSTODY IN A DIGITAL ASSET WORLD Institutional money requires institutional-level custody. Third-party custody of traditional assets is an established and secure service offering, but these services are not readily applicable to digital assets, says Jeanette Turner, chief regulatory officer, Compliance Solutions Strategies. D igital assets such as Bitcoin or other cryptocurrencies are fundamentally different from traditional assets, and institu- tional investors in digital assets have particularly challenging needs with respect to custody. Custody firms are evolving, trying to determine how best to meet the needs of such institutional customers. Each owner of a digital asset has a pri- vate key—a unique number generated by a digital asset wallet. The key enables the key holder to transact the specific digital asset. Third-party custody of digital assets is not custody of the currency itself—the currency is on the blockchain. Rather, custody involves holding the wallets that store the keys to the assets. Because they are built on blockchain technology, digital assets are by nature highly secure and essentially hack-proof. The problem is that the wallets are not. Digital assets are bearer instruments— whoever has the key is the owner of the asset. This makes them hard to track or 10 Securities@Sibos January 2019 recover if lost or stolen. The risk of finan- cial loss is significant and over the past few years millions of Bitcoin have been lost due to hacking and fraud. Third-party custody options are grow- ing for digital assets, but there is a lot of noise among the offerings. How can an owner of digital assets evaluate whether a custodian is institutional-grade? Although there is no clear model for what constitutes institutional-grade custodianship, there are some common features and best practices. Hot wallet vs cold storage Digital keys are held in wallets. The type of wallet you should use depends on your risk profile. A hot wallet is online and connected in some way to the internet, making it easy to transact the digital assets. Cold storage (aka cold wallet) involves generating and storing private keys in an offline environment, away from the internet. The key could be printed on paper, stored on a USB, or in a special hardware storage product. Hot wallets are vulnerable to hacking, while cold storage might be exposed to physical harm where the wallet is located, such as weather or a break-in. For purposes of security, it is better to hold digital assets in cold storage, says Adam Capon, EVP, operations at Digital Asset Custody Company, which provides institutional custody for digital assets with technology and services purpose-built to protect. “You need air- gapped cold storage, meaning that the keys are not stored anywhere near the internet and are not on a device that has touched the internet,” he explains. Tom Jessop, head of Fidelity Digital Assets, which offers enterprise-quality custody and trade execution services for digital assets, makes clear that, “Given that the assets are digital and can be eas- ily transferred, the only way to safeguard them is to hold your own keys.” This level of security comes at the cost of convenience. You eventually need to be online to use your digital assets. If stored in cold storage, the keys must be imported