[ I N - D E P T H | C R Y P T O C U R R E N C Y C U S T O D Y ]
Unlike some of the other capital markets functions , custodian banking is yet to break into Hollywood as the subject matter for a feature film . Investment banking , hedge funds and derivatives trading have all secured star roles over the years , while there was even a steamy bathtub scene for mortgage-backed securities in The Big Short . For custodians though – as the infamously ‘ un-sexy ’ side of banking – staying out of storylines like these is part of the business . Safety , security and discreetness is in the DNA of a custodian bank whose job it is to protect assets . The only time Spielberg would likely come calling is if the vaults were ever breached , setting up a storyline that would blow the $ 160 million Oceans 11 heist out of the water – for context , the likes of BNY Mellon and State Street sit on over $ 33 trillion worth of assets .
“ Because it ’ s crypto , there are these hackers around and you open yourself up .”
CARL KRUGER , HEAD OF OPERATIONAL DUE DILIGENCE , LUMX GROUP
Of all the financial themes to prop up the next markets blockbuster , the shortest odds must be on Bitcoin . In a rags-to-riches biopic of the burgeoning cryptocurrency , the grand finale could easily involve a custodian bank , for the security and safekeeping of these digital assets may be the only thing holding them back from becoming a fully-fledge asset class , traded by not only retail clients , but the world ’ s largest institutional investors alike . Billions of dollars-worth of the cryptocurrency have been stolen since Bitcoin ’ s inception , with $ 1.2 billion pirated away since 2017 alone , according to estimates from the Anti-Phishing Working Group . Hackers have taken aim at anyone holding digital assets due to the lack of safekeeping , and comparatively insecure online storage of cryptocurrencies .
Safety first “ Because it ’ s crypto , there are these hackers around and you open yourself up ,” explained Carl Kruger , head of operational due diligence at LumX Group , speaking at Cryptocurrency Fund Forum in London .
“ Anyone who say ’ s I ’ m a crypto fund : you are inviting people to come in and look under the hood .” A simple Google search of ‘ crypto ’ and ‘ hackers ’ will provide numerous stories of millions - and sometimes billions - being stolen in all sorts of creative ways , from hijacking government websites to hacking during live streams on YouTube . It ’ s got to the point where many retail investors who have struck gold through the Bitcoin bull run and earned interviews with popular media outlets won ’ t disclose their earnings due to concerns about being targeted by hackers . For major investment companies publicly announcing their intentions to trade crypto , they could be placing a target on their head . So quite simply , security is the Achilles heel of cryptocurrencies . The options available for the safekeeping of cryptocurrencies take two forms , self-custody and independent custody . The former involves hot and cold storage wallets – whereby the assets are stored online and offline , respectively - while the latter could be provided by a coin exchange or a traditional custodian . “ When you have a currency you have a token – you have two sides – the public key and private key – when someone is holding the custody of assets they have your private key ,” explains Teana Baker-Taylor , CMO of cryptocurrency exchange , Coinfloor . “ A significant number of exchanges hold private keys online allowing you to move it around , but it means you are at risk of a hack .”
Tentative custodians The hot storage Baker-Taylor describes essentially trades heightened security for convenience , in that the assets are easily accessible as opposed to cold storage , in which customers deposit directly to an offline address , so they are never held online . “ When they want to withdraw them or call them up then we have to physically get them from cold storage ,” she says . “ We hold assets literally in multiple vaults and in addition we provide a multiple signature service , meaning that multiple signatories from our side need to validate that key ,” Baker-Taylor adds . A hybrid of the two , known as ‘ warm ’ storage also exists , with extra safety and accessibility , but not in the same timeframe as hot wallets . The issue for many institutional inves- tors is that neither provide the security and big-name assurance which traditional custodians provide for traditional assets , and these incumbent banks have been tentative in their approach to entering the cryptocurrency servicing world . For 40 Act funds in the US , they are required by regulation to maintain their securities and other investments with certain types of custodians designed to assure the safety of the fund ’ s assets . But they are undoubtedly taking an interest , whether it ’ s just keeping an eye on developments or actively trading - though this is mostly coming from new crpyo-dedicated hedge funds right now .
“ The most interest right now is from crypto first hedge funds , and family offices and the next wave are pension funds and endowments , who are starting to ask questions , then at some point in the future the traditional asset managers like the Vanguard ’ s and BlackRocks of the world ,” explains Sam McIngvale , product lead at Coinbase Custody . Nomura became the first bank to offer custody services for digital assets in May 2018 , while State Street has previously said to Global Custodian that “ servicing cryptocurrencies – whether it is from a custody , depositary or administration perspective – is something we would consider .” Providing access to these networks raises several know you customer ( KYC ) and anti-money laundering ( AML ) challenges , as well as exposure to high volatility , which have put off many banks . Kruger added that funds need to respect the wishes of these large and experienced institutions .
Respect their wishes “ If you meet a bank or custodian and they say ‘ we don ’ t want to touch crypto ’, for them they will have a very thin slither of exposure to crypto compared with the big business of traditional assets ,” he explained . “ If something goes wrong over there it ’ s way too much risk on their business and you have to respect that .” A report from McKinsey in March , however , said that custodians brave enough to venture into the cryptocurrency asset servicing world could be rewarded with significant revenues . The report argued that securities services providers could play an important role as custodians for crypto assets , which as
30 Global Custodian Summer 2018