Institutional-grade crypto custody solutions have arrived. Now what?

In traditional financial markets, a custodian is a financial institution that provides a secure storage service for financial securities to minimize the risk of loss or theft. Custodians hold securities in physical or digital form and are usually referred to as custodian banks. Additionally, custodians handle administrative tasks such as daily asset pricing, the collection of dividends and interest payments, and expense tracking, amongst others. The largest custodian banks measured by assets under management include Bank of New York Mellon, State Street, JP Morgan, Citigroup, and BNP Paribas.

What is crypto custody?

In the blockchain space, custodians provide the same services but tailored to institutional crypto asset investors. Crypto custodians securely store crypto assets for investors who want to minimize the potential loss of funds due to a lack of technical expertise or are required to use a qualified custodian by law. Due to the technical challenges involved in securely storing and managing crypto assets, crypto custodians provide a critically important service.

While the specific list of services differs from one provider to another, crypto custodians offer an enterprise-grade cold storage solution, fork management, asset insurance, a user-friendly dashboard, and around the clock customer service. Some custodians, such as Coinbase Custody also offer staking support and on-chain governance participation. The Coinbase solution shows where the near future of the industry is heading. Proof-of-stake blockchains have powerful investment implications because they offer passive income for completing simple tasks such as on-chain voting.

Barriers to participation include technical ability and asset storage considerations. Coinbase’s solution caters to risk-averse institutions seeking exposure to participation focused crypto networks such as Tezos, Decred or Augur, without wanting to deal with the storage or participation duties themselves. Coinbase Custody offers staking services as a non-discretionary fiduciary activity to its clients. At present, most crypto custodians support bitcoin and the largest altcoins by market capitalization. BitGo, Kingdom Trust and Coinbase Custody support a wider array of digital assets.

How does crypto custody work?

Institutions who wish to buy and hold crypto assets lack the expertise to do this in a safe and secure way, at scale and are legally unable to take on this level of risk. Instead, they will use a regulated, insured, trusted third party, a professional crypto custodian. Each custodian utilizes its own bespoke institutional-grade air-gapped cold storage solution. Cold storage protects the private keys that provide access to crypto assets.

Cold storage adds a manual step to the process of accessing the assets but provides another layer of security. Most custodians also use a multi-signature approach, meaning that to access and move the assets, multiple parties holding different parts of the private key need to sign the transaction together. This mitigates against one single point of failure.

Who uses crypto custodians?

Custodians are used by financial institutions, such as hedge funds, mutual funds, and RIAs, who are required to hold their assets with a professional custodian for regulatory reasons. US-based funds with over $150 million assets under management, for example, are legally required to keep their clients’ funds with a qualified custodian.

High-net-worth individuals and family offices may also use custodians to ensure that their investment holdings are kept safe while retail investor funds are usually held in segregated accounts under the investment advisor or brokerage’s name.

In the crypto asset markets, SEC-registered crypto hedge funds, blockchain venture capital firms, RIAs, and family offices make up the bulk of crypto asset custody clients. The number of pension funds and mutual funds that are investing is still small as the regulatory hurdles to invest in high-risk alternative assets for these types of funds remain considerable. As crypto becomes increasingly recognized as a legitimate asset class, and the regulatory framework falls into place, eventually this is likely to change.

The crypto custody market is booming

In just the first five months of 2019, six new custodians have entered the market while a number of existing crypto custody providers have announced new features, such as an expansion of supported assets.

There has even been some M&A activity in the crypto custodian market with BitGo attempting to acquire Kingdom Trust in early 2018, Bakkt acquiring Digital Asset Custody Company this year, and Coinbase and Fidelity Digital Assets reportedly competing to purchase Xapo.

Moreover, a number of exchanges, including Coinbase, Gemini and itBit, have launched custody services in a push to introduce more institutional investors to bitcoin and other digital assets.

Given the amount of activity in the crypto custody market, this a bullish sign indicating that there is substantial demand from institutions for this type of service.

Meet the crypto custodians

Today, there are over two dozen crypto custodians scattered across the globe. The twelve most notable existing and soon-to-be-launched crypto asset custodial services providers are:

Anchorage is a newly-launched crypto custody firm backed by Andreessen Horowitz and a number of other prominent blockchain-focused VCs. The company refers to itself as “the first crypto-native digital asset custodian for institutional investors.”

Bank Frick is a Liechtenstein-based private bank that offers a range of blockchain banking services, including token launch support, crypto trading, and digital asset custody. The regulated bank’s services are targeted at professional market participants and financial intermediaries in Europe.

BitGo is a Bitcoin storage solutions provider that launched a qualified custodian service in 2018. The California-based company leverages its six years of experience as a security-as-a-service provider to provide financial institutions and fund managers with digital asset custodianship.

The new ICE-backed crypto asset venture, Bakkt, which is expected to go live in July, will provide an on-ramp for Wall Street investors who want to start trading Bitcoin in a regulated environment. In April, Bakkt acquired leading crypto asset custodian, Digital Asset Custody Company, and entered into a partnership with leading custody bank, Bank of New York Mellon, for geographically-distributed private key storage to bolster its custodial service offering for its upcoming digital asset trading ecosystem.

Fidelity Digital Assets is the recently launched crypto venture by bitcoin-friendly Wall Street giant, Fidelity Investments Inc. The New York-based financial services provider launched its crypto custody service in March and plans to add trade execution soon.

San Francisco-based digital asset exchange and wallet provider, Coinbase, added a crypto custody service to its offering in 2018. Coinbase Custody is a qualified custodian that enables institutional investors to store over 30 digital assets securely with a regulated, insured third-party storage solutions provider. Additionally, Coinbase recently introduced a crypto asset staking service for its institutional custody clients.

Regulated digital asset exchange, Gemini, launched its qualified custodian service for institutional investors in 2018 to combine secure digital asset storage with its popular trading platform.

New York-based digital asset exchange itBit launched a crypto custody service last year to complement its exchange and OTC business. As a regulated New York State Trust Company, itBit ensures that all customer assets and funds are fully backed by mandatory capital reserves.

Alternative asset custodian Kingdom Trust launched in 2017 and was one of the first custodians to provide crypto asset storage solutions. Today, the Kentucky-based company has become a market-leading qualified crypto custodian with asset insurance provided by insurance giant, Lloyd’s of London.

Koine, which is scheduled to launch in June, will offer crypto asset custody and settlement for institutional clients. The London-based startup is targeting trading venues, institutional investors, digital issuers, and market infrastructure providers. As part of its push to become a leading crypto custodian, Koine has acquired the pre-launch fintech company, Recruitable Ltd (trading as “hireabl”), to strengthen its client onboarding capabilities.

Prime Trust is a Las Vegas-based qualified crypto custodian that supports Bitcoin, ETH, and ERC20 tokens. In April, Prime Trust secured a new round of funding led by bitcoin exchange, OKCoin, and has started to act as a US dollar gateway for OKCoin users.

Xapo is one of the longest-standing Bitcoin storage solution providers. In the past five years, the Hong Kong-based company has grown its assets in storage to over 700,000 BTC (around $5.6 billion), making it the largest crypto custodian in the world. Coinbase and Fidelity Digital Assets are reportedly in talks to acquire Xapo.

Additionally, leading financial institutions such as Bank of New York Mellon, State Street, Northern Trust, and Goldman Sachs have reportedly been exploring crypto custody as a possible addition to their existing service offerings.

Northern Trust, for example, has started working with three mainstream hedge funds who are investing in crypto assets since early 2018, according to a report by Forbes, while BNY Mellon, as mentioned earlier, has partnered with Bakkt to provide private key storage.

For now, however, specialized crypto custodians are dominating the market as they have the ability to adjust to market and regulatory changes quicker than large Fortune 500 companies while also possessing the required in-house technical expertise to provide secure storage for cryptographic assets.

How do crypto custodians make money?

Just like custodians in the traditional financial markets, crypto custodians generate revenue by charging a percentage fee on assets held.

The majority of existing crypto custodians charge each customer a personalized fee that is not publicly shared. A number of providers, however, share their fee structures online, which provides an approximation of the fees involved.

Coinbase Custody, for example, charges 0.50 percent for a minimum of $1,000,000 plus an implementation fee that ranges from $0 to $10,000 depending on the customer.

Gemini Custody charges 0.40 percent plus a $125 administrative withdrawal fee but has no minimum deposit requirement.

Prime Trust has a zero AUM fee model for its crypto custodian business and instead, makes money by earning interest on fiat currency held as well as other services.

Why crypto custodians matter

The crypto custodian market has become a hot topic in the crypto space as custodians are one of the final pieces of the puzzle needed to attract fresh institutional capital into crypto.

With a healthy number of qualified crypto custodians to choose from, including some backed by major Wall Street firms, if the crypto market booms again, creating significant new wealth, even conservative institutional investors may eventually be forced to diversify a small percentage of their portfolio to bitcoin.

Mutual funds and insurance funds, who have some of the strictest investment constraints, may soon be able to start venturing into digital assets now that the technical and cybersecurity risks of holding crypto assets are no longer an issue.

While bitcoin has already become a mainstream investment asset for younger retail investors, for institutional investors it is not there quite yet. Crypto custodians will help change this. And as a result, we may soon begin to see the long-awaited institutional capital flow into bitcoin.

With $100 trillion stored in traditional assets and a bitcoin market capitalization of just $155,000 billion, once old money on Wall Street finally recognizes bitcoin and starts taking a position, there may be not much in the way for bitcoin to shoot past its 2017 all-time high to finally go “to the moon.”