On July 2, Coinbase announced the launch of its new custody service for institutional clients. In simple terms a custodian is a financial institution that holds assets on behalf of its clients to ensure that they are kept safe and secure. Custodians can hold financial assets in both electronic and physical form, depending on the asset and the client’s needs.
Additionally, custodians offer auxiliary services such as account administration, securities settlements, the collection of interest payments and dividends, and tax support. For its services, custodians charge fees based on the value of a client’s holdings.
Boston-based State Street, for example, is widely known as a ‘custodian bank’ as one of its core banking activities is to provide custodial services to large institutional clients.
In the cryptocurrency markets, a custodian service does the same thing but exclusively for cryptographic assets such as digital currencies and tokens. The strong appeal of using a custodian as an institutional investor in digital assets is that the technical process of securely storing digital assets is outsourced to a trusted third-party to minimize the risk of loss due to theft or operational errors.
Coinbase Custody launches with ambitious targets
“Coinbase Custody’s mission is to make digital currency investment accessible to every eligible financial institution and hedge fund in the world. Coinbase Custody is a combination of Coinbase’s battle-tested cold storage for crypto assets, an institutional-grade broker-dealer and its reporting services, and a comprehensive client coverage program.” the company said in its announcement.
Coinbase’s new custody service has reportedly already onboarding ten institutional investors and offers on-chain segregation of crypto assets, multiple layers of security, cold storage auditing and reporting, and split, offline private keys that require a quorum of geographically distributed agents to use cryptographic hardware to sign transactions.
Coinbase aims to onboard 100 institutional clients by year-end with five billion dollars of assets under management, on top of the $20 billion of retail funds it already holds.
Coinbase’s new custody service will be compliant with current regulations in the US as the company has partnered with SEC-regulated broker-dealer Electronic Transaction Clearing Inc to provide this service.
"We sort of have an understanding with the SEC and Finra, and it allows us to execute contracts with clients and take the first deposits," said Coinbase Custody’s Product Lead, Sam McIngvale.
The crypto custodian market is on a growth curve
Coinbase, however, is not the only company offering cryptocurrency custodianship to institutional investors. Japanese investment bank Nomura, for example, has recently announced the launch of a digital asset custodian venture called Komainu in partnership with Coinshares’ parent company Global Advisors and Ledger wallet creators Security Business Ledger.
The new custodian venture “is a progressive stepping stone towards the creation of the necessary prerequisites for further growth within the digital asset ecosystem. This will open new and exciting opportunities to global participants and contribute to move digital asset closer to mainstream offerings.”
Bitcoin payment processor BitGo has purchased the longstanding crypto custody service provider Kingdom Trust at the beginning of 2018 and announced in May that is launching an institutional-grade custody service for digital assets.
“If you’re an SEC-regulated fund over $150 million, you’re required to use a qualified custodian. You can’t just take some guy and have him hold your coins for you."
— BitGo CEO Mike Belshe
“What we’ve seen in the last year and a half is this massive shift where the new folks that want to get in — financial institutions and businesses — they would much prefer and much rather see custodial options,” BitGo CEO Mike Belshe told Bloomberg.
“If you’re an SEC-regulated fund over $150 million, you’re required to use a qualified custodian. You can’t just take some guy and have him hold your coins for you,” he added.
New York-based digital asset exchange Gemini has already been offering a segregated custodial service to its institutional clients since 2016. This service ensures that “client digital assets are segregated, using unique digital asset addresses in Gemini’s Cold Storage System, which are independently verifiable and auditable on their respective blockchains,” according to the company’s website. For providing its Segregated Custody Account, Gemini charges its clients 0.964 percent per annum of the amount deposited.
Crypto a challenge for establishment custodians
Crypto custodians have the potential to attract a substantial amount of institutional investor capital to the crypto asset markets as they alleviate operational risks related to investing in digital assets, which institutional investors will likely be willing to pay a few basis points for.
The more recognized brands or financial institutions start to provide state-of-the-art custodial services for cryptographic assets, the more institutional investors will be willing to diversify their portfolios into these assets.
For established financial institutions, however, the reputational and regulatory risk to roll out crypto custodian services may currently still be too high as most financial institutions find it too risky to be involved in an asset class that rightly or wrongly is perceived by many as helping facilitate money laundering and terrorist financing. This is a big concern for banks, for example, to get involved in actual cryptocurrencies transactions as opposed to trading regulated crypto-based investment vehicles such as Bitcoin futures on the CME or CBOE.
Having said that, once a regulatory framework is in the place for investing in bitcoin and its peers, we could expect more custodians emerging in this space who end up holding substantial sums of institutional money. Interestingly, State Street is mulling over adding digital asset custodianship to its range of services.