Custody 101

Custody solutions for digital assets: The necessary next step for institutional investors

Custody solutions are critical for the token economy to move into its next phase of growth. And they were needed yesterday. As reported by Bloomberg, Bitfinex is the latest exchange to suffer significant losses — allegedly some US$850 million in holdings — due to hacking.

This makes the case for custody clear. Over the past few years, digital asset markets have been experiencing exponential increases in losses — 2016: US$152mm; 2017: US$266mm; 2018: US$1,700mm — due to hacking, fraud and process failures. And with Q1 2019 already reporting US$1,200mm in losses and counting, the market is in need of reliable custody solutions and providers.

The value custody brings to digital assets

A custodian in traditional financial markets works as a holder of securities, as well as a manager and executor for a range of other services, including “account administration, transaction settlements, the collection of dividends and interest payments, tax support, and foreign exchange.” The market for custody is mature, sophisticated, and in many cases regulated (e.g. as in the United States). For digital assets, this is not the case. Not only is the market for custody solutions relatively nascent, there are also additional threat vectors which traditional custodians may not have the capability to manage atop process and control risks.

As digital assets are only accessible through private keys, custodians promise best-in-class security measures designed to protect them, thus allowing investors to trade with confidence. Custody also provides an extra layer of security support to exchanges, enhancing their credibility and assuaging concerns about the industry’s history of loss incidents. To quote Warren Buffet, “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.”

Custody also delivers value in the area of regulation. For example, according to SEC regulations, institutional investors managing over US$150,000 in client assets are obliged by law to solicit the use of a custodian bank to hold them. Similar regulations, if promulgated for digital assets, and will likely serve to bolster confidence in the token economy over time. Those who anticipate these legal developments and build future-ready custody solutions will only stand to benefit.

The challenges exchanges (and thus investors) are facing

With billions of dollars in digital asset deposits, exchanges have become prime targets for hackers. And as these exchanges are largely focused on delivering fast transactional capabilities, many are not spending the necessary time on digital security, thereby making them susceptible to competent hackers.

Hackers themselves are also becoming increasingly sophisticated in their methods. If exchanges do not have the wherewithal to develop robust security capabilities and internal controls, they would be well advised to outsource the safekeeping of their assets to more experienced and specialized firms.

Moreover, although wallet technology is advancing, it is not risk-free. For example, while hardware wallets are excellent alternatives to storing digital assets in online wallets, they are only as secure as the ability of the owner to protect them. Operational and process risk poses a significant challenge to this type of storage, as can be seen with the use of social engineering and other techniques. Also, if the hardware wallet is lost or disposed of by accident, it can mean the temporary or permanent loss of assets.

A robust custody solution protects against these risks.

Best practices in the provision of custodial services

While there are a growing number of custody solutions and providers for digital assets, not all are made equal. For institutional investors, there are three core requirements.

Experience peace of mind with ANXONE Custody Solutions

ANXONE Solutions offers a world-class proprietary digital asset custody solution, boasting a zero incident track record. Our full-suite solution features a frozen wallet that only communicates with whitelisted wallet addresses and safe-keeps your assets, as well as a cold wallet that acts as another level of security before withdrawals are executed. Our cold wallet infrastructure is built in a military grade Faraday cage and is insured through a panel of international insurance underwriters and arranged by Aon.

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