This holiday season, consumers are eager to give the gift of crypto, with an estimated 10% of Americans looking to buy a cryptocurrency, like Bitcoin, Ethereum, or Dogecoin, for their family members and friends. This surge in popularity is also raising questions about digital asset custody.
A recent report, “An Evaluation of Digital Asset Custody Solutions,” researched by The Block and commissioned by Fireblocks, explores and evaluates the range of custody options in the digital currency space, highlighting that there is no “Bitcoin customer service department.”
Once digital assets are transferred from one party to another, transactions are final and immutable. In 2014, one user accidentally sent 800 bitcoins to the wrong address, and hasn’t confirmed if they were ever returned. This is why placing controls on how digital assets are stored and transacted, also known as “digital asset custody,” is an important consideration for operators in the industry.
The report from Fireblocks and The Block examines the important distinction between public keys, which can theoretically be used by anyone to send funds to the individuals or entities in control of the public address, and private keys, which provide control over the digital assets themselves. That means effective private key management is a paramount concern.
Given the easily quantifiable financial risks and the significant reputational risks associated with key management, a diverse landscape of digital asset custody solution providers has emerged. The report points to how operators in the landscape can broadly be classified as custodians, technology providers, and hybrid operators.
Custodians perform key management, and therefore assume the risk associated with any safekeeping. These custodians are usually regulated financial institutions, which means they are typically licensed under local domicile regulations. Coinbase serves as a helpful example of this model.
By contrast, technology providers offer computer software and hardware solutions that enable their customers to establish custody of their own assets. Fireblocks, an enterprise-grade platform that delivers a secure infrastructure for moving, storing, and issuing digital assets, exemplifies the technology provider model.
Meanwhile, hybrid providers, such as BitGo, provide custody solutions and also function as tech providers in delivering solutions that enable companies to establish custody over their own assets.
Although security, accessibility, and even insurance limitations are recognized as some of the biggest challenges for operators, the report also points out a more fundamental question that needs to be asked:
“Do we outsource the safekeeping of our business and/or client assets to a custodian (i.e., sub-custody)? Or do we partner with a technology provider to safe keep assets internally (i.e., direct custody)?
The report examines whether a firm’s needs are best met by outsourcing custody of assets to a third-party custodian or by partnering with a technology provider and retaining custody over their own assets.
By retaining custody over their own assets, firms can withdraw, deposit, and transfer assets on a 24/7 basis and avoid the “closed-loop” nature of some sub-custody relationships, whereby they would be required to trade through their sub-custodian’s venue. This could be a critical factor for allowing firms to rapidly and opportunistically deploy capital in a fast-moving digital asset market – an action that could be severely limited if they outsourced custody to a third party that needed to be contacted to retrieve assets from cold storage.
Finally, the report concludes that in the short term it will take significant time and resources for traditional firms to develop custody platforms and the related products and services they rely on (i.e., digital asset prime brokerage services).
But in the long-term, trillions of dollars in value will likely be tokenized into liquid, fungible, and non-fungible blockchain-based assets. As the report explains, “All signs point to traditional financial firms, incumbent digital assets custodians, and technology providers all playing an important role in this rapidly evolving and competitive market.”
You can read the report in full here.
About the authors:
The Block is an information services company founded in 2018. Its research arm, The Block Research, produces research content that covers the digital asset, fintech and financial services industries.
Fireblocks is an enterprise-grade platform delivering a secure infrastructure for moving, storing, and issuing digital assets. Fireblocks enables exchanges, lending desks, custodians, banks, trading desks, and hedge funds to securely scale digital asset operations through the Fireblocks Network and MPC-CMP Wallet Infrastructure. Fireblocks serves over 725 financial institutions, has secured the transfer of over $1.75 trillion in digital assets, and has a unique insurance policy that covers assets in storage & transit.