Will Centralized Custody Solutions Save your Coins or Hurt Bitcoin?
If cryptos were digital elements, Bitcoin (BTC) would be the first digitally scarce element.
Because it’s the first, many globally are slowly but surely using BTC as a way to save and store wealth while speculating on the tech.
As a result, storage facilities that hold BTC are becoming important human capital holdings.
Traditionally people would store wealth in old elements such as gold, antiques, collectible items, real-estate, art, live stock and equity in businesses. Most of which are physical assets that have large central custody systems built around them to improve the efficiency and access.
For example, buying shares in Real Estate Investment Trusts (REITs) is a highly profitable way to gain exposure to real-estate and all thanks to REITs centralization of custody.
Today, we have a new store of wealth asset BTC which throws a wrench in the long tradition of centralized wealth storage. One reason for that is BTC is the first digitally scarce asset that anyone can self-custody, meaning we no longer are reliant on central agents to verify that your assets are your assets.
Yet, crypto self-custody does come with risks and a heavy burden of responsibility:
- High chance for human error while securing keys (losing private keys)
- Cyber attacks (exposing keys online)
- Incompatibility with inheritance (difficulty to pass crypto on)
- Difficulties for governments to tax their citizens
- May disrupt lending practices
- Crypto may encourage hoarding of wealth which, in turn, may cause an economic slowdown due to poor wealth circulation
- Difficulty for large institutions to self-custody due to the technical burden and strict regulations imposed on their investment practices
Bit of Old, a Bit of New
If managing and storing your own crypto is riddled with these problems it explains why we are seeing a spike in custody services coming online.
For example, Coinbase the number one recommended service for retail clients are managing a gigantic 5% of all Bitcoins.
However, many in the crypto realm would argue that custodians like Coinbase aren’t part of the original utopian P2P vision Satoshi Nakamoto had in mind.
But rarely do utopian visions come true. Including Satoshi’s. Reality tends to play out where the old and the new meet.
Borrowing from the old ways, current crypto exchanges like Coinbase have inadvertently become de facto crypto storage facilities of our time. Crypto exchanges broke the long traditional model that had custodian and trading mechanics separated and instead combined the two.
Having to juggle both the duties of a crypto custodian and that of a trading platform, exchanges have made many mistakes resulting in millions of dollars’ worth of stolen cryptos.
The risks associated crypto exchanges are now well known and the reaction to this has been on solutions that solely focus on crypto custody only.
The Secret Crypto Stash
Most of these custody only solutions take the form of quasi- old school institutional solutions, one of which is Xapo. When Xapo first came on the scene many criticized the solution as overpriced.
Why store with Xapo when you can self-custody for free one would ask.
Xapo reported in 2018 to manage 7% of all BTC and there’s a safe bet that figure is well over that today.
Quietly, Xapo has gained the lead, secretly managing the largest stash of Bitcoin in the world.
Grayscale Bitcoin Trust is one client of Xapos and Greyscale have been the only go-to investment vehicles for institutions to gain exposure to BTC.
Greyscale has reported to manage over 1% of all global BTC and where do they store their BTC? Good old Xapo.
Titens Enter the Arena
Nearly half of institutional investors (47%) view digital assets as having a place in their investment portfolios.— Fidelity Digital Assets, Crypto Division Research
When it comes to crypto custody, 2019 seems to be the year when the veterans come to play. With big names such as Fidelity and State Street just beginning to expand their offerings into crypto, we should also see others follow suit.
For example, computer giant IBM has just entered the crypto arena, and we at bitHolla are currently working in gather on secure and practical crypto custody solutions, combining IBM’s advanced HSM mainframes with our white-label exchanges.
Slow Transition Period
Despite all the media hype and name dropping, the truth is crypto assets such as Bitcoin are viewed by institutional investors like a diamond in the rough that has to be thoroughly polished before any will consider investing.
Crypto custody providers are thus wrapping up crypto in a tradition financial framework to make them more palatable for institutional investors.
Though the process is slow, the writings is on the wall, custody solutions are in great demand and once the red tape has been cut, it will garner huge legitimacy for crypto assets and mean the green light for institutional investors.
If all goes well, there should be a influx of new crypto adopters piling into crypto custody provides, which begs the question, what would be the cons of more centralized crypto custody services? Are we coming around full circle?
Lets take a look at some of the possible issues that come with the normalization of crypto custodians:
- Governments could easily seize wealth through the custody provider
- Custodians can report on assets making it easier to overtax citizens
- Big privacy concerns since custodians hold a load of sensitive data.
- More friction when moving crypto if clients must ask a permission from custody provider (defeating the purpose of crypto)
- With an opaque central storage of cryptos, rehypothecation and fractional reserve crypto banking are much easier to pull off
- False sense of security through security theater
On top of these issues, custody providers have to grapple with a new reality… Once cryptos are lost they are really lost forever.
Crypto custody comes with its own challenges. If they are ever to attract customers, providers will have to come up with enticing benefits.
Besides strong security, custodians would have to offer other perks such as high interest on crypto deposits, attractive loans and solid insurance which should make all the difference when attracting clients.
And although Bitcoin was invented as a reaction to the heavy centralization of our financial system, ironically much of the BTC is stored in a handful of companies, some might say “What a disaster!”, but it may be less of a disaster than it seems.
The takeaway is that crypto is now giving everyone the opportunity to take full custody of their finances, which will hopefully help balance our delicate financial system should it ever go off-kilter again.