How do crypto custodians make money?
Until recently, one of the missing pieces in the broader crypto ecosystem.
was an institutional-grade custody solution for crypto assets.
In 2019, that piece of the puzzle is finally in place and the crypto custody industry is booming.
Institutional investors have now found a way into the market and can choose from a variety of solutions that allow them to secure crypto assets in a safe, trusted and regulated manner.
Who are the players and what are the implications for the industry?
In traditional financial markets, a custodian is a financial institution that provides a secure storage service for financial assets to minimize the risk of loss or theft. Custodians hold securities in physical or digital form and are commonly referred to as custodians. In addition, custodians perform administrative tasks such as valuing assets on a daily basis, collecting dividend and interest payments, and recording expenses. The largest custodian banks in terms of 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 offer the same services but are tailored to institutional crypto investors. Crypto custodians store crypto assets securely for investors who want to minimize the potential loss of funds due to a lack of technical expertise or are required by law to use a qualified custodian. Due to the technical challenges associated with the safekeeping and management of crypto assets, crypto custodians provide an extremely important service.
Although the list of services varies from provider to provider, crypto custodians offer an enterprise-grade cold storage solution, fork management, asset insurance, a user-friendly dashboard, and round-the-clock customer service. Some custodians, such as Coinbase Custody, also offer staking support and participation in on-chain governance. Coinbase's solution shows where the near future of the industry is headed. Proof-of-stake blockchains have a strong impact on investments by providing passive income for completing simple tasks like on-chain reconciliations.
Barriers to participation include technical skills and asset storage considerations. Coinbase's solution is aimed at risk-averse institutions that want to participate in crypto networks such as Tezos, Decred or Augur without having to worry about storage or participation themselves. Coinbase Custody offers staking services to its clients as a non-discretionary escrow activity. Currently, most crypto custodians support Bitcoin and the largest altcoins by market cap. BitGo, Kingdom Trust, and Coinbase Custody support a broader range of digital assets.
How does crypto custody work?
Institutions seeking to buy and hold crypto assets lack the expertise to do so securely and on a large scale, and are legally unable to take on such risk. Instead, they turn to a regulated, insured, trusted third party, a professional crypto custodian. Each custodian uses its own customized, institutional-grade, air-cooled cold storage solution. Cold storage protects the private keys that provide access to cryptocurrencies.
Cold storage requires an additional manual step when accessing assets, but provides another layer of security. Most custodians also use a multi-signature approach, meaning that multiple parties holding different parts of the private key must jointly sign the transaction to access and move the assets. This avoids a single point of failure.
Who uses crypto custodians?
Custodians are used by financial institutions such as hedge funds, mutual funds, and RIAs that are required by regulation to hold their assets with a professional custodian. For example, U.S.-based funds with more than $150 million in assets under management are required by law to hold their clients' funds with a qualified custodian.
High-net-worth individuals and family offices may also use custodians to ensure the safety of their investments, while retail investors' funds are generally held in segregated accounts under the name of the investment advisor or broker.
In the crypto asset markets, SEC -registered crypto hedge funds, blockchain venture capital firms, RIAs, and family offices account for the majority of crypto asset custody clients. The number of pension funds and mutual funds investing is still small, as regulatory hurdles to investing in risky alternative assets remain significant for these types of funds. With the increasing recognition of cryptocurrencies as a legitimate asset class and the establishment of a regulatory framework, this is likely to change soon.
The crypto custody market is booming
In the first five months of 2019 alone, six new custodians have entered the market, while a number of existing crypto custodians have announced new features, such as an expansion of supported assets.
There have even been some mergers and acquisitions in the crypto custody market: BitGo attempted to acquire Kingdom Trust in early 2018, Bakkt acquired Digital Asset Custody Company this year, and Coinbase and Fidelity Digital Assets reportedly competed to buy Xapo.
In addition, a number of exchanges, including Coinbase, Gemini, and itBit, have launched custody services to attract more institutional investors to Bitcoin and other digital assets.
Given the level of activity in the crypto custody market, this is a positive sign, suggesting that there is significant demand from institutions for this type of service.
Meet the crypto custodians
Today, there are more than two dozen crypto custodians scattered around the globe. The twelve most prominent existing and soon-to-be-launched crypto custodian service providers are:
Anchorage is a startup crypto custodian backed by Andreessen Horowitz and a number of other prominent blockchain-focused VCs. The company describes itself as "the first crypto custodian of digital assets 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 aimed at professional market participants and financial intermediaries in Europe.
BitGo is a bitcoin storage solutions provider that launched a qualified custody service in 2018. The California-based company leverages its six years of experience as a security-as-a-service provider to offer custody of digital assets to financial institutions and fund managers.
Bakkt, a new crypto-asset venture backed by ICE and set to launch in July, will provide an entry point for Wall Street investors looking to start trading bitcoin in a regulated environment. In April, Bakkt acquired leading crypto-asset custodian, Digital Asset Custody Company, and partnered with leading custodian bank, Bank of New York Mellon, for geographically distributed private key storage to strengthen its custodian services offering for its upcoming digital asset trading ecosystem.
Fidelity Digital Assets is the recently launched crypto venture of bitcoin-friendly Wall Street giant Fidelity Investments Inc. The New York-based financial services provider launched its crypto custodian service in March and plans to offer trade execution soon.
Coinbase, a San Francisco-based provider of exchanges and wallets for digital assets, added a crypto custody service to its offerings in 2018. Coinbase Custody is a qualified custodian that allows institutional investors to securely store more than 30 digital assets with a regulated, insured third-party storage provider. In addition, Coinbase recently launched a crypto asset-staking service for its institutional custody clients.
The regulated digital asset exchange, Gemini, launched its qualified custody 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 client assets and funds are fully backed by required capital reserves.
Founded in 2017, different quality manager Kingdom Trust was one in every of the primary custodians to supply cryptocurrency storage solutions. Today, the Kentucky-based company could be a market-leading qualified crypto guardian with quality insurance through insurance big Lloyd's of London.
Koine, that is ready to launch in Gregorian calendar month, can provide custody and settlement of cryptocurrencies for institutional shoppers. The London-based startup is targeting commercialism venues, institutional investors, digital issuers and market infrastructure suppliers. As a part of its push to become a number one crypto guardian, Koine has noninheritable fintech company Recruitable Ltd (traded as "hireabl") to strengthen its client property capabilities.
Prime Trust could be a Las Vegas-based qualified crypto guardian that supports Bitcoin, ETH and ERC20 tokens. In April, Prime Trust secured a brand new spherical of funding semiconductor diode by bitcoin exchange OKCoin and has begun acting as a U.S. dollar entry for OKCoin users.
Xapo is one in every of the longest-standing bitcoin storage answer suppliers. Over the past 5 years, the Hong Kong-based company has grownup its assets to over 700,000 BTC (about $5.6 billion), creating it the biggest crypto deposit supplier within the world. Coinbase and Fidelity Digital Assets area unit reportedly in talks to amass Xapo.
In addition, leading monetary establishments like Bank of recent royalty Andrew 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, as an example, has been operating with 3 thought hedge funds finance in crypto since early 2018, in keeping with a report by Forbes, whereas BNY Andrew Mellon has partnered with Bakkt to supply personal key storage, as mentioned earlier.
Currently, however, specialised crypto custodians dominate the market as a result of they're ready to adapt to plug and regulative changes additional quickly than giant Fortune five hundred firms, whereas having the in-house technical experience required to confirm secure storage of crypto assets.
How do crypto custodians build money?
Just like custodians in ancient monetary markets, crypto custodians generate revenue by charging a share fee on assets below custody.
Most existing crypto custodians charge every client a personal fee that's not publically disclosed. However, some suppliers publish their fee structures on-line, that provides Associate in Nursing approximate summary of the fees incurred.
Coinbase Custody, as an example, charges 0.50 % for a minimum quantity of $1,000,000 and Associate in Nursing implementation fee that ranges from $0 to $10,000 betting on the shopper.
Gemini Custody charges zero.40 % and a $125 body withdrawal fee, however has no minimum deposit demand.
Prime Trust includes a fee model with no Aum for its crypto custody business and instead makes cash through interest on edict currency command moreover as alternative services.
Why crypto custodians area unit necessary
The crypto guardian market has become a hot topic within the crypto area, as custodians area unit one in every of the ultimate items of the puzzle required to bring recent institutional capital into cryptocurrency.
With a healthy variety of qualified crypto custodians to settle on from, together with some backed by major Wall Street companies, even conservative institutional investors could also be forced to diversify alittle share of their portfolios into bitcoin because the crypto market booms once more and creates vital new wealth.
Mutual funds and insurance funds, that have a number of the strictest investment restrictions, might presently be ready to venture into digital assets currently that the technical and cybersecurity risks of holding crypto assets are not any longer a problem.
While bitcoin has already become a thought investment for younger retail investors, it is not quite there nevertheless for institutional investors. Crypto pto custodians can facilitate amendment that. As a result, we have a tendency to might presently see the long-awaited institutional capital flow into Bitcoin.
With $100 trillion keep in ancient assets and a Bitcoin market capitalisation of simply $155,000 billion, there might not be a lot of standing within the manner of Bitcoin once inherited wealth on Wall Street finally acknowledges Bitcoin and begins to require a foothold to shoot past its 2017 incomparable high and eventually "fly to the moon."