Cryptocurrency Custodians May be Far More Important Than You Think

Blockchain adoption has been coming along quite nicely, with hundreds of new funds entering the space, institutional quality investors dipping in their toes, and corporate users testing out their own use cases.

But institutional investors holding cryptocurrency often worry about the safety of their digital coins. They have good reason to be concerned.

Hackers in the cryptocurrency world are technologically savvy and dedicated.

A Range Of Cryptocurrency Heists

There have been more than three dozen cryptocurrency exchange heists since 2011, allowing thieves to make off with more than 980,000 Bitcoins in total. Security firm CipherTrace said in early July that $731 million dollars worth of virtual currency was swiped during the first half of the year.

Some choose to turn to hardware wallets in order to secure cryptocurrency. But these types of devices might not be exactly what they seem.

TechCrunch reported in March how 15-year old Saleem Rashid was able to find a flaw in Ledger’s hardware wallet that could let hackers obtain PIN numbers for the device.

These types of security issues have raised the alarm for many digital currency holders who are now wondering how they can actually keep their assets safe.

As a result, many institutional investors and larger funds have, until now, stayed away from the virtual currency market in general because they don’t see a safe and easy way to access the industry and protect their money.

Custodial Services Enter The Picture

But things are rapidly changing. A growing market of cryptocurrency custodial services is now taking shape to give investors looking to enter the market peace of mind.

The emergence of cryptocurrency custodians is a great sign for the future of the industry. Their presence draws in more investors, and crypto-specific firms understand the intricacies of digital money like Bitcoin and Ethereum better than traditional institutions.

“I knew that 2018 would be the year of “adult supervision” in the crypto space, and it has come to pass. This is the year that we are seeing significant, albeit early, involvement from larger institutional-quality holders and investors. Even the ICOs have grown in size to be large holders all their own”

— Pamela Day, CEO and founder of Paladin Trust, one of the first crypto custodian shops.

There are several reasons why cryptocurrency holders need to use a custodian:

1) Safety: A quick glance at cryptocurrency news should tell you one thing: exchanges are definitely not a safe place to store digital assets. And using digital or paper wallets can be cumbersome.

Instead, everyone, especially institutional investors, should use a custodian to keep their digital coins safe.

Unlike banks, who keep a record of users’ transactions and can, in theory, fix any mistakes, distributed technology is currently unyielding to mistakes. There is no central authority to call up if your coins go missing, or you type in the wrong wallet address for a transfer.

Once it’s gone, it’s gone and there is zero method for undoing a mistake. This inflexibility scares most stewards of capital into needing another party to handle the risk of holding the currency.

Many custodial services have a wide array of safety features and protocols that are currently unmatched in today’s world. They also have the expertise and training to use the technology, so most larger investors choose to “leave it to the professionals” to perform the technical handling.

2) Convenience: It’s not news that there are a lot of ICO scams out on the market. An April study from the New-York based Satis Group LLC looked at publicly available information and claimed up to 80% of all ICOs were scams.

It’s pretty clear sending Ether or Bitcoin to an unknown wallet during an ICO can be a huge risk for investors.

That’s when a custodian comes in. In the offline financial world, companies doing an IPO cannot touch the money until the raise is finalized. Then, everyone gets the same pricing.

In the ICO world, however, investors are exposed to making investments in untested companies, using an investment vehicle (usually bitcoin or Etherium) which itself is wildly fluctuating.

An investor may place $100k into an ICO, only to have the value of ETH cut in half in the market, rendering his/her investment only 50% of expectation, and the company hasn’t even started yet.

And what if the company doesn’t complete the capital raise?

Markets change. Governments intervene. It’s highly probable that the ICO will not be completed in the time-frame expected.

What recourse do investors have? Without a custodian, nothing.

But with a custodian wallet handling the capital during the raise, all of those issues are pre-negotiated and handled by the custodian.

“Paladin was originally founded to fix the ICO investment problem”, Day said. “I was losing money in ICO investments because the value of ETH or BTC was fluctuating while I was waiting for my ICO to peg its value. It was outrageous. I swore I would never invest in an ICO again unless it had investor protections and hedging that a custodian provides”.

The SEC would be pleased.

3) Large Holders Need Treasury Management: An unforeseen missing piece in new crypto currency based companies is the challenge of financial management.

Many ICO companies do not have a treasurer or even a CFO, and they definitely don’t have a full time trader to convert their crypto to fiat. Liquidating crypto to pay for salaries and rent is not a simple task.

And what nobody told the entrepreneurs is the banks do not like crypto businesses. So many post-ICO companies found themselves unbanked and cash poor, despite highly valued crypto holdings.

“We were very surprised at how many great technical companies who completed successful ICOs were unbanked and struggling for treasury management.” Day said. “Their attorneys and advisors never told them about the real nuts and bolts of running a crypto business after the capital raise.”

Instead of trying to manage things yourself, ICO companies began turning to Paladin to hold, liquidate or hedge their holdings for them.

“It allowed many of our clients to put off needing to hire a CFO for a while.”, Day said. “Paladin just manages their funds for them.”

4) Technical protocols for digital assets storage are not user friendly and do not integrate with existing platforms: Cryptocurrency custodial services are expected to revolutionize the world of digital coins.

Sam McIngvale of Coinbase projects about $20 billion dollars’ worth of cryptocurrency assets are set to flow into custody services once they are fully available.

This figure will probably only grow higher as time passes and more and more institutional investors understand how valuable custody services really are. However, the new and growing software platforms that track cryptocurrency holdings such as Libra do not integrate easily into traditional banking or custody software.

Furthermore, the technical steps and protocols to moving crypto assets are extremely different than moving fiat in the software banks and institutions currently use.

Shifting to Custodians To Mitigate Risk

For this reason, most staff at traditional financial services companies have incomplete training in moving and handling crypto assets. The training and future system integration required to make crypto assets usable and manageable to financial institutions has not even begun to be formed.

Banks and financials institutions have smartly steered away from what could be financial risk exposure from mishandling and mistakes.

They gladly turn it over to the crypto custodians.

(Images courtesy of Pexels)