Hi all!
Things seem to be getting even more intense on the macro conversation front, with Bank of England governor Mark Carney publicly talking about the need to rethink the global monetary system and expressing concern about the dollar’s hegemony. This was echoed in a slew of conversations in mainstream and crypto circles on the potential impact of currency wars and the role of central banks going forward.
And Libra is back in the news, with continued regulatory scrutiny starting to spook some of the high-profile backers.
THE BRIEFING this week looks at crypto custody, and how part of the problem is that we are not sure what we even mean by that. If you haven’t read our introductory report on Crypto Custody, you can download it here.
Read on…
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The Crypto Custody Conundrum: What Are We Even Talking About?
The crypto asset sector is notorious for its confusing use of vocabulary. Seriously, in what sense is a sequence of code a “coin”? And in the real world, “wallets” contain things, not intangible addresses.
The same can be said of the word “custody.” A complicated word at best, the traditional common law definition is being applied to crypto assets, with the result that most investors believe it means the same thing: the authorized safekeeping of property rights. It doesn’t. This confusion is even more damaging than other misconceptions, as custody is not only an integral part of the security of an investor’s holdings; it is also a fundamental aspect of the emerging regulatory framework.
What’s more, the confusion is being overlaid onto an already baffling web of protections around the concept of asset custody, which highlights the colossal complication of establishing uniform rules and expectations. Solutions that employ best practices are emerging, which should reassure institutional investors interested in crypto assets; but without greater clarity on what we’re even talking about, it is unlikely that a coherent framework will emerge in the short term, adding a further layer of risk onto a compelling alternative investment.
C is for Custody
First, let’s look at the official definition of the word: oh wait, there isn’t one.
“Custody” is not a legal “term of art,” which means that it does not have a specific definition. The term could refer to a legal relationship, or it could be used generically to imply the holding of an asset. Treatment of the concept differs between and even within states, and federal application is often different again. “Custody” can imply transference of ownership, or merely third-party authorization, and does not always come with the guarantee of protection in case of custodian default.
Confusingly, we all tend to think we understand what custody means, but we don’t. Even official agencies often apply the term inconsistently.
One aspect most seem to agree on, however is that “custody” implies the “holding” of something. In a 2003 amendment to the Investment Advisers Act of 1940, the U.S. Securities and Exchange Commission (just one of many official bodies that oversee custody of investment assets) attempted a formal definition:
“An adviser has custody of client assets… when it holds, ‘directly or indirectly, client funds or securities or [has] any authority to obtain possession of them.’”
But this still falls short of specifying what custody is.
Focusing on the word “holds,” we can start to glimpse how crypto assets can send this definition – and all others that rely on the pillars of “ownership” and “trust” – into a spin.
C is for Complication
For the purposes of this conversation, we’ll be focusing on bitcoin; it currently dominates the crypto asset market, and serves as the gateway for most investors, given its relative liquidity and variety of on-ramps.
Ownership of traditional assets tends to rely on ledger entries. On some computer somewhere, you are listed as the owner of a certain asset. It doesn’t matter who holds that database – only you are the owner.
Bitcoin, however, is a bearer asset, and as such, has no names attached. Instead, bitcoins are associated with addresses, which in turn are associated with “wallets.” The assets themselves don’t live in the wallets, nor in a a central depository, nor in the account of the issuer; they live on the bitcoin blockchain, a decentralized global network with no identifiable accountability.
Whoever holds the private key to those wallets “owns” the bitcoin, in that he or she has the exclusive right to move them. Again, no names or proofs of ownership are necessary – possession of the private key is enough.
So, how do you confer “custody” without handing over, or sharing, the private key? But if you hand over the private key, you effectively hand over ownership. If a custodian has equal access to the code that can move your bitcoin, it has as much ownership as you do. Custody is generally understood to be about holding something of yours, on your behalf.
C is for Consent
“Multisig” options protect your bitcoin to the extent that more than one private key signature is needed for a transaction – but that also implies a sacrifice of ownership. Your custodian could not move your bitcoin without your consent, but nor could you move it without your custodian’s consent.
Sure, a custodian can commit by contract to recognizing that, although they hold the asset, they recognize that it is really yours.
But then trust comes into the equation. What if the custodian disappears? In theory, traditional securities can be returned to their rightful owners in case of custodian default. With bitcoin, there’s little reassurance that will happen, especially since regulatory protections are scant.
Part of the reason is that globally accepted standards do not yet exist. Associations such as GDF are drafting “best practices” in collaboration with industry participants, but getting agreement on the detail and the application will take time.
C is for Consumer
In an attempt to add clarity, in July the SEC and FINRA issued a joint statement highlighting concerns about the custody of digital securities by broker-dealers. They point out that the application of the Customer Protection Rule, which protects a client’s holdings in the event of a broker-dealer collapse, is unlikely to apply in the case of crypto assets.
Even if a holder “shares” private keys with a custodian, how does the custodian know that others don’t also have access? With this possibility, how can it ensure safekeeping? How can it be certain that the client’s access point can’t be compromised? The inability to reverse or correct transactions may be one of bitcoin’s value propositions for holders, but it is a significant concern for custodians and regulators.
The statement goes even further in highlighting the barriers of disjointed definitions: a failed broker-dealer would be liquidated in accordance with the Securities Investor Protection Act, which has a different understanding of the term “security” than that of the SEC. This leaves broker-dealer clients who have invested in crypto assets without protection, which the SEC is understandably uncomfortable with.
Obviously, any clarity at all is better than none, but the statement is limited in that it refers to digital securities held by broker-dealers – according to most regulators, bitcoin is not a “security,” and many bitcoin holders bypass broker-dealers by buying directly on exchanges. It does, however, underline the concern at regulatory level about the lack of understanding and standardization.
C is for Challenge
So, being a “custodian” for bitcoin is a totally different proposition from being a custodian for traditional assets. And yet we persist in using the same word.
This makes it harder for newcomers to the sector to get their heads around the nature of this new asset class. It also makes it even harder for regulators to establish a coherent framework, when the standard understanding of “ownership” and “liability,” fundamental pillars of the custody concept, crumble under the crypto lens.
Symbolic words such as “coin” and “wallet” have good intentions – they give us a frame of reference. But in the case of “custody,” the misplaced metaphor adds to confusion more than it subtracts.
Throughout history, the development of technology has easily outstripped the emergence of a vocabulary that fits the new concepts. Metaphors are employed to facilitate comprehension, and they usually work. Often the expropriated words change in meaning thanks to their new applications (what do “web” and “net” mean to you today?).
But sometimes the semiotics encroaches onto areas where vocabulary needs to be specific in order to have impact: that of law. The use of the term “custody” to refer to the authorized safekeeping of private keys, and “custodian” to refer to the provider of this service – areas which call for the comfort of regulatory protection – are prime examples.
Coming up with a new term might help, and might even set a precedent on how establishing specific definitions to use across jurisdictions and mandates could facilitate and strengthen oversight. But a systemic barrier is the fragmented nature of financial regulation in the U.S. and elsewhere – who would decide on that new term and its definition?
Not all barriers are unsurmountable, however – and with so much at stake, coordination could perhaps be achieved. Meanwhile, the sector continues to mature. In the case of bitcoin and similar crypto assets, the problem is not so much that crypto custody is so different from traditional security custody – it’s that we’re trying to fit a new concept into an old box that doesn’t have the same dimensions.
– Noelle Acheson
For a basic primer on crypto custody, check out our new report which you can download for free here.
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* six especially interesting entries in case you're short on time 'cos who isn't
BIG IDEAS
*Bitcoin is Not Too Slow (Unchained Capital) – A bird’s-eye view of bitcoin’s emerging role in the stream of evolution. Favorite quote: “Every other problem that bitcoin will have to overcome is more pedestrian relative to scarcity.”
The Impact of the Global Currency Race on Bitcoin (Arca Funds) – It’s one thing to be skeptical of the traditional financial system – it’s another to expect change overnight.
The Faketoshi Circus: Even Bitcoin Can’t Escape the Politics of Money (CoinDesk) – Why do the crypto sector’s shenanigans seem particularly absurd? Because, unlike other new technologies, this one’s about money.
Crypto means cryptotheology (TechCrunch) – Jon Evans spins another intriguing take on the impact of bitcoin’s culture on its outlook, this time with an historical overlay.
Weighing a new risk tool for bitcoin (New Money Review) – The intensifying development of new crypto derivatives could be paving the way for deeper liquidity.
*What I’m Waiting to See… (Drew Hinkes) – A peek into the future (from a self-professed cloudy crystal ball) – not what Drew wants** to happen to crypto governance and token issuers, but what he thinks will.
Crypto Funds Are Outperforming; You Shouldn’t Be Surprised (CoinDesk) – Josh Gnaizda of Crypto Fund Research shows that crypto funds haven't done nearly as badly since the beginning of the bear market as most of us think, and dispels some myths about the sector.
Winklevoss twins on crypto: Wall Street has been asleep at the wheel (CNN, video) – The founders of crypto exchange and trust company Gemini talk to CNN’s Poppy Harlow about the opportunity and risks of bitcoin. Favorite quote: “Unlike the internet, which you couldn’t buy a piece of, you can actually buy a piece of this new internet money.”
Crypto exec: The vast majority of people are using bitcoin for trading (CNBC, video) – Marcus Swanepoel, CEO of crypto platform Luno, talks about the influence of China on bitcoin markets (“a factor, but not _the_ factor”), the split between speculation/investing and actual use (90/10), and bitcoin in the macro narrative.
Arianna Simpson (@AriannaSimpson) acknowledges bitcoin’s dominance in market narratives, but points out the risk of overlooking other crypto assets when it comes to seeking outperformance.
MARKETS
Hedge funds up 0.62 per cent in July, says Eurekahedge (HedgeWeek) – The Eurekahedge Hedge Fund Index monthly increase brought the year-to-date return to 6.5%; in contrast, the Eurekahedge Crypto-Currency Hedge Fund Index fell 5.9 % in July, but has grown by 76.5% since the beginning of the year.
CoinFLEX rolls out market maker incentive program as it eyes moonshot triumph over BitMEX (The Block) – Top market makers will get a $250,000 rebate if daily volumes for XBT/USDT futures on CoinFLEX hit $500 million, plus a $1m bonus if those volumes surpass those of BitMEX.
Incentive programs are sweeping crypto exchanges, but they look different from Wall Street’s (The Block) – A deeper look into the rebate programs that some crypto exchanges are adopting, and what this says about overall ecosystem development.
Crypto derivatives traders are abandoning Telegram for a newly launched chatting app to do large trades (The Block) – Netherlands-based crypto derivatives platform Deribit has switched from using Telegram for its OTC block trades, to a new messaging platform called Paradigm.
Gemini Heads Down Under With Crypto Exchange Launch in Australia (CoinDesk) – In the exchange’s fifth international move, Australian users will now be able to buy and sell five cryptocurrencies on Gemini, including including bitcoin, bitcoin cash, ethereum, litecoin, and zcash.
PROFILES
Investor Highlight: Matthew Walsh, Castle Island Ventures (ErisX) – The “Money Thesis” vs the “Tech Thesis”, and what’s holding back institutional investment.
CRUNCHING NUMBERS
BTC Realized Cap Passes $100 Billion (CoinMetrics) – This metric measures the market value of all bitcoins at their last traded price, which isolates the total figure from price swings. Analysis also shows that the majority of coins that were bought above $13,000 have been sold, which means that “capitulation” is most likely almost complete.
Deep Dive Into Crypto-Asset Fundamental Analysis: Slides and Recording (IntoTheBlock) – A recording of a webinar hosted by IntoTheBlock on how analysis of blockchain data can hint at investor behavior.
Bitcoin Cash vs. Bitcoin SV: What Data Tells Us 10 Months After the Hash Wars (Jesus Rodriguez) – How have BSV and BCH evolved, and which has the stronger fundamentals?
CryptoCompare’s July 2019 Exchange Review (CryptoCompare) – A detailed breakdown of crypto exchange activity, which shows (among other insights) that almost half of bitcoin trading is US$-based (with 4% growth), and that yen-based trading grew 25% vs June.
Around The Block 8/23 (Blockforce Capital) – A look at the Sharpe ratio of bitcoin vs that of the S&P500 showing that bitcoin’s excess return has been over 1 for all but a few of the past few years.
Bitcoin actually dominates 90% of the market: report (Decrypt) – A resurfacing of a report we referenced a couple of weeks ago, which shows that the standard measure of bitcoin dominance does not paint the real picture.
REGULATORS AT WORK
Switzerland Meetings Didn’t Clear US Lawmaker’s Doubts on Facebook’s Libra (CoinDesk) – Congresswoman Maxine Waters (D-CA), who also heads the House Financial Services Committee, said in a statement that her recent meetings with regulators in Switzerland left her with doubts over “allowing a large tech company to create a privately controlled, alternative global currency.”
Facebook Libra Already Facing an EU Antitrust Probe: Report (CoinDesk) – According to Bloomberg, the European Commission is currently investigating potential anti-competitive behavior by the Libra Association, based on the suspicion that it could unfairly lock out competitors.
US Secretary of State Says Crypto Should Be Regulated Like SWIFT (CoinDesk) – In an interview with CNBC’s Squawk Box, Michael Pompeo has said he believes that cryptocurrencies should be regulated in the same way as all other electronic financial transactions.
Swiss Regulator Licenses Two New Blockchain Companies as It Shores up Legal Requirements (CoinDesk) – As well as issuing “banking and securities licenses” to SEBA Crypto AG and Sygnum AG, making them the first broker-dealers in Switzerland with a specific blockchain focus, Swiss financial authority FINMA also offered guidance this week on anti-money laundering requirements for blockchain-based companies.
Tether to Issue Stablecoin Backed by Yuan in Belgian Bank: Insider (CoinDesk) – Zhao Dong, an over-the-counter (OTC) trader in China and a shareholder of crypto exchange Bitfinex – which shares managers and owners with Tether – revealed the move on WeChat on Wednesday, saying Tether plans call the stablecoin CNHT.
It Took 18 Months, But This Blockchain Securities Firm Got the Nod From FINRA (CoinDesk) – IOI Capital and Markets plans to act as a placement agent for privately placed, digital securities on a permissioned Hyperledger Fabric blockchain.
SECURITY TOKENS
SEC Approves Blockchain Tech Startup Securitize to Record Stock Transfers (CoinDesk) – Securitize, a provider of technology for issuing blockchain-based tokens, has registered as a transfer agent with the U.S. Securities and Exchange Administration, which means it can now act as the official keeper of records about changes of ownership in securities.
STABLECOINS
*Where stablecoins are headed (Linda Xie) – There is a market for both centralized and decentralized stablecoins, but the former are likely to end up with the larger market size.
Beyond USD: The Next Frontier for Stablecoins (CoinDesk) – George Harrap, CEO and co-founder of Hong Kong-based money transfer platform Bitspark, reviews the current state of the stablecoin market, and argues for a diversification of stablecoin base currencies.
Tensions Rising at Facebook Libra as Backers Consider Quitting: Report (CoinDesk) – According to a report by the Financial Times, two Libra backers are considering pulling out of the project, and others are concerned about growing pressure from regulators.
Traces of manipulation: How the mind of the market predicts Tether and vice versa (Augmento) – Sentiment data mined from Reddit, which can be manipulated, shows forward correlation with tether’s market cap and price, which itself influences bitcoin’s price.
PAPERS
On the investment credentials of Bitcoin: A cross-currency perspective (Prateek Bedi, Tripti Nashier) – An examination of the diversification capabilities of bitcoin for a global portfolio spread across six asset classes from the standpoint of investors dealing in five major fiat currencies.
Methods for preventing front running in digital asset transactions (Dong Wang) – A patent application for a method for matching orders of digital assets.
Should All Blockchain-Based Digital Assets be Classified Under the Same Asset Class? (Voraprapa Nakavachara, Tanapong Potipiti, Thanawan Lertmongkolnam) – No, they have a variety of roles in the financial system, and should therefore not all be subject to the same rules.
The Effect of News on Daily Bitcoin Returns: A dictionary-based sentiment analysis of market efficiency of the Bitcoin market (Kelly van Eert) – Findings suggest that the bitcoin market is efficient, and that bitcoin traders tend to be loss averse.
Optimal Bitcoin Trading with Inverse Futures (Jun Deng, Huifeng Pan, Shuyu Zhang, Bin Zou) – A proposed trading strategy to maximize return using bitcoin, derivatives and a risk-free asset.
Cryptoassets: Value and Price Drivers of a New Asset Class (Korhonen Asko Pekka) – Correlation and regression analyses for six crypto assets in three timeframes.
An assessment of Bitcoins capabilities as a diversifier, hedge and safe haven (Anders Stensås, Magnus Frostholm Nygaard) – Analysis of 13 equity markets, five regional indices and 10 commodities shows that bitcoin acts as a hedge for most developing countries, as an effective diversifier for developed markets, and as a safe haven asset in specific crisis periods.
PODCASTS
*THE SCOOP: Frank Chaparro of The Block chatted to Nelson Minier, head of OTC sales and trading at Kraken, about the daunting task of setting up an OTC desk, how Wall Street’s loss is crypto’s gain, and why we should watch the derivatives space.
CHAIN REACTION: Tom Shaughnessy of Delphi Digital interviewed Kyle Davies of Three Arrows Capital about borrowing and lending in alpha strategies, prop funds vs hedge funds and the matrix of potential returns in the crypto sector.
BASE LAYER: David Nage of Arca Funds interviewed Mike Alfred of Digital Assets Data on the role of data in investment theses, and the roots of institutional inertia.
GLOBAL COIN RESEARCH: Joyce Yang spoke to Jeremy Allaire, CEO of crypto platform Circle, about China’s plans for a digital currency and the potential impact it could have on global settlements and the demand for stablecoins.
VENTURE COINIST: Luke Martin spoke to Yan Liberman, co-founder of research boutique Delphi Digital, about altcoin analysis and dynamics, as well as the benefits of crypto portfolio diversification.
BLOCKCRUNCH: Jason Choi spoke to Alex Shin, former partner of Korea’s largest crypto fund Hashed, about why valuations differ across time zones, how the crypto sector has evolved in Korea and the differences between US and Asian retail crypto markets.
SECURITY TOKEN STORIES: Derek Edward Schloss chatted to Nick Cowan, CEO and founder of the Gibraltar Stock Exchange Group, on the goal to list and trade security tokens on a regulated stock exchange.
A-HA!
*UK Central Bank Chief Sees Digital Currency Displacing US Dollar as Global Reserve (CoinDesk) – Speaking at the Economic Policy Symposium in Jackson Hole, Wyoming, the Bank of England governor Mark Carney discussed the need for a new international monetary and financial system, and suggested alternatives to the dollar as a reserve currency, including a a digital currency supported by an international coalition of central banks.
Carney’s Libra Idea Shows How the Dollar Is Everyone’s Problem (Bloomberg, paywall) – The Bank of England governor’s remarks point to increasing concern about the dollar’s hegemony.
The Growing Challenges for Monetary Policy in the current International Monetary and Financial System (Bank of England) – Here’s his full speech.
*Bitcoin Dreams (LA Review of Books) – Masterful reviews of “The White Paper”, “Bitcoin Billionaires” and “Digital Cash”, by professor Kevin Werbach.
Nagging misconceptions about nudge theory (The Hill) – An update on the “nudge theory,” with a debunking of some myths, by Cass Sunstein (co-author of the original “Nudge” book).
*In an epic thread, Allen Farrington (@allenf32) questions the metrics used to measure growth, presents an alternative and extracts a sobering explanation of the current economic situation based on faulty definitions.
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FUNDING
Crypto derivatives exchange CoinFLEX has raised a further $10 million from Polychain Capital, NGC Ventures, Divergence Digital Currency, and Roger Ver
FIRMS
Cryptocurrency exchange bitFlyer has enabled trading in bitcoin and ethereum for European and US users of its recently launched “Buy/Sell” platform can start trading Ethereum and Bitcoin.
Eleven more crypto projects have joined the Messari Disclosures Registry, including four top-100 projects by market cap: Cardano, Lisk, V Systems and Beam.
Binance, one of the world’s largest cryptocurrency exchanges by trading volume, has launched a crypto lending business (for tether, ethereum classic and Binance’s BNB token) with rates between seven and 15%.
PEOPLE
Patrick Byrne, long-time champion of cryptocurrencies, has stepped down as CEO of public company Overstock and resigned from its board of directors, after admitting to a three-year relationship with Maria Butina, a Russian agent currently serving 18 months in prison.
He has been replaced on an interim basis by current Medici Ventures president Jonathan Johnson, also a blockchain enthusiast, who will continue the firm’s initiatives in the sector. .
Circle is hiring a new general partner to raise a $100 million venture capital fund, which will take advantage of the deal flow coming through SeedInvest, the equity crowdfunding startup that Circle acquired in March 2019.
Square Crypto, the division of the publicly traded payments company that focuses exclusively on bitcoin, has hired Matt Corallo, a bitcoin developer and Blockstream co-founder, to experiment with models for accelerating bitcoin development.
The former head of the Securities and Exchange Commission’s Cyber Unit, Robert A. Cohen, will join the corporate law firm Davis Polk & Wardwell LLP as partner.
Jeffrey Wang, a former head of derivatives trading for Asia at Morgan Stanley, has joined cryptocurrency trading and technology startup Amber Group as head of Americas.
Facebook has hired lobbying firm FS Vector, led by former Coinbase head of policy John Collins, to work on “issues related to blockchain policy.”
Have a tip? Drop me a line at noelle@coindesk.com. |
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In THE BRIEFING above, we look at how different crypto custody is from the traditional understanding of the word. For a basic primer on the crypto custody sector, take a look at our introductory report “Crypto Custody”, in which we examine the unique custody challenges crypto assets present, and provide an overview of efforts to solve them.
You can download the report for free here.
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Previous newsletters: 36, 37, 38, 39, 40, 41, 42, 43, 44, 45, 46, 47
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CoinDesk is not an investment advisor. This newsletter is for informational purposes only, and any comments here do not constitute investment advice. |
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Institutional Crypto - The Crypto Custody Conundrum: What Are We Even Talking About?