Encrypted Custody Takes the Wind: Be a Bank in the Blockchain World

Produced | Odaily (ID: o-daily)

Produced | Odaily (ID: o-daily)

How far is it from Wall Street capital pouring into the cryptocurrency world? There is still a distance away from a mature hosting service system.

“95% of the barriers to institutional acceptance of blockchain assets are related to custody.”

Brendan Blumer, CEO of Block.one, the parent company of EOS, tweeted.

Indeed, after a year of ups and downs, the U.S. bitcoin futures exchange Bakkt is finally scheduled to go live at the end of September. One of the important reasons for the regulatory green light is inseparable from its support for compliant digital asset custody companies (DACCs). acquisition. The compliant hosting solution is not only an important help for Bakkt on the road to compliance, but also its biggest highlight in attracting institutional funds.

At the same time, encrypted asset custody services are still a blank piece of the puzzle in the traditional financial world.

According to a report released by foreign media The Block, large banks are still reluctant to provide banking services to cryptocurrency businesses due to risks/costs outweighing benefits. 3%, and only nearly a third of crypto-friendly banks now offer crypto custody as a supplement.

As a result, the encrypted custody industry, which is an encrypted digital currency storage and security service for institutional investors, is becoming a strategic layout site for military strategists in the old and new worlds.

But its threshold is not small, and most of its service objects are enterprise-level customers, including project parties, trading platforms, Token Funds, family wealth funds, mortgage lending platforms, etc., which require sufficient capital, technology and trust threshold.

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Custody and Fund Security

One of the important reasons why custody can attract institutional funds is to ensure the security of encrypted funds.

Just as gold bars or dollar bills can be lost, cryptocurrencies are no exception. According to research by Chainanlaysis, nearly 4 million bitcoins have been lost forever, and that number is likely to keep growing. The reasons for the loss are various, but they can all be attributed to the loss of the private key or theft by hackers.

The news of hackers stealing cryptocurrencies has been endless. According to a new report from crypto intelligence firm CipherTrace Cryptocurrency Intelligence, $5 billion in crypto assets were stolen in 2019.

The "custodial" to be mentioned in this article, to put it bluntly, is a role to help users or customers keep funds to ensure the safety of funds. Specifically, there are two levels of risk for custody prevention: one is the loss of coins caused by hacking or improper storage of the user's private key; the other is the moral hazard of the asset management team embezzling users' funds or even running away.

Anti-hacking is the first step in the current hosting industry. The service is mainly for blockchain startups such as exchanges, asset management platforms, and quantitative funds.

Keeping coins that are essentially digital assets for customers is actually to store data well, the most critical of which is the "private key".

In the world of cryptocurrencies, whoever possesses the "private key" of an account is considered the owner of the account. Therefore, the escrow company must keep this key safe. There are two ways to save the key, one is to store it in a networked hot wallet/cold storage, which is convenient for customers to transfer money at any time; the other is to store it in an offline cold wallet, which is more secure because it is not connected to the Internet.

"Cold storage" is the basic function of the hosting organization, including the isolation of offline devices (mostly HSM, which provide a reliable key backup mechanism, and confidential data can be transferred safely), and physical security protection (such as a vault).

In order to cope with the weak liquidity of offline storage, most custodians often combine hot and cold wallets to realize automatic scheduling of hot and cold separation. There are also new ways to play. Take domestic extension chain technology Jadepool as an example. Combined with a centralized gateway, it can issue staking share certificate tokens in dex and centralized exchanges. Tokens can be traded on exchanges to provide liquidity for investors.

There are also examples that go beyond hardware security. In early 2019, the founder of QuadrigaCX in Canada died unexpectedly, leading to the accidental loss of private keys, which was cited several times. In February of this year, QuadrigaCX founder and CEO, Gerald Cotten (Gerald Cotten) died suddenly during a visit to India. Since only Gerald Cotten owns the private key of the exchange wallet, his accidental death also means that the approximately $190 million in digital currency stored on the exchange will also be unable to withdraw.

This oolong incident not only brought unwarranted disasters to the users of the exchange, but also sounded the alarm on the security proposition of asset custody.

In this regard, the third-party hosting multi-signature mechanism provides more spare private keys and an emergency freezing mechanism to deal with unexpected risks. Even if one party dies or cannot operate, the other party or multiple parties still have control over the assets. If the Quadriga CX wallet had adopted multi-signatures, such tragedies of property loss might have been avoided.

Take the Cobo Custody multi-signature scheme as an example. Cobo Custody holds at least one private key, and participating parties such as fiat currency lenders hold a private key. No one can do evil alone.

On the other hand, the absence of supervision in the cryptocurrency industry has put project parties, quantitative trading teams, and fund parties at risk of misappropriating funds or even running away. Clear certification also improves financial transparency.

Matrixport, which has a mining background, also provides a set of digital asset financial management system for miners, which aims to facilitate the systematic management of people, assets and information by miners. Many of the functions are to meet the daily operations of miners. Lists, batch tokens, hot and cold collection, asset reports, financial reconciliation, etc.

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Overseas capital grabbing the beach

2018 is a year in which traditional financial giants are ready to move.

After the huge bull market of cryptocurrencies in late 2017 and early 2018, traditional institutions began to include digital currencies in their investment targets. This in turn requires hosting to pave the way for institutions.

This year, Goldman Sachs (Goldman Sachs) is currently considering offering cryptocurrency custody services, and invested $15 million in cryptocurrency custody company BitGo Holdings Inc. with former Goldman Sachs partner and billionaire Mike Novogratz. The former manages about $5 billion in assets, and the latter has raised a total of $84 million in financing so far.

Fidelity, which manages trillions of dollars in assets, also announced the establishment of a subsidiary to manage encrypted assets for hedge funds, trading companies and other institutions, while providing encrypted currency custody services.

According to Bloomberg, citing people familiar with the matter, at least three large Wall Street custody companies-Bank of New York Mellon, JPMorgan Chase & Co., and Northern Trust are working on developing or exploring encrypted custody services.

There is no shortage of Asian consortiums across the ocean. Investment bank Nomura Holdings Inc. has joined forces with cryptocurrency firm Ledger and Global Advisors to form a custody consortium called Komainu.

While traditional institutions are making frequent moves, cryptocurrency custody startups have also ushered in a small outlet. At the end of 2018, giants in the technology and blockchain industries also received seed round financing of US$1.2 million and US$8 million for Singaporean encrypted custody project Propine and encrypted currency custody service provider Trustology; domestic Cobo completed A round of financing of US$13 million, and Officially released Cobo Custody (Cobo Custody), an institution-oriented digital asset custody solution.

In January of this year, Anchorage, an encrypted custody company for institutional investors, received $17 million in financing. Aegis, a San Francisco-based crypto custody company, has completed a $4 million Series A round led by Hong Kong's Fosun Group.

In February, IBM announced the progress of the IBM Cloud Hyper Protect series of cloud-native services at the Think 2019 conference, in which a dedicated cloud hardware security module (HSM) can be used to build a secure wallet.

In early July, crypto exchange and wallet provider Coinbase announced that it will launch a digital asset custody solution for institutional investors. In August, it acquired the Xapo custody business for $55 million.

At present, overseas trusteeship institutions have begun to take shape. The top custodians include Coinbase, BitGo and Kingdom Trust, all of which have a custody scale of more than US$1 billion.

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Domestic grassland staking

At the end of 2018, Oceanex, a cryptocurrency exchange, was preparing to launch.

On the eve of its launch, Oceanex adopted the custody service of the digital wallet Cobo. The founder of Cobo, Shenyu, is an ashes-level old man who got rich at a young age in the blockchain industry, and CTO Jiang Changhao is a former senior Facebook scientist. Out of trust in the two, Oceanex became the first partner of Cobo hosting service.

This also reflects the reckless state of the industry in the early days: compared with the overseas hosting in full swing, the pace of domestic hosting is slightly slower in terms of launch time and hosting scale; higher.

In addition, there are still few domestic start-up companies whose main business is hosting. Cobo, Jadepool, Matrixport, and inVault are the few players.

One of the reasons is the high threshold.

"Talents in the field of encryption and security are scarce, and a set of financial-level security infrastructure is not affordable for small and medium-sized companies." Wu Mengxia, Senior Vice President of Matrixport, said about the threshold of the hosting service industry.

Matrixport is a new start-up company of Bitmain co-founder Jihan Wu. Cactus Custody, a separate escrow business, has already managed assets worth 1 billion US dollars once it was made public.

It is precisely because of factors such as trust, capital, and technology that most domestic custody services originate from the consortium ecology. Take Matrixport and Jadepool as examples.

According to Wu Mengxia, the custody solution was originally born inside Bitmain. As the world's largest ASIC mining machine chip designer and manufacturer, Bitmain itself has a need for safe custody of digital assets. At present, Matrixport's strategic partners currently include Bitmain, BTC.COM, Antpool, Bitdeer, and Coinex, all of which are trading platforms and mining companies under the Bitmain investment system, and are also regarded by the outside world as opening up Bitmain's ecological landscape. The key to the downstream industrial chain.

Jadepool, which is also in Wanxiang Capital, has partners including Hashquark, Hashkey Hub, Hashkey Pro, Fenbushi Capital, Math Wallet, and decentralized exchange CYBEX.

According to CEO Yan, Jadepool initially provided centralized mining pools to ecological partners. After the development of cross-chain gateway hosting technology, Jadepool gradually polished out privately deployed hosting products.

Cobo and inVault are more "startup companies". In addition to the blessing of brand and security technology, the former is also relatively cheap; the latter has more advantages in compliance. According to public information, InVault has a Hong Kong compliance trust license and is also one of the earliest digital asset custody institutions in China.

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"Blockchain Bank"

Just as traditional custodian banks have developed a diversified business model of custody, settlement, asset services, fund services, banking services, and agency payments, the encrypted custodian business is also standing at the corner of the "one-stop blockchain bank".

According to Wu Mengxia, Senior Vice President of Matrixport, the current custody business model is based on the percentage of the user's custody funds (AUC), but this percentage will become lower and lower as the industry develops and the infrastructure matures.

"Take advantage of the hearts of white fans to earn money from selling cabbage." Yan also believes that pure hosting is not a good business model.

When the industry has not yet scaled up, finding new ways to make money is becoming a problem that the hosting business needs to think about. In addition, hosting users are often not satisfied with "storage security", and "asset value-added" is becoming a new customer demand.

Mortgaging assets for PoS mining has become the first choice. At the beginning of this year, as the popularity of many PoS public chains heats up, staking tokens to obtain inflation rewards has become a new popular posture. Like bank deposits.

Matrixport Wu Mengxia believes that meeting the needs of custody customers to obtain due income through staking is an inevitable direction. The reason is that Staking and digital asset custody have many similarities in service forms and technical requirements: both emphasize the safe custody of private keys, System reliability and brand awareness.

The cryptocurrency exchange Coinbase announced in early February that it invested in staked.us, a node service provider (PoS mining service provider), and announced on March 29 that its custody system supports customers to store Tezos in cold wallets for collateral.

Then turn your attention to the country. Jadepool CEO Yan introduced that its business model is not limited to custody fees and withdrawal fees, but also "PoS mining commissions, transaction commissions within custody, lending commissions, legal currency fund channel commissions, etc."

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More Trust Needed: Insurance and Compliance

In addition to exploring business models, compliance and insurance are still two difficult problems for crypto startups.

Jadepool CEO Yan told Odaily that the current encryption hosting industry relies on strong credit endorsements from acquaintances and big brands, which is not reliable and professional. He believes that countries do not have clear compliance audits and licenses, and there are very few types of insurance that cover encrypted assets, which is the biggest pain point of the encrypted custody industry.

At present, the regulations on cryptocurrencies in various countries are still ambiguous.

"There is no relevant license in the country" is a common voice. As for the United States, where the law is clearer, BitGo Trust once claimed to be approved by the South Dakota State Banking Department and is the first custodian institution approved by the US regulatory authorities.

Lawyer Guo Yatao of the chain law team told Odaily that, in fact, the digital currency custody industry as a whole is in a state of lack of regulatory mechanisms. As far as it is known, no country or region has issued special regulatory rules or established a special regulatory department for digital currency custody. Hong Kong has previously issued the "Statement on the Regulatory Framework for Virtual Asset Portfolio Management Companies, Fund Distributors and Trading Platform Operators", which involves the custody of virtual assets, such as users depositing digital currency on exchanges. account, but did not elaborate on the digital currency custodian.

He said that at present, some institutions claiming to hold licenses in the traditional custody industry are engaged in the business of digital currency custody. But it needs to be emphasized that for practitioners in the blockchain industry, the biggest risk has always been regulatory policy risk. In view of the uncertainty of the current regulatory situation, even if you hold a traditional industry custody license, in addition to technical risks , still faces great policy regulatory risks.

As for insurance, it is a way to increase credit or guarantee assets in traditional finance, which is equivalent to adding another layer of protection to assets.

Yan further elaborated that capital and insurance represent the ability to pay compensation. At present, insurance companies have strict audits on safety, risk control, and anti-money laundering. Large threshold; currently, a large part of the audit of insurance institutions is not on the currency custody technology, but on the background, team, business credit and traditional risk control of the applicant institution, which makes Jadepool need to apply for insurance together with traditional institutions.

Currently, there are very few custodians that purchase insurance services, and most of them are overseas custodians, including Coinbase Custody, Xapo, Bitgo, and KingdomTrust. However, the role that insurance can currently play is unclear. In March this year, BitGo announced plans to purchase $100 million in insurance for its digital assets. Later, it was accused by insurance underwriters, saying that BitGo used ambiguous Language exaggerates its insurance coverage.

However, in the face of traditional institutions entering the market to compete for the encryption custody business cake, start-ups have more optimistic expectations.

Cobo CTO Jiang Changhao once said in an interview: "There is a new set of game rules in the blockchain field, and everyone is on the same starting line. Startups in the field are more familiar with digital assets, and the blockchain field itself is a technology Driven by technology, start-ups are in a better position.”

Yan also believes that "but the custody service provider of the currency circle has a better understanding of target users and needs, and responds faster to new assets, new technologies, and new markets."

Regardless of who has more advantages, large institutions or start-up companies, in any case, the maturity of custody services will inevitably promote the development and popularization of the encrypted asset industry. Yan said that "lowering the threshold for the use of encrypted asset custody" and "compliance" are the efforts that the industry needs to make.