Third-Party Custodians are not what most people think of when discussing Crypto or Blockchain technology. Nevertheless, companies continue to announce custody offerings suited for these assets. So why do cryptonatives need a Third-Party Custodian?
As discussed in our previous article, “It’s 10pm, do you know where your digital assets are?“ today’s Cryptonatives operate vertically integrated based on the popular “Not your keys, not your coin” self-reliance ethos. This approach towards keeping operations in house is an understandable approach toward security with respect to crypto’s nature as a bearer asset. Afterall, the most expensive blow ups (FTX/Alameda) and hacks (Ronin, Coincheck, Mt.Gox, etc) in crypto history involve a third-party holding keys representing client assets, not self-custodied tokens. However, the issues associated with a third-party failing to maintain client assets originate from a lack of qualified custodians rather than self-custody being a silver bullet.
Self-custody mitigates the creation of a large single point of failure which works well when considering an individually owned asset. However, the average individual owner often lacks the sophistication necessary to self-custody their tokens with a greater level of security than what a third-party provides. Individuals cannot afford to spend hundreds of millions on asset maintenance procedures while this level of expenditure is common for large Third-Party Custodians. Furthermore, institutional assets and assets held by institutions on behalf of their clients create their own challenges when considering self-custody.
These two types of assets are interacted with by multiple parties as part of primary business activities which creates execution risk, opportunities for theft, and accidental loss. This dynamic becomes especially prevalent in growing organizations as a rapidly expanding client base often breaks existing procedures and processes. Legal constraints are also prevalent when considering self-custody. Many companies are mandated to segregate customer assets which is an obligation easily satisfied with the support of a qualified Third-Party Custodian. Institutions without a Third-Party Custodian would have to produce auditable evidence themselves that they are meeting customer protection rules which are now more than ever in customers' thoughts.
There are very good reasons why Custodians play a vital part of traditional financial markets. They collectively oversee over 190 trillion dollars worth of assets with giants like State Street holding 38.2 trillion dollars of assets alone. These companies exist because the safekeeping and maintenance of assets differs from why a company owns an asset. Companies own assets for a wide variety of reasons ranging from investment to use in business activities. However, rarely is the reason for asset ownership solely to maintain and safekeep an asset. This is where Custodians differ.
Custodians provide maintenance and safekeeping functions as a service. This mutualizes costs, benefits economies of scale, and creates deep expertise for the market. Otherwise said, custody is a necessary support function for most businesses while for Custodians it is a primary revenue generating business activity. The difference in incentive structure creates market benefits and more efficient allocation of resources to favor the use of Custodians beyond the previously mentioned legal incentives.
Cryptonatives need regulated Third-Party Custodians. They need Custodians because custody services enable companies to remain focused on their primary business objectives while providing market benefits and reducing risk. We will continue to see a shift in market structure towards the use of Third-Party Custodians as the crypto market matures and regulates. This shifting dynamic is why Protego Trust Bank has always been focused on providing regulated infrastructure, advanced technology and safeguards at the core of its third-party custody offering to help Cryptonatives build the next generation of financial services.
Protego Trust Bank N.A (in formation) is a purpose-built, conditionally federally chartered trust bank, exclusively serving the needs of institutional clients. With a firm belief that the future of all assets is digital, Protego Trust is defining the next generation of financial services by providing regulated infrastructure, advanced technology and safeguards that allow institutional clients to securely participate in cryptocurrencies and digital assets. In 2021, Protego Trust received a conditional federal charter from the U.S. Office of the Comptroller of the Currency, in addition to its Washington state charter. It plans to launch in 2022. Learn more about our institutional custody solutions today.
2Q 2022 Financial Highlights . State Street, 15 July 2022, https://s26.q4cdn.com/446391466/files/doc_financials/2022/q2/v1/STT-2Q22-Earnings-Presentation-vF.pdf.
“Custody of Funds or Securities of Clients by Investment Advisers.” Final Rule: Custody of Funds or Securities of Clients by Investment Advisers; Release No. IA-2176; File No. S7-28-02, SEC.gov, 5 Nov. 2003, https://www.sec.gov/rules/final/ia-2176.htm.
The Evolution of a Core Financial Service | Custodian & Depositary Banks. Deloitte, https://www2.deloitte.com/content/dam/Deloitte/lu/Documents/financial-services/lu-the-evolution-of-a-core-financial-service.pdf.
“Investor Alerts and Bulletins.” SEC.gov, 1 Mar. 2013, https://www.sec.gov/investor/alerts/bulletincustody.htm.
“Segregation of Assets and Customer Protection.” Segregation of Assets and Customer Protection | FINRA.org, Finra.org, https://www.finra.org/rules-guidance/guidance/reports/2022-finras-examination-and-risk-monitoring-program/segregation-assets-customer-protection.
Silverman, Jonathan. “It's 10pm, Do You Know Where Your Digital Assets Are?” Protego Trust Bank, 23 May 2022, https://www.protegotrust.com/knowledge-center/its-10pm-do-you-know-where-your-digital-assets-are.