Philosophical arguments about the nature of money apart, one of the biggest stumbling blocks to adoption of bitcoin as an investment vehicle is the absence of a cryptocurrency custody solution. Institutional investors have largely stayed away from the cryptocurrency as an increasing number of hacks and scandals at crypto exchanges, which are responsible for a bulk of bitcoin trading, have roiled its ecosystem. At a recent innovation summit, Goldman Sachs called the current cryptocurrency ecosystem “brittle” because it lacks safeguards and controls necessary for institutional investors to enter the space.
But that might change soon.
North America’s biggest cryptocurrency exchange Coinbase announced the launch of a custody solution for institutional investors over the weekend. “Coinbase Custody is a combination of Coinbase’s battle-tested cold storage for crypto assets, an institutional-grade broker-dealer and its reporting services, and a comprehensive client coverage program,” the company wrote in a blog post. According to a Bloomberg article, Coinbase has already signed up ten clients consisting of hedge funds and family offices for the service. By the end of this year, the service expects to have 100 large institutional customers with $5 billion in assets, Sam McIngvale, Product Lead for Coinbase Custody said. A bulk of these customers will come from 250 or so crypto-focused hedge funds that have mushroomed in recent times. Kyle Samani, cofounder of Multicoin Capital, told Bloomberg that the service could lead to a “wave of capital” into the industry.
As is to be expected from a service that targets institutional clients, Coinbase Custody is expensive. Setup fee is $100,000 and a minimum deposit of $10 million is mandatory. Monthly fee for the custody service is 10 basis points of the value of stored coins. Coinbase Custody is only available to customers in America and Europe but the company said it would roll out the service soon to Asia.
Along with the “wave of capital” predicted by Samani, there is a wave of new custody services in the crypto markets as well. Japanese investment bank Nomura Holdings Inc., announced a custody service in partnership with Ledger and Global Advisors in May this year. (Incidentally, Coinbase entered the Japanese market earlier this year). A slew of banks, including BNY Mellon Corp., JP Morgan Chase & Co, and Northern Trust are also reportedly developing similar services for customers.
Why Coinbase’s Custody Solution Is A Big Deal
“Solving the crypto custody problem means integrating a deeply conservative and traditional system (used for stocks, bonds, currencies, etc.) with disruptive upstarts (wallets and exchanges),” writes Nicholas Colas, co-founder of Datatrek, a research consultancy. According to the firm, the custody business in the United States is an oligopoly. State Street, BNY Mellon, JPMorgan Chase and Citi control the US market. “You don’t get to sit at the top of the heap in this business by taking undue risk or jumping on the next big thing,” writes Colas.
There are also two important reasons why Coinbase’s move into custody could jumpstart institutional investment in crypto markets.
First, SEC regulations have made custody a necessity for cryptocurrency markets. Bitcoin is often compared to gold but lacks similar investment-to-physical custody solutions. Several questions regarding cryptocurrency custody remained unanswered even as bitcoin futures were launched at CME and Cboe. The absence of a cryptocurrency custody solution is especially problematic for crypto-focused funds, which do not have places to store their cryptos.
Custody is also important from a security standpoint. Numerous hacks and scandals have shone the spotlight on the inadequacy of security at cryptocurrency exchanges. A theft could leave institutional investors, which invest large tranches of cash, high and dry.
Coinbase is an experienced hand with ambitions to become the “Google” of cryptocurrency markets. It is already busy mopping up talent and expertise to expand its services ecosystem. It acquired Keystone Capital, an SEC-regulated broker-dealer, alternative asset marketplace Venovate Marketplace Inc., and Digital Wealth Inc., in preparation to become an SEC-regulated broker-dealer. Per SEC regulations, investment advisers, such as hedge funds and family offices, have to keep their assets with an approved custodian. While it has not been officially approved, Coinbase has partnered with Electronic Transaction Service, a regulated broker-dealer, for the service. (Media attention has mostly focused on the SEC’s cease-and-desist order issued to ETC last year for not protecting customer funds).