Bitcoin Soaring? Thank A Third-Party Custody Provider
Are custodial solutions driving institutional interest or the other way around?
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Bitcoin is rising yet again, as the largest digital asset consolidates above $10,000. While it’s common to attribute bull runs to institutional money, Chinese tariffs or inverted yield curves, this year’s rise could have been triggered by an unexpected catalyst: third party cryptocurrency custody solutions.
By introducing sophisticated storage solutions, these companies are paving the way for institutional investors to safely enter the space. With Coinbase announcing its acquisition of Xapo’s custody infrastructure for $55 million, savvy startups and unicorns are starting to see the value in holding investors’ private keys for them.
It’s hard to separate cause from effect; it probably runs both ways. Regardless of who drove what, institutional interest in cryptocurrencies is growing as quickly as the cryptocurrency custody as-a-service industry.
Institutional Investors Eye Crypto as a Hedge Against Uncertainty, Source of Diversification
In May, Fidelity Digital Assets released results of a survey, highlighting that one-fifth of the institutional investors were invested in cryptocurrencies. Forty percent of respondents were ‘open’ to making an investment in the near future. Investors surveyed included both traditional and non-traditional investment companies. Per the findings:
The findings support the bullish sentiment surrounding Grayscale Investment’s results for 2019. The digital asset management company reported consecutive quarterly gains for the year, with $24 million entering Grayscale’s funds in the first quarter of the year and $84.8 million in the second.
Evidently investors are seeking a hedge against uncertainty, asset diversification, and exposure to an asset class with a low correlation to others. However, it’s still hard to separate those benefits from the inherent risks of theft and hacks.
Is Cryptocurrency Custody the Chicken to the Institutional Egg?
Institution-facing custody services such as those offered by Coinbase, Gemini, and BitGo could be ushering big money into the space. Even the most incautious money manager would hesitate before putting client money into an asset with bitcoin’s checkered security history.
Crypto purists might cringe at the idea of using custody services, but they are big business. From the perspective of a fund manager, a professional storage service poses far fewer risks than a Trezor in the drawer.
After its Xapo purchase, Coinbase now has around $7 billion worth of digital currency under management. The San Francisco-based exchange reportedly won a bidding war against Fidelity for the Swiss company and its famous mountain vault. CEO Brian Armstrong is optimistic about the role of custody solutions in the industry:
The question as to whether institutional investors are driving demand for custody, or the reverse, is perhaps moot. The growth in the two is clearly correlated.
But it’s clear that custodial arrangements are important to serious investors, with Fidelity finding that “76% of institutions surveyed placed security and safety as their most important considerations” when choosing how and where to store digital assets.
Independence from banks may have once been the ideal for cryptocurrency and continues to form a significant part of bitcoin’s ambitions. But there is no reason to allow the perfect to be the enemy of the good.
Is there a place for third party cryptocurrency custody services for retailers? BlockFi has a lending and borrowing platform that utilizes the storage services and insurance of Gemini Trust. The platform is targeted toward retail investors, with interest payments falling below competitive rates after the first ten bitcoins deposited.
While the platform is primarily intended for lending and borrowing against digital assets, it has found some appeal for the security of its storage arrangements. Gemini is a fiduciary under Section 100 of the New York Banking Law, and the exchange also has digital asset insurance.
What may be anathema to some is crucial to others. For conservative asset managers and those who feel less-than-confident when it comes to holding private keys, insured custody is an integral component of crypto exposure.
Retail investors aside, cryptocurrency custody solutions are keeping apace with developments in the crypto markets. Insofar as strong price pressure benefits everyone in the sector, even private-key fundamentalists should find it difficult to object to the growing presence of custody services and the legitimate role they play in the industry.