Digital coins are an entirely new asset class. They’re neither stocks, nor bonds, nor options, nor swaps nor futures nor forwards nor swaps nor collateralized mortgage obligations. Satoshi Nakamoto probably never intended them to be traded as securities. He/She/They might not have even intended them to be used as off-chain currency.
So why should we be trading them in the same way as those legacy assets? Does crypto even need exchanges in the way that equities do? Let’s be honest: many decentralized exchanges are really just phone apps. At the code level, dex has more in common with Instagram than with Nasdaq.
We also need to understand that the analogy isn’t perfect, and there are some stark differences between a dex and a legacy bourse. There are some roles that make sense at Nasdaq — and might even make sense at a centralized crypto exchange — that would just get in the way at a dex.
Three kinds of custody
First of all, let’s define what a custodian is in the sense of legacy exchanges. A custodian is firm that holds your assets to guard against theft or loss (loss in the sense of getting lost in the paper shuffle — if you made a bad bet, that’s on you). A custodian might also offer settlement services, account administration or other related services. Because of such custody banks as Bank of New York Mellon or State Street, brokers and dealers can concentrate on researching companies, buying their securities and, if they start losing money, selling them to you and me. (Jaundiced? Me? Never. Let’s just say there are reasons I went into crypto.)
As Phil Glazer’s excellent article in Hacker Noon last year notes, there are three custody options available for cryptocurrencies:
Exchange custody: After you’ve bought coins on an exchange, you could just leave them in your account there — which is not without risk, but it’s what most people probably do.
Self-custody: This is another term for cold storage in a physical wallet that has never been connected to the internet. This works fine if you are absolutely, positively sure that you won’t lose or misplace that wallet or the keys thereto. If someone steals your wallet and keys, then they essentially become the owners of everything you have stored there. Yes, that guy is a thief, but he’s also the bearer, and crypto is really just a 21st-century bearer instrument.
Third-party custody: This refers to firms that specialize in storing digital assets via some cold storage, multi-signature authentication or both.
Glazer lists what he terms “key providers” of third-party crypto custodians:
He also notes that, once you get beyond bitcoin, ether, ripple and litecoin, you have a very small pool of custodians who’ll hold your assets. And, as your economics prof kept trying to explain to you, if you hold demand constant as supply gets scarcer, prices will go up. Custody isn’t the rounding error in crypto investing that it is in stock trading.
What about old-school custodians?
So far, the leading custodians of legacy securities trading have been slow to the table in the crypto space. In fact, one of BNY Mellon’s custody product managers spent a lot of time delineating exactly why the bank is in no rush. It’s pretty much what you’d expect: They only want to secure assets that are already secure. State Street’s fig leaf is that their clients have not yet expressed sufficient demand for this service.
That said, published reports JPMorgan Chase, Citigroup and Goldman Sachs all seem to making some moves toward crypto custody. Another exception is Fidelity Investments, which recently launched its Fidelity Digital Asset Services subsidiary, intended to handle trading and custody of cryptocurrency on behalf of institutional clients.
Questions remain. How serious are they? Are these just pilot programs? Will they bail at the next bearish signal? And has this $200 billion (as of this writing) space already been disrupted by crypto market specialists to the point where legacy custodians might feel like Borders Books shareholders at Amazon’s annual meeting?
As to this last question, I’m not sure but I think not. As noted earlier, there’s more demand than supply for third-party custody on the chain so, as long as they’re in for the long haul, there’ll be room for the descendents of the Morgans and the Mellons alongside a new generation of financial pioneers.
As I mentioned, a dex isn’t really an exchange in the mode of the New York or London stock exchanges, nor even in that of Coinbase, Binance or other centralized crypto exchanges.
In those instances, it really makes sense to have financial institutions serve as custodians. Legacy exchanges have trust through intermediation baked into their DNA, so they need custodians, administrators, clearinghouses and the like to function. Centralized crypto exchanges get hacked with the regularity of celebrities going to rehab. If you park your assets in your exchange account out of convenience or inertia, good luck with that.
For dexes, self-custody is the default. Hacking accounts on such platforms is a much heavier lift than on centralized exchanges, but there are no guarantees.
At BQT, we cater to sophisticated traders but soon to release amazing self-custody vault with cold wallet integration. If you’re savvy enough to use our hedging tools, you’re savvy enough to buy a cold wallet, keep it locked in a safe place, write down your keys and keep them in a different safe place.
And that’s our position. For now at least. If you, our clients, feel the need to have a third party guarantee that your assets are safe, we won’t let our crypto-enthusiast preferences for trustless transactions and decentralization get in the way of basic customer service. As the crypto space widens and broadens, I expect this is a topic we’ll have to revisit at some point, sooner or later.
Edward is an Ernst and Young Entrepreneur of the Year Finalist, Blockchain Enthusiast and visionary behind many successful organizations. An avid entrepreneur, Edward has a knack for designing distinctive business models complemented with superior technology to deliver unparalleled service and profitability. Edward also has been advising and consulting for various successful Blockchain technology and ICO projects and recently launched his own BQT.IO P2P exchange helping traders connect with each other to leverage their crypto assets.
BQT.IO has been in development since March 2017 and its ICO launched September 18. The information can be found online at BQT.IO, on Telegram @BQTCommunity and on Twitter as @bqt_ico.