Why Coinbase Custody is a Milestone for the Industry?
One of the impending factors for cryptocurrencies to keep growing in valuation in its current format is the lack of regulatory clarity as well as custodianship solutions. However, the pieces of the jigsaw are slowly but surely starting to come together in order to see further adoption by institutions, as Coinbase, one of the largest crypto exchanges globally, just announced that deposits for its new custodianship service are starting to be accepted.
According to a tweet by Brian Armstrong, Co-founder & CEO at Coinbase: “Deposits are now rolling in for Coinbase Custody. We're live!” It has been reported that as many as 10 hedge funds and family offices are now officially using the custody service to safe-guard their crypto assets. The announcement marks a milestone for the industry, as it provides a solution to one of the most pressing issues being faced if we are to witness further widespread advocacy over the diversification of institutional portfolios into cryptos.
Qualified Custodians the likes of the service Coinbase just launched is a long-awaited welcomed feat for the industry, in part, because crypto assets such as Bitcoin and other highly regarded virtual currencies have an almost non-existent correlation to other traditional assets such as stocks, bonds and commodities, which makes for a very attractive and broadly-applicable diversification strategy for the professional money as it reduces one’s portfolio volatility. However, the allocation by large players into cryptos can only be justified if the assets can be stored hack-proof, which is why it represents such a ‘landmark’ moment.
According to the official announcement by Coinbase: “As crypto continues its maturation as an asset class and more institutions enter the space, Coinbase is committed to delivering products and services that are tailored to their unique needs. Coinbase Custody delivers the trusted storage service that our clients need to fully immerse themselves in the potential that crypto assets provide.”
Coinbase Aims to Leverage First-Mover Advantage
Coinbase intends to serve an exclusive group of clients, often referred as institutional investors, who must meet the requirements of a minimum deposit of $10 million and custody's fees of $100,000 as a set-up payment, in addition to 10bp monthly fee on the assets under custody. The geographic location of the clients to provide the custody solution include both the US and Europe, with Asia set to be given the ‘green light’ by year-end. Coinbase will currently support a limited number of crypto assets, including BTC, ETH, LTC and BCH.
Polychain Capital, with over $1 billion in assets under management, is among the very first clients to use the custodianship solution. Quoted by Bloomberg via a phone interview, Olaf Carlson Wee, chief executive officer of the crypto hedge fund, said that “Coinbase is incredibly well positioned to store the next $100 billion of crypto assets due to its long history of successful digital asset storage.”
The exchange has been storing clients’ assets ever since it began operations back in 2012 and given its growing ambitions to establish itself as the ‘Go-To’ investment vehicle for cryptos in the United States and leverage their first-mover advantage, they are currently under the process of acquiring a broker-dealer license, an alternative trading system license and an investment advisor license. Upon the approval of these licenses, Coinbase may incorporate the offering of securities as well, anticipated to boost their revenue generation significantly.
Going forward, upon the necessary regulatory compliance, Coinbase aims to expand its services by supporting “more crypto assets, flexible access to funds via secure, segregated hot wallets and scheduled withdrawals as well as allowing clients to participate in the crypto ecosystem through proof of stake and distributed governance, although this latter feature is not expected to be implemented in the short term,” Coinbase states.
A Tsunami of Custody Solutions Lined Up
How much more capital can be unlocked? What does the new custody solution mean for the potential adoption of digital assets? The popular exchange aims to hold around $20 billion worth of crypto assets as part of its custody service by the end of 2019 assuming current valuations, with a base of more than 20 million existing customers, nearly the same number as 70-year old Fidelity Investments and doubling up Charles Schwab.
Adam White, Coinbase’s Vice President told CNBC: “We think this can unlock $10 billion of institutional investor money sitting on the sideline,” adding that “we’re seeing a rapid increase in attention awareness and adoption in the cryptocurrency market.” However, that’s just the tip of the iceberg. The Federal Reserve in the United States alone holds approximately 8,000 tons of gold bullion, valued at more than $500 billion.
Overtime, as the digital age solidifies, Custodian solutions have enormous implications to unleash a barrage of interest by large institutions with billions under management at a global level. With the custody of virtually-held assets via a qualified entity, institutions aim to achieve both a strategic diversification of their portfolio while engaging in speculative buys of future on-demand coins/tokens, as done with any other asset class. In the context of a market that is becoming increasingly competitive with dozens of other custody solutions in the works, soon enough, we will see multitude of alternative custodians to cater the needs of global clients.
Institutions, the likes of Circle, BitGo, Nomura along with Ledger and Global Advisors via a custody consortium named Komainu, Bank of New York Mellon, JPMorgan Chase, and Northern Trust are all about to embark upon the offering of custodian solutions as well, with some approaching the final phase before the launch of the service to its global clients’ base later this year, which will include hedge funds, pensions, academic institutions, sovereign funds. The professionalization of the industry will have immense repercussions for global adoption.
State-of-the-Art Cold Storage Cardinal to Keep Assets Safe
These more sophisticated custodianship solutions that are about to become available – Coinbase Custody as first mover -, unlike hot wallets, which refer to devices connected to the internet that carry costly risks of hacking, must provide much higher safety standards that guarantee the protection of the digital assets as an impenetrable wall unable to perforate by cyber-criminals. In its simplest format, this is achieved via cold storage, in other words, a physical device that is kept in offline mode while providing the option to be connected into a machine when necessary in order to manage one’s digital assets.
The distinctive characteristic of qualified custodians, as in the case of Coinbase, is the addition of a set of second-layer features as part of its cold storage ability, aimed to minimize to almost nonexistent any risk of hackings and hence keep the assets safe. Some of these extra elements include: On-chain segregation of crypto assets; offline private keys that require a quorum of geographically distributed agents to use cryptographic hardware to sign transactions, multiple layers of security, and robust cold storage auditing and reporting.
Flood of Parked Institutional Capital Eyed
Safe-guarding one’s assets against cyber-attacks is perceived as one of the final obstacles before we see a gradual and constant influx of new capital into crypto custody services. It is thought that as many 250 crypto-oriented funds, due to the opaque regulatory conditions they had to face up until this point, may have had to limit their potential investment allocations until further qualified custodians were available.
Ari Paul, co-founder at Blocktower — a crypto-focused hedge fund led by former Goldman Sachs executives — notes: “Institutional money started trickling into cryptocurrency in mid-2017, but it’s been slower than many (including myself) expected. That doesn’t mean it’s not coming. There are a lot of pieces that need to come together, one big piece being third party custody. Custody isn’t binary. It’s not like Coinbase custody launches and suddenly every pension will throw $100 million into Bitcoin. It takes time for custody solutions to gain trustworthiness. But, I think we’ll have solid third party custody by September of this year.”
“Over the next year, the market will come to recognize that custodianship is a solved problem. This will unlock a big wave of capital” Kyle Samani, a managing partner at Multicoin Capital, told Bloomberg back on June 18th.
And while we will only provide an early spoiler, one must not forget that as the custodian box gets ticked, other milestones are edging ever closer, most notably the anticipation of a Bitcoin ETF, which will simplify the current cumbersome steps to own Bitcoin. One of the main roadblocks for an ETF has always been to first conduct a rigorous regulatory examination of its suitability, which has one of its main cornerstones in the ability to store crypto asset hack-proof, a panacea that Coinbase just committed to solve and a handful of others are about to.
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