Last week, Copper’s Business Development Director, Adam VandenBoogaard, was asked to speak at Bank of America’s Global Markets Head Trader Conference on the "Building & Implementing the Crypto Industry into Your Organization" panel. This highly exclusive gathering of top global asset managers at New York City’s prestigious Carnegie Hall, focused on the broader traditional equities, fixed income, and digital assets markets.
The question that stood out was: “Why do institutional clients need a custodial provider instead of leveraging custody on an exchange?” In short, Adam’s answer was that disparities between traditional finance and digital asset exchange market structures have led to vast differences in how clients interact with these exchanges.
For example, as a retail participant investing in traditional finance there is no such thing as a NYSE or NASDAQ account — instead a licensed broker is used to trade on one’s behalf. However, with digital asset exchanges, traders are required to create accounts, establishing direct relationships between exchanges and investors.
These structural differences have led to exchanges taking custody of digital assets as an ancillary business to their primary focus— acting as a trading venue. Although the market remains nascent, it is clear that exchanges are poorly positioned to offer these seemingly contradictory services. Separating the two responsibilities may be the best way forward for institutional investors to keep investments in the digital asset space safe.
When it comes to digital asset safety and security, there are several important points to note when comparing a dedicated custodial solution to holding assets on exchange:
The importance of counterparty risk mitigation for institutional players cannot be overstated. Leaving private keys in the control of an exchange means that the institution is beholden to the exchange to move assets. The adage, ‘not your keys, not your coins’ poignantly applies here.
The primary revenue source and operational focus for exchanges is as a trading venue and liquidity provider for the market. A strict adherence to safety and security protocols to protect underlying customer assets does not exist on exchanges in the same way as custodians.
It is in the exchange’s best interest (i.e., revenue generation) to rehypothecate client assets to earn yield on customer deposits, which is how they can offer yields to their users. At a high level, this is no different from how a traditional financial institution takes customer deposits and repackages that capital as loans to other customers. However, in the digital asset space, there is often no FDIC or governmental agency regulating this practice and providing a safety net to depositors. A custodian safekeeps assets for a client and does not engage in any rehypothecation with client assets.
Digital asset exchanges have a history of significant security breaches, hacks, and theft (dating back to the notable Mt. Gox hack and ultimate collapse) as well as BitMart, KuCoin and several other market makers and DeFi exchanges. This is due to the high value of assets that sit on these platforms and a lack of security focus. For a custodial provider, safety and security is paramount and foundational to the offering.
There is an institutional need for a segregated account structure that legally remains in the beneficial owner's name and not on the exchange’s balance sheet. This was highlighted earlier this year during one firm’s quarterly announcement that noted in the event of insolvency, customers could be treated as general unsecured creditors. (i.e., customer crypto assets held in the exchanges custody could be subject to bankruptcy proceedings) (What happens to my funds if a crypto exchange goes bankrupt?)
Institutions should recognize the importance of leveraging an architecture that allows for the movement and withdrawal of assets that is independent of the exchange or custodian’s input. Having a robust and easy to follow disaster recovery process and procedures in place assures an institution that they won’t be impacted by the halting of withdrawals to protect against a run.
Copper’s offering addresses each of the above points in market-leading fashion. Copper’s architecture is unique in that it’s built upon geographically dispersed Multi-Party Computation (MPC) technology. This infrastructure solves the Access vs. Security conundrum (the more secure the asset, the less liquid the asset) by enabling optically air-gapped cold storage movements in less than 15 minutes.
The elimination of single points of failure in the generation and distribution of private keys solves concerns around compromise, loss, and theft. Leveraging Copper’s vault structure, clients maintain majority control of their private key shards. As such, they can retrieve their assets independent of Copper via segregated vaults that are not omnibus or comingled in nature and held off-Copper’s balance sheet (Worth noting that Copper does offer the option to hold assets in omnibus if that is the client’s preference)
Further, Copper’s ClearLoop offering allows Copper clients to delegate funds to exchanges without requiring an on-chain transaction— minimising counterparty risk because assets remain in safe custody. This secure trading loop enables the ‘delegation’ of assets from Copper custody to a participating exchange without moving those assets at a blockchain level— providing instant buy-power immediately after delegating assets and underpinned by Copper’s client segregated MPC custodial offering.
The biggest takeaway from the panel was that institutional investors have much to consider when entering the digital asset space. Custody hasn’t fundamentally changed in centuries. At its core, a custodian’s responsibility is to safeguard assets, and in the digital world this means creating and storing cryptographic private keys. In the traditional space, custody is important — in the digital asset space, getting custody right is imperative. With cryptographic digital assets, custodians must deliver perfectly 100% of the time. This unique asset class requires a dedicated custodial set-up that custodians, not exchanges, are best positioned to provide.
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