Top consulting firms, major investment banks, and other enterprise-grade institutions share a common goal moving into 2020: cryptoasset custody.
Companies that enable customers to hold cryptoassets have an opportunity to increase revenue through assets under management (AUM) fees, custodial fees, or trading on behalf of clients.
As a result, there is a race for AUM, and some institutions leading the race, to name a few, are Fidelity, Gemini, Coinbase, Anchorage, and Bitgo. Recently, German banks have been authorized to store and sell cryptocurrencies come 2020, so we will see how Germany does as a whole throughout next year as well.
But, even beyond revenue, it allows these institutions to stay ahead of their competition by acting as early players in the growing cryptocurrency industry. While it seems like an obvious move, to include cryptoassets in addition to traditional assets, there are barriers of entry to ensure that custody operations are done properly. These barriers are what hold lots of other firms back. In this piece, I’ll break down the not-so-obvious barriers that must be understood and overcome, then segue into the upside potential that still exists in the market.
Cryptoassets Require ‘Physical’ Custody
Unlike equities, futures, or options, cryptoassets need to be physically stored by the firm in a way that requires more technical security. With cryptoassets like Bitcoin, firms need to actually hold Bitcoins for their clients. They cannot be represented as an IOU or based on credit, the company must store the Bitcoins somewhere if the client chooses to withdraw. Additionally, companies holding part of their treasury in cryptocurrency must understand the best way to secure their futures.
Common ways to store Bitcoin can range from hot wallets, to cold wallet, to paper wallets (another form of cold storage), or multi-signature setups. A hot wallet is a wallet that is connected to the internet, while a cold wallet is a wallet that is disconnected from the internet, making the funds more protected from attackers. A multi-signature wallet requires multiple parties to sign the transaction to release funds. These are different methods of storing what are called private keys, which give the user access to the funds stored on the blockchain. Without getting into detail, it’s clear there is an educational and technical security barrier to cross here.
Network Fees
When sending Bitcoin, a network fee must be paid. The network is the decentralized network that Bitcoin runs on. The higher the fee paid, the faster your transaction will be confirmed and included in the next block on the blockchain. The lower the fee, the longer your wait time will be.
In addition to this, large exchanges and financial institutions may look into batching transactions, a method of sending large quantities of Bitcoin on behalf of many users at one time, to save on fees for both the user and company.
Regulations and Taxes
Regulations are a big topic around cryptocurrencies as regulators still learn how this industry works. It’s important to understand which countries are flexible with cryptoassets, and for those in the US, which states are more or less flexible. For example, the state of New York has a BitLicense, while other states do not. This requires added paperwork and fees to serve the residents of New York.
Additionally, cryptoasset trades are taxed differently than traditional equities. To keep things simple, if you purchase Litecoin with Bitcoin, then that purchase is viewed as a taxable event. It is implied that to acquire Litecoin, Bitcoin was sold to USD, even if this was not the case. In contrast with equities, one cannot purchase MSFT directly to AAPL. AAPL would need to be sold to USD, giving an opportunity to save cash for any possible capital gains, then purchase MSFT.
Understanding the financial and legal implications of entering the cryptomarket can be understood with the proper team, but still requires time and understanding.
The Upside Potential
The upside potential has shown itself over and over again in the past. Looking four years back in December of 2015, Bitcoin’s market capitalization was $6.2 billion. Today in December of 2019, it sits at $134.6 billion with a 1,531% increase in price. This shows the customer need for custodial solutions rising exponentially.
Accenture performed a study that showed 90% of major banks were exploring blockchain technology, and it’s no surprise that many filtered through to practical experimentation and implementation today.
While crypto may not be in the mainstream as of late, it’s still more active than ever. With institutions actively getting involved, we see no sign of the potential growth slowing down. There are still many other technicalities to consider when entering the crypto industry, but it shouldn’t hold any company back.
At this point, there are also plenty of firms out there to help with this, such as Blockset, a major initiative that I am part enabling large institutions to enter the space in a cost-effective and timely manner.
Through Blockset I am speaking with top consulting firms and financial institutions who are looking to break in. The interest is growing rapidly by the day.
Brent Traidman is the CRO of leading crypto wallet, BRD. He has over 15 years of experience leading high impact growth software companies, of which many have had successful exits.