The evolution of institutional-grade Digital Asset Custody
Whilst digital asset custody has evolved significantly over the past decade - moving from digital assets being stored on paper wallets and computer disks to institutional-grade infrastructure currently supporting the custody of hundreds of billions of dollars of digital assets - the development of next-generation custody platforms is just starting. Digital asset custody lays at the foundation for any institution’s digital asset strategy by ensuring the secure and compliant custody of their digital assets.
To offer Komainu’s perspectives on the fundamental role of compliant and secure digital asset custody in today’s rapidly maturing market, and why the need for regulated and institutional-grade digital asset custody offerings, such as Komainu’s, is becoming increasingly important, we are going to provide a quick overview of the technological and regulatory developments that enabled today’s digital asset custody landscape to come to existence, and then provide an outline on what’s next for digital asset custody solutions for institutions.
In the early days of Bitcoin around 2011-2013, when early retail adopters started to use the network, the most secure way to custody digital assets was in the form of self-custody, through paper wallets kept in a safe or security deposit box. Given that Bitcoin was predominantly a retail phenomenon and only a small set of institutional investors actively looked at digital assets as a potential investable asset class, the need for institutional-grade digital asset custody solutions wasn’t apparent.
Over the coming years, as Bitcoin saw increased adoption and new digital assets, such as Ethereum, went live, providing Turing-complete protocols that enabled the creation of smart-contracts, presenting new opportunities and use cases for digital assets, institutions started to grasp the potential of this new technology. Whilst institutions only explored permissioned versions of these protocols, increased capital started to flow into digital assets, leading to an increase in more sophisticated hacks of individual user wallets and established exchanges, most prominent of which the Mt. Gox hack, which saw 850,000 Bitcoin being hacked, amounting to c. US$4bn in today’s value. Because of these increased security threats, a number of early adopters set out to launch service offerings looking to help individuals to custody digital assets at a third party. During this time, custody providers still relied on cold storage, whereby private keys are stored on offline devices or wallets, stored in ultra-secure vaults across the globe. Due to the nature of digital assets this was a cumbersome process and having access to digital assets would often take days and involve a lot of human and manual operations, which would not have met the standards of any institution.
Around 2017, as digital assets started to proliferate driven by increased interest in Bitcoin and initial coin offerings, most market participants, including exchanges, still relied on self-custody solutions, often in the form of hot wallets, which led to a series of hacks with multi-billion dollars of digital assets being stolen. The sharp rise in the digital asset market cap alerted institutions who started to evaluate what role digital assets could play as potential alternative investable asset class, as well as an increased interest of regulators around the globe who started to take a closer look at the market.
Because of this increased institutional and regulatory interest in digital assets, Japanese investment bank Nomura, an early institutional insvestor exploring digital assets; Ledger, a pre-eminent security infrastructure firm; and CoinShares, a leading digital asset fund manager, joined forces to announce the Komainu joint venture, aimed at creating the first regulated digital asset custody solution built by institutions for institutions. Incorporated in 2018 and launched to the public in 2020, Komainu has been established to fill a gap in the marketplace and to provide institutions with a secure and compliant custody service for digital assets, leveraging leading technology and institutional-grade controls, supported by a transparent regulatory framework. Since then, the trend of institutions adopting digital assets has only accelerated, further increasing the need for regulated and institutional-grade infrastructure and market services. In a short period of time Komainu has reached significant milestones, on-boarding key strategic partners as early Series A investors and supporting custody for the USD equivalent of billions of dollars of digital assets for institutional clients today.
As digital assets are seeing faster adoption and development, driven by increased pressure to move natively digital following the ongoing Covid pandemic and pressure on traditional financial markets due to current monetary policies, needs for digital asset custody are further evolving.
Digital asset custody is evolving from “traditional custody services” which include custody, depositary and clearing & settlement services to also include enhanced custody services powered by digital assets, such as staking and access to decentralized financial markets (DeFi), as well as traditional prime brokerage activities, including liquidity provision, trade execution and financing services.
Today the digital assets industry is maturing, but still quite complex and fragmented, leading to new market entrants hesitating to gain exposure to this asset class without a trusted partner that helps them through their digital asset journey. Komainu is building the necessary infrastructure, processes and procedures to be able to act as strategic partner to new institutions entering the digital asset market, allowing them the secure management and custody of digital assets.
Throughout the next decade, we expect digital assets to play a key role in both public and private markets and integrate most of the traditional financial markets, led by developments of central bank digital currencies (CBDC) and stablecoins as well as large-scale implementations of tokenization initiatives. To ensure the success of this market, established digital asset custodians like Komainu will continue to play an increasingly important role as gatekeepers between traditional and decentralized financial markets powered by digital assets. Furthermore, we expect to see the development of decentralized business models, driven by staking and digital governance, which would enable decentralized autonomous organisations (DAOs) to proliferate and enable new services for institutions across the globe, with custodians retaining a pivotal role in the management of underlying smart contracts and other digital assets to ensure transparency and regulatory compliance.
We are convinced that digital assets are here to stay. Regulated digital asset custody will act as key entry point to any institution considering digital asset exposure - if you are an institution with an existing or planned digital asset strategy, reach out to Komainu and we will help you to meet your regulatory and operational requirements, today and in the future.