The collapse of FTX was a landmark moment for the digital asset industry. The 2nd largest exchange fell, and around 8 billion dollars worth of assets were lost. While this has sparked intense conversations among retail investors around lost trust, there are also implications to consider regarding institutional adoption. Such turn of events have also pointed to the significance of utilizing independent licensed digital asset custodians to ensure that customers and organizations participating in the decentralized economy are protected. For institutional adoption to continue growing, service providers such as custodians must stand to facilitate their entrance to digital assets and help rebuild the industry with credibility.
What does digital asset custody really mean?
Conversations around digital asset custody are often hyper focused on the safekeeping and management of assets or private keys. What most fail to realize however, is there are many layers to custody. Branching away from just the safekeeping and management aspect, digital asset custody also comes with considerations on the reliability/scalability of technological infrastructure, regulatory/compliance frameworks, counterparty evaluations, monitoring/reporting obligations to clients and much more.
Qualified digital asset custody comes with the big responsibility of finding the right balance of integrating the traditional side of custody with the speed of development in the digital asset ecosystem. This requires custodians to have an in-depth and high level understanding of the ecosystem itself, including its different products, gateways of access, and implications for different business operations. Additionally, being flexible and adaptive to client needs or changing market conditions is crucial in a rapidly evolving ecosystem. Custodians must be able to respond to such, and translate them into product/service functionalities in a time appropriate manner.
Is self-custody a viable long-term solution for institutional investors?
Recent turn of events with the FTX fallout has sparked intense discussions around the topics of ‘not your keys, not your crypto’ and self-custody. However, it’s important to not overuse or abuse such topics in a manner which does not acknowledge the compromise that self-custody requires. Self-custody demands accountability, responsibility, and discipline from respective owners in exchange for higher freedom, control and convenience. To be the sole owner of your assets, users must fully understand the security risks.
Self-custody may be a viable solution if you are the sole owner of your assets – but the moment there is a discrepancy between the manager of the assets and the ultimate beneficial owner, risk agency comes into play and self-custody should no longer be an option. Institutional investors must consider the risks brought onto not just themselves but also for the firms they represent, meaning self-custody is not a sustainable answer. However, the decision of adopting either self-custody or otherwise, would depend ultimately on the institution’s investment strategy and what they aim to achieve with digital assets.
What can the digital asset industry learn from traditional finance in relevance to custody of digital assets?
The first and foremost lesson would be that the fundamentals of custody itself has and always will remain the same. Traditional finance has taught us the strong rationale behind why custodian business models exist, including the need for methods of regulation or clear segregation of duties. Yes, technology is constantly evolving in the digital asset space. But the FTX fallout has once again shown the entire industry that the fundamentals of custody remain untouched.
Previous financial crises in the traditional space have shown that what is happening in the digital asset industry is no different. These cycles will continue, but it is just up to the industry itself to learn and evolve based on past mistakes. What makes digital asset custodians different is to understand that assets are being represented differently, and they must change the way they operate based on these representations. The only questions to ask in today’s market conditions are: why are things done a certain way? Why did custodians come to be in the first place? Regrounding based on these principles will allow digital assets to move in a similar direction to traditional finance, and help eliminate unnecessary activities which heightens risk.
Can traditional banks and digital asset specialists work together to provide viable custody options for the future?
The simple answer is yes, they should be working together. The digital asset industry still requires much advisory from the traditional world, being a young and nascent asset class. However, there is clear growth and impact brought by this new technology, and traditional institutions are in the midst of educating and understanding. This is also where digital asset specialists can help.
There is very high potential for partnerships in the space, with both sides of the coin having something to offer to the other. Digital asset specialists in this scenario are market creators, and also require the participation of market growers (which can be traditional institutions) for the whole industry to scale beyond its current state.
Why would the FTX collapse be a good thing for institutional adoption of digital assets?
Post-FTX conversations around institutional adoption of digital assets have mainly been negative, but there are definitely positives to look forward to. The collapse of FTX provided users, organizations, and regulatory bodies with clarity on the blindspots or weaknesses of the decentralized economy and what types of rules must be implemented to prevent future risks. With such insights, the digital asset industry can work towards a more sustainable ecosystem with better infrastructure, participation models, and management of participating entities to move more towards a regulated and rigid structure. This will result in a stronger, leaner, and fitter ecosystem with credible, trustworthy players supporting proper use cases in the future.
Experts state that FTX is not the last time something like this will happen. The industry is still very much in early stages and regulation should be integrated properly to ensure all participants are protected. Institutions will look for opportunities to use the decentralized economy in a more regulated and controlled framework with the help of credible parties. The industry just needs to slow down a little, and prioritize strengthening the foundations of the decentralized economy rather than attracting new players.
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