Crypto Custody for Advisors

Crypto custody can be a challenging topic, as there are many options investors and advisors face when considering the storage, security and accessibility of digital assets. In today's main article, Todd Bendell, from Amphibian Capital, discusses the different custody options financial advisors need to know.

Meredith Yarbrough from LaHoja Capital Partners answers questions about bitcoin custody and collateral in today’s Ask an Expert.

–S.M.

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In the dynamic world of cryptocurrency, strategic foresight is a necessity. Financial advisors seeking to navigate this volatile landscape must understand the full spectrum of crypto custody options, balancing innovation with risk management to optimize client portfolios.

Self-Custody: The Ultimate Control

Opting for self-custody equates to holding the reins of responsibility. This approach involves securing private keys through cold storage – hardware wallets isolated from online threats. It’s a fortress of solitude for crypto, offering maximum security but requiring technical acumen. For the savvy investor or the privacy-centric individual, self-custody is best suited for those prioritizing absolute control over their digital assets.

On-Exchange Custody: Convenience with a Catch

The convenience of on-exchange custody cannot be overstated. Cryptocurrencies remain readily accessible, facilitating swift transactions. However, this method is not without its pitfalls—security is only as robust as the platform’s weakest link. Here lies a paradox: the more convenient the access, the greater the vulnerability. The collapse of FTX highlighted the potential vulnerabilities and the importance of selecting platforms with strong, transparent security practices and regulatory compliance. Advisors must thus choose platforms with military-grade security protocols, yet even the most fortified castles have fallen.

Off-Exchange Solutions: Institutional Assurance

For those managing substantial assets, off-exchange custody solutions represent a strategic chess move. This type of arrangement can include additional verification layers by involving a third party in the authorization of transactions, aligning with the stringent demands of institutional investors. It represents a strategic blend of old-world banking safety and new-tech efficiency.

Investing in Crypto Quant Funds

Venturing into crypto quant funds offers a compelling narrative. These funds utilize algorithms for high-frequency trading and other market-neutral strategies, potentially reducing risks through diversification and sophisticated strategies. This method can allow for diversified, long-term exposure to flagship cryptocurrencies while minimizing the typical complexities and risks associated with direct crypto asset management and custody.

Navigating the Regulatory Landscape

Advisors must also master the complexities of regulatory frameworks governing digital assets. The landscape is as politically nuanced as it is technologically advanced, requiring a judicious balance of compliance and strategic innovation.

Concluding Thoughts

In summary, integrating cryptocurrencies into investment portfolios requires a confluence of knowledge, strategic acumen and a keen understanding of risk. The paths of self-custody, on-exchange custody, and innovative off-exchange solutions offer diverse strategies that cater to different needs. Whether directly holding assets or investing in algorithmically driven funds, the key lies in leveraging these tools to achieve superior outcomes, reminiscent of digital assets’ ethos of bold, strategic innovation.

- Todd Bendell, co-founder and managing partner, Amphibian Capital

Q. What do credit fund managers look for when choosing a custodian for bitcoin collateral assets?

Credit fund managers prioritize minimizing business risk when selecting a custodian for bitcoin collateral. Since bitcoin collateral is typically held for the duration of the loan, custodians are evaluated for their long-term viability, including their audit practices and business continuity plans. Safety is also a key concern; managers assess both general safety policies and specific procedures tailored to bitcoin, along with any additional services the custodian might offer. The biggest challenge in choosing a custodian is lack of standardization as many institutions retrofits traditional frameworks to include bitcoin programs.

Q. How does custody of bitcoin collateral differ from traditional asset custody?

While there are shared concerns like cybersecurity risks across both traditional and digital assets, bitcoin custody carries unique challenges. For example, the cyber risks associated with digital assets can potentially translate into physical risks through the unauthorized access to keys. Competent bitcoin custodians mitigate this risk by implementing robust key ceremony procedures, where the keys controlling the assets are distributed across multiple geographic locations with strict protocols governing their access and use.

Q. Is it possible to insure bitcoin assets?

Obtaining insurance for bitcoin assets is possible, though not commonly practiced among credit managers handling bitcoin collateral, similar to the lack of standard insurance policies for traditional financial assets. Instead, managers rely heavily on stringent security protocols and existing regulatory frameworks to protect these assets.

- Meredith Yarbrough, Managing Partner, La Hoja Capital Partners LLC

Note: The views expressed in this column are those of the author and do not necessarily reflect those of CoinDesk, Inc. or its owners and affiliates.