On the morning June 22 crypto custody giant BitGo terminated its acquisition of rival Prime Trust, by that afternoon Nevada's Financial Institutions Division (FID) ordered Prime Trust to cease all activities alleging the company’s “overall financial condition had considerably deteriorated.” Yesterday, Nevada’s FID filed to place Prime Trust into receivership.
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This escalated quickly for what seems to be a good reason: Prime Trust allegedly owes its clients $85 million in fiat, and has about $3 million in fiat currency on hand. The company also owes a further $69.5 million in crypto, and has $68.6 million in crypto on hand.
It’s not just the number mismatch that has caught eyes, but also the way Prime Trust came to experience this shortfall.
According to the FID filing, Prime Trust is unable to access "legacy wallets." Before 2020, Prime Trust managed its customer’s crypto in its own wallets. In 2020, Prime Trust migrated customer assets to Fireblocks’ non-custodial custody platform.
Then, in 2021, after Prime Trust had turnover in its management team, it set up something called "legacy wallet forwarding" for clients and had funds sent back to Prime Trust’s old pre-2020 wallets, after issues on the Fireblocks platform. This, it turned out, was a huge mistake.
In December 2021, Prime Trust discovered that it was unable to access those "legacy" wallets. Here’s the bombshell from the filing: "It is understood that from December 2021 to March 2022, to satisfy the withdrawals from the inaccessible Legacy Wallets, Prime Trust purchased additional digital currency using customer money from “omnibus customer accounts.”
There are two major takeaways here.
First, a custodian like Prime Trust not having access to wallets is incomprehensible; the whole point of a custody service is to pay someone to be better at custody than you. This incident completely undermines the marketing pitch and business case used by third-party custodians – the claim that people aren’t smart or brave enough to hold their own crypto, so they should trust a custodian. They’re the experts after all. Apparently, that wasn’t the case with Prime Trust.
And to get in front of the claim, don’t let anyone tell you for a second that Prime Trust is some second-rate firm. Prime Trust was known to be a legitimate, young company with promise. It raised over $100 million in a funding round last year that included FIS, Fin Capital, Mercato Partners and Kraken Ventures, and counted several crypto firms including Swan Bitcoin and Coinbits as clients.
Second, and here’s the main issue: Seriously, how difficult is it to custody crypto for others?
It should be straightforward. You give me crypto, I hold crypto for you, I give it back to you when you want it, and you pay me for those services. This is something individuals are wholly capable of achieving on their own in the world of self-custody. This should be a cakewalk for sophisticated companies that garner nine figures worth of venture funding.
The Prime Trust story is developing, so I’ll refrain from casting final judgment until we know the full story, but there are a few things that need to be fleshed out. How exactly did this happen and what exactly was the “additional digital currency” Prime Trust purchased allegedly using customer money? Was Prime Trust trading crypto in hopes it would make up the difference and pay back customers without a hitch?
If this is the case, then we enter an entirely new world for this story. The counterparty risk associated with custodians is that they might lose your crypto, there shouldn’t be an additional risk associated with the custodian trying to make it back in one trade after they lost your crypto.
Big picture, this is bad news, and not just for Prime Trust customers. If we’re being honest, the situation sends the message that this kind of basic failure is the norm in crypto, not the exception.
As bad as the financial losses are, the larger problem is the apparent coverup by Prime Trust seemingly exposed during its failed acquisition negotiations. (By the way, who on the other side of that table did they think they were going to fool? And how?)
Crypto has a shady mainstream reputation and here’s yet another example of shady behavior. Given Prime Trust’s pedigree, it immediately makes you wonder what other companies – maybe even with a trusted name – are playing fast and loose with user deposits.
Maybe they are. Hopefully they aren’t. But during crypto bull markets where no-name tokens can increase by a factor of 100 or 1,000, maybe they have and gotten away with it.
The issue for the industry is that stories like Mt. Gox, Quadriga and FTX dominate its reputation, casting doubt even on the good firms. And telling people to watch their backs just won't work.
CORRECTION (THURSDAY, JUNE 29, 2023 – 19:30 UTC): Fireblocks' platform is non-custodial, the company does not manage assets directly.