Q&A: institutional investors eye up long-awaited crypto entrance
What has held institutional investors back from entering the cryptocurrencies space?
It’s the same barriers that prevented the asset management firm I worked for from launching a cryptocurrency fund late last year. We couldn’t find any custody or execution venues that did what we needed to be able to enter this space. Traditional investors and investment managers need things like audit trails, reporting capabilities, multiple logins and multiple trading accounts, as well as integration with traditional portfolio management systems. These features were lacking in the existing custody venues.
What are the key flaws in traditional custody venues?
If I have $100-million-worth of gold in my office, I don’t want it there. I want it somewhere safer and that’s where custodians come in. It’s no different in the crypto market. However, the downside to custody is I need to trust someone else to look after that $100 million for me. The other problem with traditional custody venues, and it’s quite a big one, is if you are an investment manager deploying your capital across many exchanges to generate returns on your strategy, as soon as your funds leave a custodian’s wallet, you’re essentially in self-custody mode because you have access to those exchanges. That prevents large institutional investors from giving the funds to the investment manager.
Our architecture is created in such a manner where, even if we get hacked, nothing will happen to client funds
How does the solution you’ve built with Copper overcome these issues?
The way we structure our custody application is quite different. We kept the good things about custody and we left the bad things behind. We use mathematics and cryptography to make it so the client no longer has access to the funds at any point in time, but when they want to have it, they have it. By allowing investment managers to deploy their capital across many exchanges without having complete access to them, institutional investors can be satisfied they have enough tools to generate returns, but don’t have access to the funds outside a specified number of venues. We’re effectively a bespoke prime brokerage in the cryptocurrency space.
How is your application more secure than technologies traditionally used by custodians?
With self-custody, funds are stored on a USB stick or a Trezor so you basically have them in your back pocket. That doesn’t sit well with investors and asset managers because they don’t want access to such amounts of money and there are obvious security issues. Traditional custody venues, on the other hand, have typically adopted hardware security modules where they keep the private keys centrally and investors have to rely on their custodian to have good enough processes for that not to be compromised. However, more often than not, security threats stem from internal dangers such as rogue employees. That means any person with access to the server could comprise the private keys. We address security differently. By using cryptography to split private keys offline, we never put those keys together on our or our clients’ servers. This means our architecture is created in such a manner where, even if we get hacked, nothing will happen to client funds.
By enabling institutional investors to pursue cryptocurrencies for clients, what impact will this have on the market?
We’ll see a more mature market and a move towards security tokens and blockchain agnostic solutions, such as Copper. Currently the whole industry is in a build-out phase for service providers and layer-one protocols. Right now, in people’s minds, there is bitcoin and 2,000 bitcoin alternatives. A more mature market will see a consolidation of available assets, with a focus on those that can generate actual returns for investors. With the correct infrastructure and governance in place, we will also see less volatility, and hopefully a spill-over to traditional finance, potentially resolving the redundancy of settlement-over-days processes and creating greater market efficiency.
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