Europe’s institutions and the struggle of safekeeping digital assets
When large institutions feel fully empowered and safe to participate in digital assets, we will start to see the true manifestation of the capabilities of blockchain technology.
With the Euro growing progressively weaker over the past months, recently measuring at a two-decade low against the dollar and showing signs of dipping further, it stands to reason that institutions are exploring their diversification options.
One area that banks may have considered moving into is the digital asset and cryptocurrency space. Despite criticism from European Central Bank President Christine Lagarde, and others who cite security and trust issues, cryptocurrency adoption has been generally trending upwards since Bitcoin made its debut in 2009. In fact, it may be these difficult times of pandemics, wars and financial crises that are making the public look towards alternative ways to approach saving and investing—and come to the conclusion that they want to explore digital assets.
Blockchain, like any emerging technology, has its own language to learn and specifications to consider. As regulators in both Europe and the U.S. work to form fleshed-out crypto policies, it is crucial for any institution that desires to become involved with crypto to understand the mechanics behind safe custody of digital assets, and how to balance security considerations with the ability to make the most of these burgeoning ecosystems.
Challenges of digital asset custody
Banks have always been trusted with financial instrument custody—but digital assets, along with their opportunities, present a new set of challenges. Cryptocurrencies rely on private keys, unique sets of letters and numbers, to determine asset ownership, and unwelcome access to these keys can result in irreversible security breaches. Considering the height of the stakes at play, it is imperative for banks to make informed and effective custody decisions.
When it comes to end-to-end security in custody, there are four critical components that institutions must consider: Generation, Storage, Usage, and Responsibility. The moment when a private key is generated has the potential to be one of the most vulnerable points in the storage lifecycle of one’s assets. Post-generation, these keys are most secure when stored in locations that are disconnected from the internet—while still having the capability to be used flexibly. Finally, it is crucial to define who holds the responsibility for asset safety: is it a certain member of the institution itself, or their custodian?
Historically, crypto custody has been, in large part, a choice between hot and cold wallet paradigms. Hot wallet keys are generated on demand in software in online servers and stored in memory, with their constant connection to the internet allowing for ease of asset use and transfer—but opening the door to security vulnerabilities. On the other side, cold wallets derive their security primarily and almost entirely from the proposition that keys are created and held in a device that is never connected to the internet.
Beyond hot and cold: what institutions need
Both of these paradigms possess downsides, with the constant live internet connection of hot wallets making them subject to hacks, and therefore not in line with institutional custody standards. However, cold wallets necessitate complex human processes of key storage, and human failure at one of these vectors can result in wallet contents being lost forever.
Additionally, as the digital assets space has matured, assets that feature governance, staking, and other novel systems have emerged. Institutions naturally want to take advantage of these new forms of utility, which require custody solutions to meld security with functionality. Private keys need to be stored in safe ways that can be accessed by the appropriate parties, with the custodian simultaneously offering full access to the features that make each token unique. Custodians that have a crypto-native bent and true history in the space are, naturally, better equipped to understand the intricacies of the many blockchains and tokens, and provide their institutional clients with crucial vetting as they select which ones to support.
The future of digital assets for institutions
As someone who grew up in Portugal and moved to the US in order to participate in the Silicon Valley ecosystem, I see digital assets as a global opportunity to level the playing field. In the midst of this tumultuous moment, it is imperative for institutions to make well-informed decisions as they move into this burgeoning space.
Custodians should fully take on the responsibility factor of digital asset storage, with a focus on providing a mix of security and utility to their clients. In my opinion, when large institutions feel fully empowered and safe to participate in digital assets, we will start to see the true manifestation of the capabilities of blockchain technology.