Introduction
In the fast-evolving landscape of digital assets, institutional investors are increasingly turning their attention to the critical aspect of custody.
The recent report on the state of digital asset custody by Pwc sheds light on key developments, challenges, and considerations that institutions must navigate to safeguard their investments effectively.
Let’s delve into the essential insights provided in each chapter of the report to understand the nuances of digital asset custody for institutional investors.
Current State of Digital Asset Custody
Reliability, security, governance layers, and usability in digital asset custody for both high-net-worth individuals (HNWIs) and family offices are a fundamental piece. HNWIs from Hong Kong emphasize the significance of opting for institutional-level solutions due to the risks associated with self-custody and the dynamic nature of digital assets. They prefer institutional-grade digital asset custodians for secure asset management.
Institutions are increasingly seeking institutional-grade digital asset custody solutions to access various sectors within the digital asset ecosystem, such as the metaverse and DeFi protocols. Custody 3.0 refers to custodians connecting institutions to the Web3 ecosystem, offering flexible custody services for assets beyond trading, catering to the evolving needs of institutions.
The landscape of digital asset custody includes third-party service providers like digital asset custodians and self-custody solutions. Most institutions prefer third-party custody services over self-custody solutions due to the ongoing trading and operational support provided by regulated custodians, trust-licensed custodians, technology service providers, and hybrid custodians. These custodians manage private key information, ensuring asset security and compliance with regulatory requirements.
Key Developments for Institutional Investors
The Ethereum Merge transitioned Ethereum from Proof-of-Work to Proof-of-Stake, leading to significant institutional interest in staking. Total ETH deposited in the Ethereum network increased to 23.9m since the Merge in September 2022.
Institutions stake their Ether through decentralised staking pools or centralised third-party providers. Decentralised staking pools are popular among retail investors for participating in DeFi protocols but may pose challenges for family offices due to managing private keys and risks involved. Technology service providers have emerged as a solution for family offices, offering security, ease of use, and product diversity in digital asset staking.
Institutions are also exploring non-fungible tokens (NFTs) and the metaverse for business utility. NFTs provide digital asset ownership protection and value exchange opportunities. The metaverse is projected to be a trillion-dollar market by 2030, with institutions eyeing investment opportunities in NFT collections and virtual land. However, NFT custody services are primarily self-custody solutions, prompting the emergence of third-party providers offering NFT custody solutions for institutions, enabling them to access decentralized marketplaces and trade NFTs securely.
Key Challenges of Digital Asset Custody
Institutions face challenges in protecting private keys with self-custody solutions, risking confidentiality, availability, and integrity if compromised. Controversies arose over hardware wallet security, prompting some users to consider switching to digital asset custodians for better management and security.
Custodians aim to balance security and accessibility using multi-party computation (MPC) to prevent single points of failure. Regulatory clarity on digital asset custody is lacking globally, with fragmented regulations posing challenges for institutions operating across jurisdictions. Insurance policies are crucial for indemnification in case of digital asset loss, with custodians and technology service providers offering varying coverage scopes.
Evaluating insurance policies involves considering factors like coverage limits, wallet segregation, insurer credibility, theft coverage, and disaster protection. Sound insurance policies are essential for building trust and safeguarding digital assets against unexpected events.
Selecting a Custody Model
The selection approach for digital asset custodians involves a systematic and structured process to identify the most suitable custodian providers. This process includes mapping the market to understand the available institutional providers, reviewing criteria based on digital strategic goals and business requirements, defining a grading system to evaluate vendors, performing a thorough review through Requests for Proposals and product demonstrations, and engaging and onboarding selected vendors based on evaluation results.
Key evaluation considerations for custodian providers include reputation, custody and trade execution model, compliance, IT & cybersecurity, suitability of services, commercials, ownership and legal aspects, and financial stability. It is crucial to assess factors such as the custodian’s reputation in the market, operational capabilities, compliance with regulations, cybersecurity measures, service offerings, financial strength, and legal structure to ensure the custodian aligns with the user’s requirements and provides secure and reliable custody services.
Additionally, considerations like the custody and trade execution model, suitability of services, commercials, ownership and legal aspects, and financial suitability play a significant role in determining the most appropriate custodian for digital assets. Understanding the custodian’s business model, service offerings, fees, legal structure, and financial health is essential to minimize risks and disruptions in asset management.
Conclusion
In summary, the report provides valuable insights into the state of digital asset custody for institutional investors, highlighting key developments, challenges, and considerations. By understanding the current landscape, staying abreast of key developments, addressing security challenges, and selecting the right custody model, institutions can navigate the complexities of digital asset custody with confidence.
As institutional interest in digital assets continues to grow, a proactive and strategic approach to custody is essential for safeguarding investments and maximizing opportunities in this evolving ecosystem.
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