Cryptocurrency custody. It’s become a big buzzword lately, but what is it and why is it so important?
Join us as we go over this exciting new offering that is powering the massive influx of institutional cash into cryptocurrency assets and markets. This is big, so read on.
The Lowdown On Custody
We here at Blockonomi have been writing a lot of articles about custody lately. That suggests it’s pretty important. Let’s go over now the basics of what custody is and then go over what it could mean for cryptocurrencies in the long term.
The simplest definition of custody (in terms of finance) is when an institution holds onto assets on someone else’s behalf. This is different from making a deposit into a checking or savings account. With a checking or savings account, the bank is free to lend out your money to borrowers in an attempt to earn interest. In a custody relationship, the bank or custodian has no right to lend out your assets to anyone. Instead, they are only allowed to store it and secure it on your behalf.
Another important aspect of custody is that the custody provider (typically a bank but not always) is responsible for your assets in the event that they are lost or stolen. That means if the custodian is robbed or your paper-issued bearer bonds are destroyed in a fire, the custody provider is required to restore your assets in full as they were responsible for the loss. This means that institutions that offer custody typically have very expensive insurance policies to protect themselves from this type of loss.
One final basic tenant of custody is that custody deposits do not earn interest. This is because as we mentioned above, the company that is holding your deposit is not allowed to lend it to others. On the contrary, a custody arrangement typically requires the depositor to pay fees known as custody fees in exchange for their providing security and insurance in the event of loss.
To translate that into cryptocurrency terms, there are a number of companies now that are providing cryptocurrency custody services. That means much like in a traditional arrangement, they will protect your assets for you and ensure them in the event of a loss. They also typically charge a fee for this service – and that fee can be quite hefty.
The Big Idea
This all sounds pretty humdrum, right? But if it’s so humdrum, why are people talking about it and giving it so much attention? The answer to that is straightforward but we need to understand a few things first.
Institutions want to make money. One of the ways they do that is by taking on risks that they think are a good bet. Cryptocurrencies like bitcoin have been a good bet for quite a long time despite their temporary ups and downs. But as cryptocurrencies are still a relatively undiscovered territory for hyper-conservative financial institutions like investment funds and retirement account holders, this has kept billions in institutional money out of cryptocurrency. Until recently, that is.
Custody is an excellent solution to this. It allows big players that don’t want to directly interact with cryptocurrency, but want to benefit from investing in it, to do so while still keeping their hands free of it.
Additionally, if cryptocurrency isn’t taken care of carefully, it can be lost or stolen. Relying on a trusted custody provider that has a proven track record of securing assets makes this a non-issue.
Piece of Stake
What is particularly interesting about cryptocurrency as a form of long-term asset saved with a custody provider is that in some cases it can provide a form of pseudo interest.
Coinbase, a major cryptocurrencies exchange, marketer, and custody provider revealed that their custody service allows cryptocurrencies that use proof-of-stake to help depositors who hold these coins to earn staking rewards. That may sound like a mouthful, but simply put it means that this is a type of asset that can be held in a custody arrangement and can also yield a passive return.
Putting it all Together
In short, the biggest reason why custody is exciting is because it allows deep-pocketed players to get involved in crypto and extend the reach of the market. With hundreds of millions of dollars flooding in according to Coinbase, cryptocurrency custody is a gigantic open door for previously withheld cash to step in and buy up assets left and right, raising the total market cap of all cryptocurrencies as a whole.
In addition to potentially pushing prices up over time, these kinds of big players can help to stabilize prices by locking away huge caches of coins and preventing smaller players from flipping them back and forth, affecting prices rapidly.
This transition could also encourage more long-term minded players to get involved in proof-of-stake coins since they can benefit from staking without needing to run their own machines with potentially risky hot wallets. If custody providers are able to add masternodes to this list, that could provide even more incentive for investment in cryptocurrencies like Dash that use the technology.
Crypto custody may seem like a dull topic on the surface, but its potential for adding billions to the market is a certainty, as it is already happening.