Institutional investors are eager to invest in cryptocurrency and other digital assets, but won’t until they’re sure those assets can be safely secured and moved in the same way cash, stocks, and bonds are.
That’s the conclusion of a March 2 report by accounting and advisory giant KPMG. “Cracking Crypto Custody” noted that $9.8 billion has been stolen in exchange hacks and other crimes since 2017. That means big institutional investors like banks, asset managers, and pension funds need better custody solutions.
“Institutional investors especially, will not take positions in cryptoassets if their value cannot be custodied and safeguarded in the same way traditional assets are,” said report co-author Sal Ternullo, co-leader of KPMG’s cryptoasset services.
Still, protecting these assets from hacks is not the only concern institutional investors have, Ternullo said in a KPMG podcast. They also need custody solutions that don’t make it difficult for them to use and move assets as they see fit.
“You want highly secure solutions that provide comfort to your customers, that the assets custody within your system will not be compromised by a hack or a malicious actor,” said Ternullo. “But you also need to guarantee that they’re highly available.”
That, Ternullo added, is the “core issue” big investors are facing in the cryptocurrency market, despite digital assets having “seen mainstream adoption and a spotlight back on crypto” in the past six months.
Tremendous growth potential
“Cryptoassets are no longer an exotic instrument, bit player, or side show,” said report co-author Mike Krajecki, managing director of KPMG’s Emerging Technologies practice.
That means there is “tremendous growth potential” for crypto custodians, which are “poised to alter the financial services landscape as we know it,” the report said.
In December, a State Street survey found 94% of large institutional investors plan to invest in digital assets by the end of 2020. Of those, 83% already have, and 38% are planning to increase those investments.
“There is broad market acceptance that permissionless blockchains, native tokens, and cryptoassets will enable robust new ecosystems of commerce and trade,” Krajecki added.
At the same time, State Street also found a hesitancy, with 55% saying “tokenized assets’ inherent risks are too great for widespread institutional adoption.”
Beyond big finance
This concern isn’t just about bitcoin and other cryptocurrencies, said Ternullo. It also means other blockchain-based currencies like Facebook’s Libra stablecoin and the forthcoming central bank digital currencies.
Nor is it just focused on financial institutions from banks and brokers to FinTech start-ups trying to digitize payments and other traditional financial transactions, he noted. Investors are looking at tokenizing everything from real estate to art.
The custody gap also creates “unique challenges for enterprises looking to transform their businesses from custodians of traditional assets,” said Tegan Keele, the KPMG US blockchain program leader, in a statement.
Still, securely custodying crypto assets is an issue “organizations across industry lines everywhere that payment rails” exist are dealing with, Ternullo said on the podcast. “We’re starting to see custody capabilities being adopted.”
Making digital assets “highly available” doesn’t just mean easy to access and spend or trade, said Ternullo.
“It’s about, how do you create a seamless integration model where custody is part of the overall operational landscape, but is integrated behind the scenes,” he said.
“You’re not only talking about infrastructure and the technology itself, you’re now talking about how this capability integrates into established core banking applications within that institution,” he added. “Established compliance reporting structures that are built on top of those core banking applications.”
Those are the challenges that large institutions face with digital assets, Ternullo said.
He added that one reason for this focus on integration is that there has been “substantial progress” on the bigger issues—scalability, performance, and privacy.
That said, technical and operational challenges remain, for both traditional financial institutions and FinTech startups, Keele noted.
The four keys
KPMG said four key building blocks are needed to meet these technical and operational requirements.
The first deals with the immutability of blockchain transactions, which are final. And as there are no “trusted intermediaries to capture, confirm, clear, settle and account for the transaction, there is no recourse for owners to recover an underlying asset once it has changed hands,” the report said. That means next-generation security and custody and wallet infrastructure resilience “is more important than ever before,” it added.
Second is compliance with the strict and varied regulatory requirements of jurisdictions around the globe. But it is not just compliance, according to the report. The infrastructure of digital asset custody solutions must be able to evolve and adapt to changes in those regulations.
Then comes the need for strong and reliable crypto custodians. More and more solutions are becoming available from crypto-native companies like Coinbase and Gemini, as well as traditional financial firms like Fidelity and Intercontinental Exchange (ICE).
Finally, these solutions should add value to clients, KPMG said. This begins with integrating front-, middle-, and back-office services currently locked in traditional silos. But, there are new revenue streams unique to crypto asset services, such as “staking-as-a-service and governance decision making.”