The Future of Institutional Custody in Crypto: Trends, Challenges, and Opportunities | KBW2023

thank you good to be here uh big stage for just C person all those people leaving like this is the most fun talk we're going to do like all day they were brainstorming what would be the most exciting thing to talk about and they said let's talk about custody right because if you come from traditional Finance you know that custody is the most exciting business okay it's not not done crypto is a little different though hopefully we'll make it a little better um my name is Mike belshi I am co-founder and CEO of bco been doing this for about 10 years now we just have at our 10 10th anniversary at bco based out of paloalto California I am wearing a suit today I look like a banker but actually I'm a technologist pretty far away from actually anything in the banking space I think generally um but I think this is a highly technical space that needs actually technology so I hope a lot of you guys are on the technology side we are uh making some changes here all right I got a slide deck um software ate the world who who who T who said software is going to eat the World Mark andreon Mark yeah um look software has been doing this right Supply chains Information Systems uh pretty much every industry we have has changed except for one which is the financial system um the financial system is kind of the last Bastion of unimproved services by way of Technology uh they they thought spreadsheets were pretty exciting look crypto is going to eat the world finally we have software which is starting to permeate the Moes of traditional Finance in particular because of regul regulatory reasons it's it's money it actually should be in a lot of ways protected by way of a whole bunch of modes that prevent you know software from coming in in irresponsible ways but it's a big deal and this is what B has been working on for 10 years um going to go into a little bit for it we have at boo kind of two sides of what we do one is wallets which is all non-custodial we pioneered multisig wallets back in 2013 today we do multisig we do MPC but everything we do starts with a core of multiple uh keys so we use this two out of three system predominantly um and and our our clients like it quite a lot um a little bit about bco if you haven't heard of us uh we're kind of the uh brand behind the brands in a lot of cases we've got hundreds of exchanges that use bitco services but it's not just exchanges it's broker dealers it's payment providers it's hedge funds uh even some endowment funds which I find exciting because endowment funds typically are about preserving wealth and when you think of preserving wealth you don't necessarily think of your high-risk assets but so we do have some of those and it started in just the last couple of years as these markets are getting stronger um we grew really fast uh I think we're the maybe one of the fastest if not the fastest growing custodian uh we went from0 to 68 billion in assets on custody uh in just a couple of years um we do about 20% of all Bitcoin transactions by volume uh this might be surprising because a lot of times people think of us as a custodian but actually remember we have both sides we have have real-time wallets a lot of times those are run in a non-custodial self self- custody manner a lot of exchanges are using that um we also have custody for the Deep Cold Storage uh let's see a few other stats Insurance Pol insurance policy look we pioneered Insurance a long time ago uh if you look at the Fiat system and the traditional Finance insurance is less important uh the government can bail out and does bail out Banks uh almost on a regular basis but in the crypto space you know this said if it's gone it's gone so pioneering insurance we started it I think all the way back to 2016 with a small little $10 million policy then today we have 250 million of Base coverage our clients buy I think what is the largest policies uh total in in combination it's about $700 million in total cover at bco and actually that's growing above the billion dollar Mark within the next couple of months here all right so let's talk about custody kind of where custody is I want to talk about where things are going I think it's exciting because we are actually unlocking a true Global Financial system um at the base of what we do is still security and when you think about um custodians and who should be a custodian it's really important for digital assets I think you probably know this to have a company that is based in technology uh you know at the core of what we do is this non-custodial wallet then we take that and we run it in another fashion for custody but the blockchains are changing constantly the technolog is changing constantly like I said we started with multi and on on the Bitcoin Network I would still argue that is absolutely the best way to secure your your digital assets but on some of the newer chains actually you can do better with some MPC and threshold signatures so you need somebody that's doing it right here we have had failures in the just last couple of months in the industry where some companies that buy wallets from other parties don't necessarily have a really strong platform I'm talking about prime trust here you know they had a failure their Nevada based trust company they were using other people's technology for the wallets that part was okay but actually they their own technology above that was not as secure um so above the foundation and security um is Regulatory and you know uh pretty much all of our clients are looking for what we call qualified custody it's a little bit of a uh mysterious definition to some but it's actually pretty pretty simple um it's about a making sure that the custodians asset or the financial institutions assets are never co-mingled with clients and B that you know even if if the financial institution should go bankrupt that your assets are your assets so you keep your ownership all the time so that's what qualified custody is and the exchanges in our space that grew up and help build this industry a lot of them don't operate as qualified custodians which means that if they run into trouble like FTX you know your assets that were at that exchange you now become a creditor to the exchange of course we learned this all the way back to 2014 and earlier when when there were failures in the early industry all right above that there's been a lot of work on settlements and liquidity so I'll get into Market structure in a moment but if we're any other asset class there's a whole bunch of participants that help make it so that even if you have your assets and deep Cold Storage that you can still connect uh and have access to exchanges for liquidity and and and and all of your needs we have to build that so custodians have more or less built this we you know boo has put this together at this point um it's kind of the basic offering and then of course this enables you know building a prime brokerage and apps I don't think this stack is done um so you hear about prime Brokerage in our space quite a lot the 2022 failures that we had you know whether you want to talk about Celsius or blockfi or whatever we had rampant lending uh with irresponsible taking of risks people not fully understanding how how these assets how how lending should be collateralized and whatnot and not having the risk mitigation systems and liquidation systems in place to cover it custody's a key role here um and and it still needs to be built further uh anybody that's prefunding exchanges where the exchange does not have access to something that's qualified custody you know if that exchange should fail you're going to fail along with it um so we're still building there I think a lot of people here in this in this room are probably building at at that level all right so what does Market structure look like today uh look I'm an engineer so I guess we'll put up a complicated slide um which is like roughly what the market structure in the equities markets looks like today um so that is you know anything regulated under the SEC and finra in the United States looks about like this but frankly if you um if you look at other markets around the globe they don't look that different usually the names are kind of kind of different um on the on the left side here you can see kind of the buyer financial institutions he's got a broker he's got a bank or custodian on the right side you've got the seller side and then in the middle there's a bunch of parties from The Exchange the Clearing House and ultimately to transfer agents and custodians that are supposed to be the risk M mitigated components that help you with with um with with stable trading in markets the crypto industry looks instead about like that and that of course is the problem and this is I think right now still the single most important problem for us to solve in order to bring institutions traditional Finance into crypto now you might say why do we want to do that which is actually a fair question but our belief is we want everybody to be able to participate in digital assets so of course we've had self- custody you know retail has been able to get into this space as part of why all of us are here it's so exciting you know retail and individuals are on the same level playing field with uh exchanges and institutions that previously had a lock on the most important parts of the financial system um but we want everybody to be able to participate we want businesses we have financial institutions when we get true ubiquity then actually we get to start making the biggest changes in in crypto but the market structure like this has inherent risks to it which frankly blocks out a whole bunch of people from participating if you are a pension fund you have multiple investment committees that look at where your risks are who your counterparties are with deep diligence and evaluation and making a $100 million uh deposit onto coinbase does not fit your risk profile so it's absolutely key that we start to change this and what's missing is frankly checks and balances uh look mount gax on the old I intentionally picked 2014 uh hack of Mount gaau and then on the on the right side there we have FTX which is just you know uh just just under a year old from happening but in all of these cases if we had separated trade and custody it would have either been significantly mitigated or prevented altogether um let's go through it so Mount gox uh I don't know how many raise your hand if you were in the industry in 2014 okay we got a couple all right great um but uh most people weren't so I don't know if you know what happened with Mount goau but Mount goau was of course the the largest Exchange for trading Bitcoin at the time and uh they started to lose money and it dribbled out we only learned about this after the fact they were losing by way of hacking and people taking advantage of various things and the owners realized that they didn't have all the Bitcoin that they were supposed to have for the depositors uh so they started trying to trade and trying to earn it back through various schemes of course all of those failed and by the time everyone eventually realized there were 600,000 coins missing uh it was too late look if they had been forced to have a separate custodian away from the exchange they would have had a balance that they said that they claimed to have on behalf of their clients there would have been somebody to be a check and a balance for that coin check separate example anybody heard of coin check that got renamed all right we got the same guys here all right those that have been historically in the space coin Che I I think it was around 2018 that that they had a failure they lost about $600 million wor of nem coins coin check uh did phenomenally well uh based out of out of Japan if you had gone to Tokyo around that time you would have seen coin check plastered all around Tokyo and when they started offering trading of the NCoin they put together a single signature hot wallet which held the N coins and of course all of you in this room probably know enough about technology to know that that's probably not a good idea but I would argue it was actually pretty safe because they had zero nem coins in it and that's perfectly fine they can probably tolerate a loss is zero but those plastered Billboards that said coin check all over town help them grow their business and their real job was signing up 100,000 new users a day and as they did that successfully the volume of n coins on their exchange went from zero to 5 million to 10 million still in the single sck hot wallet to 50 million 100 million all along this way I guarantee you there was staff inside a coin check saying I wish we had a better way to secure this stuff maybe we should do something and yet the business side was growing so much they just had to focus on that until it was too late they lost $600 million one of still I think I don't know top three or four sized failures kind of ever so the point is is that like look exchanges all the guys at the appside the prime brokerage Etc you know they need a really solid foundation back to the triangle that I I drew at the beginning um and they need and and that there's specialization with that security that that goes on which frankly most applications don't have the time nor the expertise to build all right coin check on the on the good news side they made so much money on their exchange trading they were able to pay back all their clients so like that's phenomenal but won't always be true the reality is we need to separate these things finally FTX FTX you know most familiar in everybody's mind I bet if I ask for everybody to raise your hand everybody's gonna say they heard of FTX look it's a different game with FTX uh obviously Sam bankman freed massive fraud um he was the same as Bernie maof uh since we're in Korea does everybody know who Bernie mid off is okay all right I'll tell you anyway um Bernie moff uh was a hedge fund manager I believe he was the he was like like chairman of the New York Stock Exchange if I got it right and he built uh the largest Ponzi scheme in the history of the United States uh he he ultimately was exposed as part of the 2008 financial crisis uh when he no longer had the assets to keep up with the withdrawals that were coming for his Ponzi scheme he has said if his clients had required him to use a third party custodian he could not have perpetrated the crime and the same thing is true for Sam bankman freed look that guy claimed to have all these ass and all it would have taken is a modum of inspection and that absolutely could have been figured out and even if you don't believe that statement is true or you think it's too bold there's no doubt in my mind that if he had had just a few other checks and balances verifying that what he had it wouldn't have happened so look the industry can't grow up to institutional levels until we solve this problem and we will continue to have another FTX in the future if we do not all right so let's talk about what B is doing about it real quick uh I guess it looks like an advertisement for bco to some degree but I think this is important stuff there's a few different few different uh companies that are trying to work on similar types of things I think it's important one of the things I forgot to mention at the beginning of the the talk I'm a technologist by background um I am the lead author of the htb 2.0 protocol so if you used your browser today you might have used some of my work from uh from my Google Chrome days and what what the H protocol is about is about op for how clients and servers on the web protocol talk to each other and there's a there's a body of standard of folks it's standard organization called ETF internet engineering task force it's been around since like the 1970s um and helps standardize those protocols B is building a go Network which is the ability for us to instantly settle funds and currently we do it inside of of bco what's coming next is how do we do that not just inside ofo but how do we do that across custodians why is it that a buyer and a seller both need to be aggregated at a single financial institution look it takes time to evolve these things and that's what's coming in the meantime the settlement Network that we've built what it is is first thing in the wake of silvergate exchange Network raise your hand if you heard of silvergate exchange Network sen silvergate Bank San Diego all right up until about uh February of this year silvergate was the dominant flow of US Dollars between various Market participants in crypto it was a small San Diego Bank uh State chartered in California and 95% of its Revenue came from crypto companies uh they died spectacularly in in February of this year because all of us in this room uh decided that we were afraid that they were going to they were going to be insolvent and we all withdrew our money their profits went to zero they had to shut down good news nobody lost money so they a real run Bank it just happens that we had single single party concentration risk um all right in the wake of that we finally get to build settlement actually the way we want to uh bco go network does this silvergate was born because about 2015 there were all these settlement flows that were happening they were happening between Cumberland and jump and coinbase and Kraken and everybody and the crypto markets run 247 but the traditional markets run Monday through Friday 9 to5 Us hours so it didn't work that well in terms of mitigating risk for all that all those dollar flows silvergate steps in they create a mechanism where you can do account to account transfers inside of silvergate 24 hours a day 7even days a week instantly um over the next six years basically every crypto participant you know from Sofi to square and all the guys I mentioned before everybody had silvergate accounts and that was the dominant way that the Fiat side was being settled with go Network we can finally deliver what's called DVP from those of you that might be from the traditional Finance World DV VP delivery versus payment is a fancy way of saying Atomic sofs it's the ability for me to send $5 million of eth and $5 million of Bitcoin to you and for you to send me $10 million of cash and either those two things settle together or they don't settle so it's the fundamentals of clearing and and settlement we could do that today inside of bco that's the go Network the second thing which the go network does key part of custodianship is starting to get the assets off of the exchanges so bco spends a lot of time on Cold Storage how many here use cold storage all right good some of the more some of the newer people are also using Cold Storage already which is which is good um look for smaller amounts of money I think we've got pretty good Security in place for non-custodial wallets it doesn't always have to be cold but if you're securing billions of dollars your main job your one job is do not lose the money and uh that's what we do we spend a lot of time a lot of money on it we uh we eliminate single points of failure which means there's no single machine that has access no single person that has access no single place that has access to the key material uh all of these things but after we've done all that work then you want to get out of a position in Bitcoin or ethereum or whatever it may be and you take the assets out of that safe secure cold storage and you drop it onto an exchange like FTX and then they die and you lose all of your money um so there's a huge problem there on risk and then the second thing is also terribly Capital inefficient so uh a number of people got burned pretty much all of the market makers all of the prime brokers in crypto got burned by FTX Galaxy publicly stated they lost 70 or 75 million why did they have 70 or 75 million on FTX well the really more important question is in addition to having 70 or 75 million on FTX they also have the same amount on about five other exchanges somewhere in the neighborhood of200 $300 million just by math Exposed on various exchanges this is incredibly Capital efficient you don't see this in any other Market structure and frankly this inhibits the digital asset the crypto space from growing so with something something like the go Network we do this today we're integrated with bitstamp we've got gate.io INX coming soon a handful of others coming after that now all of a sudden you can keep your assets and Cold Storage you can see it on the exchange you can trade it settle it the only exposure you have is the settlement component which is so much smaller than having the principle at risk all the time but maybe the most interesting thing especially for this talk here because we are in Korea is now we can start to see a path for how do we get interupt between custodians and how how do we start to make it an international Global Financial system um so connecting Global markets this is bit Go's uh offices and and custodians today you know it's it's a changing regulatory landscape as all of you guys are aware every single jurisdiction every regulator every legislator is thinking about how are they going to regulate how are they going to monitor the activities of digital asset trading and markets and they are mostly coming up with similar answers but they're also coming up with some different different answers all right so bco has two qualified custodians here in in the United States that's in South Dakota and New York we have two in Europe in Switzerland and Germany we have one coming in Dubai hopefully by the end of this year Singapore by the end of this year working on a couple of others as well the point of this is that we're going to have qualified custody in multiple regions now it might sound like oh it's just all bco but when it comes to regulated qualified custody even though it is Affiliated companies inside of bco each one of those has separate management teams each one of those has separate controls and every single one of those Regulators wants to make sure that their regulated nty is not just under the thumb of some us company that's holding all the keys so it really is separate an account at bito New York trust company is different than an account at bigo Deutschland Trust Company and that's a really important step so now we can start to build protocols where you can start to now swap at the custodial layer but there's another important thing here in the US regulations have become so nasty it's almost a third world of uh crypto regulation non- us companies do not want to come to the United States why would you take crypto assets that are safe in Europe or uh or in Asia and and and take them to the US unless you absolutely need it to so what we're seeing is that companies want to on board to qualified custodies custodians in their region in their local instead of at some farway land so what we can do is we can now onboard I'll say darab bit not to not to say we're doing anything with them but we could on board derit into Germany which they would feel very comfortable a US client who may have a difficult time on boarding to to Germany I'm sorry to to derit can on board through bco New York and then we can connect the settlement behind the scenes which is what we're building next all right so let's talk about South Korea for just a minute because we are here what I have been seeing and I've Spen to Regulators uh across the globe about digital asset custody and how it fits the good news I mean Regulators understand the need of custody it's actually one of the simpler things to regulate by itself the trading is perhaps harder what's a security what's not a security and those types of things but look South Korea is standing in a very good position South Korea is already by volume in terms of uh fiat currency trade against Bitcoin is already number three it has a deep history with crypto regulations dating back to 2017 2018 has some Battle Scars From some things here in the country that have haven't worked out quite as well but those lead to having Regulators that are interested and want to solve the problems there's currently about seven bills here uh that are pending to start to bring Clarity and when you talk with The Regulators here you'll hear a different story about wanting to make the industry work as opposed to trying to perpetuate maybe a legacy regulatory system that might not be the exact fit for for crypto so I think absolutely that South Korea could be like a hub um in Asia for crypto if a few things fall into place so everybody here that's from South Korea you know um kudos to you Kudos you especially if you've got sway with with Regulators um and help make this start to happen but that leads me to I guess I got one more thing um Steve Jobs style and we do have an announcement so we're excited to announce that boo and hanab Bank have entered into an agreement to try to offer custody here in South Korea it will be the most uh compliant and safe way to store digital assets uh here in Korea I hope it'll be a really great thing for not just South Korea but actually potentially all of Asia Hana Bank we are proud and humbled frankly that they have chosen us to help uh help them with this effort they are serious about it it's not going to be an overnight thing it's not going to show up tomorrow and suddenly open for everybody this is a thing that we have to build together but this starts to bring the traditional Financial system into the crypto world and by doing that that's going to make digital assets ubiquitous and we think that that's a future custody so that we can get going with actually building the better Financial system that we're all looking for all right that's all I've got thank you [Applause] [Music] Al