EN | Custody Models in Digital Assets Risks, Trade Offs and Best Practices | MERGE São Paulo

Um, welcome our moderator, uh, Rafael Castaneda. UL and founder at Casta Crypto. So, you can introduce the others speakers. Guys, hello, hello. Well, we're going to do a talk about custody.

It's my pleasure to talk my fellow panelists. Just so I don't spell any name wrong. Please, Fiu, come join us. Fiu? Fiu.

Fiu. Oh, he doesn't listen. Oh. The problem. Am I better?

Ah, yeah. Now it's perfect, yeah. So, Fiu, come aboard. Jose, please come everyone. I'll ask you to talk a little about yourself to the audience.

Please take your seats. Guys, we'll try to keep this talk brief. We have 25 minutes and lots of expertise on the table.

Here's 25. Yes. And lots of expertise on the table. Uh, talking about custody, um, I'll ask you to do a brief, like really quick introduction about yourself so we can jump into the topic. Please, from my right to left.

Thank you. Thank you. Thank you for having here. Um, um, it's a pleasure to be here. Um, I am the CEO of Prosegur Crypto, which is institutional custody.

Uh, um, it belonging to a big company called Prosegur. Everyone would know in in Brazil because it's a very big cash in transit company, a very big group with 6 billion, uh, in revenue uh, per year. Um, in the very beginning, we we do Prosegur Crypto because we are custodians from 50 years ago. And if the economy is going to be tokenized, we want to be the custodian for the new economy is raising. But in the very beginning, also, we say, yes, it This is a problem of technology.

This is a technological problem. It's private keys." We were wrong. This is not a technological problem. This is a problem of risk.

Who takes the risk? Keeping safe a private key is something that many people can do. But taking $1 billion of risk under control of customer of your customer is something that not everybody can do. And this is what Prosegur does. It's institutional custody fully insurances.

Um it's something that in the very beginning of the crypto regulation not many players accept as an asked, but I always will be here defending that custody should be the center of a crypto business architecture. This is my point of view. Okay, great. Uh hello everybody. Thank you very much uh for inviting us here.

I saw it. Thank you all at the event organizer Merge. So uh my name is John from Michelle. I'm Brazilian, half French, that's why the name. Um and uh I work in a company called Dynamo.

Uh Dynamo is um digital security company. Uh we are very specialized in cryptography. We um We provide different solutions uh for uh cryptography and for digital security. And as a matter of fact, um we exist for more than 20 years here in Brazil. Okay, so we're a Brazilian company and um we participate to several of different uh very um very critical projects here in Brazil.

As a matter of fact, um a lot of people don't know Dynamo, but every Brazilian uses Dynamo without knowing. Um, or or let's say our main big project is that we provide the Central Bank of Brazil with all the uh, centralized infrastructure there for the PIX, for the instant payments. Uh, so all PIX of Brazil goes through our uh, our our our systems there. So, it's more than 300 million operations per day that uh, that we that we guarantee the security there. And as a matter of fact, we are in several um, traditional key management and key custody, okay?

Uh, when it refers to protection of transactions like PIX SPB, like cards, uh, also digital certificates here in Brazil. Uh, and we provide a technology that is called HSM, which is hardware security model. It's basically hardware uh, meant to protect cryptography key in the best possible way. Let's say it's uh, certified by by by several organizations here in Brazil and the US as well for that. Um, to to generate and hold keys uh, in in their way.

So, we're tech provider uh, and we are very well aware that uh, digital custody is not uh, only about technology. You're very right about mentioning that Pepe. Um, it's it's many things that we we're going to we're going to talk here. Um, but it's quite naturally that as a um, let's say a big player of infrastructure here in Brazil, um, working in that traditional financial space, not only, but mainly, we migrated to uh, to blockchain and we started to see that space because our own clients were starting to see that and needing some very institutional ways to control their keys, control the the the digital assets and that's why we are in this space. Great.

Hello. Yeah, pleased to meet you guys. My name is Phil Davis. It's a pleasure to be here today. I work for the institutional arm of Ledger, Ledger Enterprise.

I'm just going to assume most people here know Ledger, one of the more sort of ubiquitous names within this space. We work with institutions on key management. Um, governance, signing rules, as well as audit trail. And I share my fellow analyst's passion for hardware, or the root of trust being grounded in HSMs, isolated physical technology, hardware-based technology. Some interesting statistics about Ledger that maybe not everyone knows.

We currently custody through our infrastructure in a non-custodial fashion, I should add, about 28% of all stablecoins globally, and about 20% of all digital assets across the board globally. But, yeah, absolute pleasure to be here. Great, guys. To kick start the discussion, when you talk about custody, there is a lot of misconceptions around crypto custody, especially a lot of misconceptions about why do users embrace crypto? But, for me, we are now living in a moment where there is much of a clear vision from the institutional side on the value of these new custody systems that are emerging with blockchain.

And I would like to discuss a little about with you guys on not only let's talk about the advantages of self-custody or blockchain custody, but I would like to to give you a a specific take on how is the emergency of this new paradigm of custody money challenging the way that the tradition the traditional financial system works. Especially if you look at Brazil in the context that we had like we had like the I the the provident share fraud the NS fraud like 60 billions. Where is it? No one knows. Like we had a big bank fraud.

Where is the money? No one knows. Where are the funds? No one else No one knows anything. Like it seems that money has become like vaporware.

And when you talk about this kind of custody uh in which way and I expect you guys to give us some light on that. In which way is this new technology can reshape or challenge the current status quo of the financial system? Let's go ahead. Yeah. Well, my turn again.

Uh yeah, I could I couldn't be more agree with you that custody should be in the middle of the focus in the institutional adoption of digital assets. Uh my perspective is as uh my fellow said before uh that the my keys is not your keys is not your money is respectable but is not for institutions, right? Uh yeah, institutions are having many reporting to the supervisors and so they have been the traditional keepers of the value of the of the people. So they So uh if you want to be the digital assets in this institutional space, my perspective if the is that the custody should be professional, at least professional, right? Uh my my opinion is that is not only technology is is also physical security very hard protocols operations everything has to be in one single point of failure.

Uh at least we have to in that way. And it should be evolving in the next steps of the regulation development. I tell you something you probably know everybody in the public know that in with the European regulation what can a custodian do with the money of the customer? Nothing except turning back the money to the owner. Nothing.

This changes the rule because previous to the regulation, if you are exchange of something, you can do things with the money, you know, accountability, right? But after my Mika regulation, you can do nothing. One to one. So, the the the law, the explanation of the law is very clear. You can do nothing as a custodian with the money of your customer.

So, this changes the rule. So, the custodian is a job. The custodian has a price. Because some somewhere has to pay the bills. So, it's it's a new paradigm as you mentioned before.

This is my opinion. This is going to be the future. If you if we want the the the institutions go very hard to the to the to the crypto space. I I am not talking only of crypto like Bitcoin Ethereum, but also real world asset tokenization, securities tokenization, everything under tokenization has to be custodied. This is my perspective.

Um Well, yes, of course, blockchain can can bring several benefits to traditional way of doing, right? We can discuss a lot about this. When it comes to custody, right? We we we can believe it's it's it's quite similar. In fact, it's it's it's a lot different.

Um Of course, technically speaking, we're speaking about cryptography keys, private keys, and and public keys. And of course, but what gives you access to the assets are the keys. And when we're talking about traditional finance and and and custody there, we are in fact also talking about keys. Here in Brazil, well, last year, I don't know if you know, Phil, we had several big impacts in the PIX system, which cascaded a lot of resolutions from the Central Bank. Basically, it was a key management problem, a custody problem.

Because some big players were delegating the keys or mismanaging some keys instead of having, let's say, a good framework of governance around those keys. And those keys are used here, we are calling them the digital certificates. They are used by these financial institutions to sign transactions of PIX, of TED here in Brazil. And what happened is basically credentials were robbed and uh attackers could could go and the first big impact was a rob of one one one half a billion of of reals here in last last last month of June and several other incidents that happened. So, um we see that globally it's there's a problem of of of key technology key and when when it comes to to digital assets, it's even more critical, of course, because a key that allows me to do a PIX for an institution to do a PIX transaction can be revoked if there's some mismanagement.

In the the financial in the digital world, it's not possible. So, it's much more critical and and so, of course, custody is is the the backbone of that because it's it's much more critical. What gives you access to those assets, it's precisely the owning the ownership, the possession of those keys. So, when you delegate to a custodian or when you do it yourself as a custodian, you need to assess everything there. And so, this is this is not not so easy.

Yeah, so I you know, working from Ledger it would be remiss of me to to say anything other than self-custody is the best model. It's it's hard-coded in our DNA and has been that way since our founding in 2014. Um I guess for much of that period we've been encouraging individuals to be the bank. My job is of course to encourage I would say banks to actually be the bank. Yeah, I I know it's it's it's it's an irony, but um Yeah.

you know, I'm on a personal journey here in in Brazil in in Latin America to learn about um I think just philosophy surrounding ownership and control of key management. Um I'm resident here of New York City. I've been living there despite this accent since 2010. And I know the institutions there very well. I think a lot of the things there will be mirrored down here as well in terms of how institutions treat key management.

Um and when I say I'm here to encourage banks to be banks because what I see up up in the north is a lot of banks following the sub-custody model basically um outsourcing custody to other firms. And I'm just not sure obviously I'm biased. Uh obviously I am biased. Um so, I see a lot of institutions that are basically sort of sub-custodying out the custody model that they're supposedly supposed to be doing themselves to to firm. And what this means is that they're essentially giving up revenue.

Um maybe not all of the revenue, but a lot of the revenue. Uh and they are moving the control plane outside of their control. It's moving out of house, and they become really nothing more than a a distribution platform for these for these custody platforms. And so again, obviously I am biased uh working for Ledger, but um you know, if you're a bank and you're considering uh you know, offering custody solutions, then we would encourage you to future-proof your business and not be sort of behest to an outsourced custodian provider and sort of do it natively. But again, I am biased.

Let's test on the mic, so. Well, my mic is is I think it's working very well.

Yeah. I think it's working very well.

This one? No, my mic is

you're you're you're the best mic. You're as well. It's good. My one is good? Okay.

Okay. So, let's keep it to the result. Guys, um we talk about uh of course about self-custody, about banks being banks. And I would like to tackle in our final minutes, we talk about best practices. Um Regardless of the discussion between the custody being delegated to an institutional professional or individuals emerging to be their own banks or banks using good technology to be good banks, I think that uh even when we talk about pics and pics having its own set of keys or its own blockchain-like system, I gave a talk about the pics on the Zcash uh conference explaining how pics works.

It really is something blockchain-like.

Yeah. Uh but the issue is uh one of the best practice and one of the best advantage that I see with the emergency of this new paradigm of self-custody, be it with Ledger or be delegated to professionals, is that we are trying to achieve standardization. Cuz you can have several banks with several systems of good custody, but they each have one independent system. In Brazil, we are talking about a of Cobol systems from the '60s. Each one has their own Cobol with their own mainframe and stuff like that.

So, even if they all have good practice, we still have a huge loss on efficiency, and that translates to a loss of money. By interconnecting and syncing all of those systems. For instance, at Oxus, we do with payments. I can instantly, like with the cheapest software ever, I can create segregated wallets for all of my users. And I have proof of funds that are done with a snap of a finger.

So, let's talk about in the term of best practices, how users can achieve best practice on self-custody, and from you guys, how can institutions use the best practice of stablecoin to bring more value to their user? And from you, I'd like to hear about uh how can we in Brazil, or central bank, or others benefit from a new wave of summarization instead of just perhaps doing everything at the domain of their own central bank? Is there a discussion going on right now? So, feel free. Uh I gave you specific questions to give you some time to address your personal opinions.

You can start. Yeah. Use your Use your good mic to start. Yeah, sure. Your smooth voice.

Yeah, it is very smooth. Um best practices in self-custody. Well, uh there are a few obvious ones. Um you can begin by not writing down your seed phrase on a piece of paper and sticking it in your drawer somewhere. Uh or putting it on a hard drive and having your girlfriend put it in a Welsh landfill.

You should probably avoid those as well. Um look, at at Ledger Enterprise, one of the big differences we have between the uh institutional offering and the retail offering that I'm assuming most of you are probably uh familiar with is that we have a a very extensive governance layer built on top. So, everything you know and love about Ledger that uh exists today from a from a from an individual perspective exists also on the Ledger Enterprise side. Uh as I said, the difference is that we have this significant governance layer that's built in on top of that. If I take a step back and refer to the seed phrase again, we also have this concept of a key ceremony whenever we onboard an institution.

And this is almost like a sort of magical moment for us. It can take several hours, but that is essentially where we create your vault. So, we will create administrators. Those are the people who basically manage the governance of the system, set up the governance rules, so who can sign with what approvals and under what circumstances. And then from there, once we have the administrators, we will create a set of operators.

And those are the people who are obviously using our our wonderful sort of signing devices to execute transactions, trades, etc. Um We believe this is a a very robust way of doing things. All of this, of course, is grounded with the root of trust grounded in isolated physical HSMs, hardware security models modules both on the governance side and on the signing side with our with our with our with our signers. So, that would be what we consider to be the highest the possible highest possible standard of security available to to to our industry. And so, you know, if you're if you're a bank that's considering sort of custodying these these assets or any other kind of institution, certainly I'd I'd love to hear from you.

Great. Who wants to go? Uh I I can start this time. Well, I totally align with your with your with your opinion, but um we are I'm also biased as a manufacturer of HSM, of course. But, um and I think that that the the best practices you gave on self-custody makes total sense.

On on the institutional side, you spoke a lot about standardization when you talked. I think that this this is one of the best practices. Try to do uh things the best standardized way way banks um already did. Um, and and and gave us these legacy systems. And that's why we try here at Dynamo to bring to that market is bring the best practice of the financial traditional finance to that new uh to that new world, okay?

Um, we see a lot of innovations in in um in that digital space. Um but we believe that standardization is key when we speak about key, okay? Uh one of the the um the let's say the standards we follow is the standards from NIST, uh which is the the the main organism of standards in technology of the US. Uh and that is reference for cryptography in the world, okay? Uh they are the ones that just published PKC algorithms right now to protect us uh against uh with new algorithms to protect us against the the future advance of of of uh quantum computers, for instance, okay?

And they're the ones that define what is what should be standard or no. And we follow a lot that uh in order to give to the banks standardized ways, the best ways to protect uh keys and and and have the best uh uh security layer around those without um going to uh uh new innovation that we're not uh yet standardized. So so for instance, when we when we speak about MPC, it's very good. Um I think it's uh it's a great innovation, but it's not yet standardized. It's still uh being assessed by the NIST.

And this last uh several decades before a pair of cryptographers, there, a group say, "Okay, this is totally secure. We can go with that." Okay. And then, I think um um of course, on top of the technology layer, there's a lot of governance layers. Uh One of them is uh uh dividing your custody between several models.

Uh mainly co- hot and cold, of course. There's a lot of different layers in in in between. But, hot would be uh for uh the the the value of uh that is needed right now to to have uh liquidity. So, it's it's automatic. But, you need also already to assess uh a more cold layer.

Uh and what we believe as best practice is to have a total physical isolation like you do at Prosegur. You know that. Um and that allows you to have the minimum possible exposition of those keys. So, you have a tremendous level of security. And of course, that's for the main parts of uh of your assets there.

Where you will leave there, and you will touch them just if needed with highly processable manual friction uh uh steps with ceremonies like you you mentioned. Uh which is essential to guarantee uh the security in that very critical world of of blockchain applications. Okay. Um I'm a basic too. I'm older than a peer, but uh I've I spent 26 27 years in working for banks.

Uh here in Latin America. Here in Brazil, Spain. With my partner Alfonso. To also 25 years in banking. And my opinion is banks are not here to take risks.

Banks are here to sell products. But, don't. Even the cash, banks don't custody the cash. They outsource the cash with us. You have all in Spain 1.

4 trillions in one single place of cash. Of cash. Okay? So, it is our business. It depends on the bank.

In in the very first approach, big banks, BBVA, Santander, the big banks are going to do the whole thing of crypto by themselves because they are big, they are powerful, they have a lot of money. But, what about tier two, tier three? But, it's different. They have to do a business plan. Okay, business plan, how much crypto I'm going to sell?

I don't know. Because it's new. So, if I am doing my For the record, if you buy a self-custody solution, you are the custodian with my regulation, right? If you subcontract a custodian regulated custodian, you are not the custodian, but you are the custodian, but the risk is on that. Right.

So, if you need a full blockchain department to do the ceremonies, the control, the governance, the architecture, the security, the CISCO, the everything, the project is going to take years, and you want to test the market in weeks. How do you go to the market in weeks if you don't exter put put this on the hands of or the third party? So, we we prefer to offer a set of APIs and test if if it works, and then, yeah, do it by yourself if you want. But, for the very for the very first approach, for a tier two, tier three, I mean, in Spain. I don't know what is a tier two here in Brazil, all right?

But, for a for a medium and small-sized banks, the first approach to to test if blockchain or blockchain related products, you understand what I mean, works or not in the market is is to to go for through an API based system. We we we call it finance as a service as banking as a service in the in the traditional market because we are regulated. So, we are your your partner in crime. So, it's easy to go to the market and test if your customer accepts or not the the product. But, as I mentioned before, it's it's just a opinion.

I mean, it depends on the bank. It's it's it's it's that. But, what I think in in in the past, if you have a very small infrastructure or very full of projects infrastructure, having a a a private key ceremony is very complicated for a bank because they don't they are not experts. So, you you have to hire expertise on blockchain. How many people do you have to hire?

Yeah, it's it's too much for a for approval of concept, right? This is my my perspective. Well, nice takes, guys. Uh we got a Let's I think that because of the mic stuff, so I would like to take this extra minutes and ask for your final remarks with a special take on perhaps we have professionals that are from the finance industry or are related to the institutionals. What would be your message from people for the finance and for the institutional side that are and not yet looking into the market of digital assets?

What would you say to such people? What is your tip for joining the revolution, for say so? And also, if you want to leave your social links for anyone to find you on LinkedIn, please feel free to do so and we close the session. Okay. Okay?

Please. We change the order. Sure. Yeah. Um So for anybody who's exploring a relatively new to the space, there's three sort of critical pieces of advice that I have for you.

And this is the same advice I give to you literally everybody and institutions and non-institutions. Firstly, you should read the Satoshi Nakamoto Bitcoin white paper. Bitcoin a new peer-to-peer digital cash. That's where it started. It's not overly technical.

I would assume that everybody in this conference would understand it with ease. And as I said, it is where everything started. So I think it's just a must read compulsory reading. Number two, we've discussed this a lot I think already on the stage. You have to think about that fundamental question that all institutions who are exploring custody solutions, you have to answer that fundamental question.

Who owns the keys? Where is the plane of control? In-house or out-house and to a large extent that will be decided by the regulatory framework that you're operating in. But certainly that's that's the second piece of advice if you're considering custody solutions. And thirdly and finally probably the most important one is to give me a call, get in touch with me.

Very good. Great. Well, my my advice is if you don't know nothing about blockchain and and digital assets, you you should study very quick because if you work in financial industry, this this will revolutionize somehow what you do right now. And I would say that you need to study it from the perspective of course how I will change my business, how this will affect my business. And for me there's three big ways for that.

First is uh, um, offering new products, marketplace, the distribution of new assets, so new investment like crypto, cryp- crypto cryptocurrencies. Uh, you you can rely to a new set of people that come um, to interact with your business. So, it's uh it's it's an example of of that field. Uh, can be on the payment side. Uh, and when we talk about payment side is doing payments in a more efficient way, more securely.

Like with stable coins for crossover, uh, uh, operations. Um, that revolutionize everything when we when we speak about forex exchange for for instance. Uh, here in Brazil we had the Drex pilot, so that was very good because it educated everyone here in Brazil, everyone from the financial industry because almost all banks participated somehow to Drex. So, um, they saw a lot of, um, different use cases about payments, uh, with DVP, yeah, with rules that you pay and and uh this uh automates something else. Uh, uh, it and you pay only when the delivery of the the service was made, so lot of use cases like credit collateral and things like that.

And the third layer is tokenization, so when we talk about, uh, uh, financial assets or uh it's it's normally, uh, we we we can see lot of benefits of having this on blockchain um, because it's more efficient, it you have less intermediaries, so there's much less cost, so uh, I think Larry Fink from BlackRock said that everything will be tokenized in the future, so this going to revolutionize, of course, what we do in the financial industry, but the importance is don't overlook custody because everything you do there's custody behind. That's that's is the basis of everything that we do and it can even be a business on its side like you do at Prosegur but like very very big banks here already in Brazil do. So, custody don't it's not sexy the custody because it goes right away on the technology side but it can be a business perspective a way for banks to have new ways to to to to do money and of course it's crucial for because it's the backbone of everything we do in in in digital world. Great. Thank you.

My thoughts. Um I've been attending to this kind of events long time ago and from for the beginning I I am working for Prosegur and I'm missing some people here. The the new products guy, the innovation guy is always here in the event but never is the private bunker never is here. The compliance guy is never here and insurance companies are never here. Never here.

So, these three kind of guys should be in this kind of events. My opinion please tell them to Someone. Yes. Someone. Someone tell them to come here in the last European blockchain commission they competence of this.

My compliance officer came to the to the event to learn how it works. Yeah. It's not free people. It's normal people. It's normal people talking about finance.

So, it's they should be in the in the business. They should be in in literally in the business because they are part of the business. So, we we are now enrolling people we So, the compliance guy is is telling me, "Okay, they are crypto guys?" Yes, they are but this is the know your customer. this is the thing Oh, okay, I'm feel comfortable.

So, it's not so easy, but if you if you are a financial institution, you are the new products guy, the tribal, whatever, please enroll the operation guy, enroll the compliance guy, because if not, they are going to reject the project. I have been a lot of projects being rejected by the compliance guy. I They have a big hammer, right? They have a big hammer in in the in the board. So, please come there and it should be it should be better for everyone.

Great. Thanks a lot, you guys, for joining us. Thanks for the audience for attending. Let's all have a round of applause for our panelists, please. Thank you.