Paying for Custody - Get used to it

🌐 Changes to our idea of Custody

Recently we talked in our live session about the changes coing to custodial solutions.

This was also a topic of conversation during my week of ETH Denver, in which I had meetings with 3 different custodians.

You’re aware of how we’ve been thinking of custody for centuries.

Current Custody

A bank or other custodian holds your assets, whether those are dollars, stocks, funds, gold, etc.

Most of you don’t pay expressly for that custodial service. The custodian of choice holds your assets and, hopefully, keeps them safe.

To make the service free, they offer other services you do have to pay for, like trading.

You’re the Product

Now, remember those custodians have to make money in other ways, so they often offer the assets you think you own to others in exchange for interest payments.

So, what you’re left with isn’t true ownership. The custodian owns your assets to the point they show up on the balance sheet of that custodian.

You think, “They’re regulated. What can go wrong?”

Just like any business, the custodian can be poor at risk management and cash flow management. When that happens (2008, 2023) the banks need help getting dollars or other assets to their clients. They go bankrupt.

Well, remember when we said the bank owns the assets. When the custodian goes under, the assets you though were yours are now subject to bankruptcy proceedings. Very long and very public.

Why am I taking the time to write all this and tell you something you probably already know?

Because with bitcoin and other crypto assets we’re seeing the ability to custody, or keep safe, your own assets. No need for a centralized custodian, right?!

But maybe there is.

What if you want to be able to exchange assets? Or move from crypto to fiat and back? Or receive other banking services like borrowing?

Now you need a custodian.

But, if you don’t want your assets on the bank’s balance sheet, you will have to pay for the custodial services.

We’re not used to paying for custody, so that’s a big shift.

The Big Shift

Now, you could say this is a crypto-only issue. That for most assets and investments, clients are fine with custody in the way we’ve seen for our lifetimes.

However, we see several trends and issues that foretell of the coming age of paid custody, with segregated assets.

First, if we stay in the crypto realm, we have the fiascos at Celsius, Voyager and of course, FTX. People initially wanted the easy button, without performing the due diligence on the custodian. Once we all realized those exchanges were acting like banks, but without the regulatory protections, we had a movement to self-custody of crypto-assets.

Second, we had bank and financial system crises. In 2008, we saw what happens when banks take unchecked risks with their balance sheets, in an effort to profit more.

We thought the new regulations solved most of this, until 2023 hit and we realized many banks had duration risk on their books. When the market realized what was happening, and the potential lower market values of their huge exposure to long-term, low-interest treasuries, there were runs on these banks, and even near failures.

Investors are starting to see the cracks in completely trusting banks to manage our assets. If the technology exists to custody and control their money, it seems more investors will choose to have more control themselves.

Third, if we look at the possibility of tokenized assets - dollars, funds, private investments - we go back to the crypto technology. More of your investments will be onchain and available for some level of segregated custody.

Last, we’ve seen some backlash from people realizing large tech companies have been selling our data for a profit. What happens when those people realize they’ve been doing the same thing for money for decades?

So we have instances of custodians, the entities we have trusted for years, failing, and having to be bailed out by the government, leading to inflation as well as criticism for backstopping and supporting risky behavior.

And we have the technology allowing for easier custody in a way that is segregated from other bank and client assets.

Based on most anecdotal evidence, I think there will be more interest in segregated accounts. I also think clients would be willing to pay a small custodial fee if it means their assets are their own.

I think selling and marketing to clients based on this conversation, that they offer a custodial solution where the investor doesn’t have the fear of losing their money to poor risk management from the custodian, will be more like the selling point of being a fiduciary.

At some point in the near future, you will likely have the opportunity to offer clients a choice when it comes to custody, and you’ll address the benefits and drawbacks of the current custody options vs. the new, segregated custody.

Get used to it.

See you next week!

-Adam