Counterparty Insights #3
How custody risk is holding back dollar inflows to digital assets
Welcome back to our weekly digest, where we explore key trends in operational risk shaping the digital asset space.
Custody Risk is Holding Back Crypto
23% of TradFi and 85% of crypto. Those are the percentages of institutions in each category that cite custody risk as the major barrier holding them back from, or a primary concern when allocating in digital assets.
The Data
Bitwise and VettaFi recently conducted a great survey on financial advisors. One of the questions they asked was, “What is preventing you from either increasing your investment in crypto assets or making your first allocation?”
While custody risk was around the middle of the pack, it was still a very high 23%, almost 1 out of 4 advisors saying custody risk is holding them back from investing in crypto.
23% is already a huge number, but when we surveyed crypto-native hedge funds, the boots on the ground, the concern was far greater. A whopping 85% indicated custody risk as a major concern.
And that’s all for good reason.
From exchanges to RWA platforms, over $1.6 Billion in losses related to custody failures (primarily private key compromise) have been reported this year alone.
We’ve compiled and analyzed this set of data thoroughly and will be releasing a long-form piece soon. If you follow me on LinkedIn, you’ve already seen some outputs from that research.
The Good News
But there is good news: people are finally starting to wake up to this risk. Pressure from investors on their custody providers will help push the industry in the right direction.
Additionally, investors tend to check a box: “Do the the managers use a trusted custody provider?” when looking at a digital asset counterparty or investment. But investors must evaluate how that custody product is actually integrated into day-to-day operations (see what happened to Prime Trust).
As we share the broader dataset (coming soon), we’ll use it to highlight the primary drivers behind custody-related losses and how to mitigate them.
A major note we can leave here is that investors should look for their custodians to receive the Cryptocurrency Security Standards Audit (CCSS). This is the only audit purpose built for the management of private keys. SOC2 Type 2, ISO 27001 cannot be the only checks performed as these are not specific to digital asset management.
In the meantime, don’t hesitate to reach out if you’d like to walk through your own operational set up or need assistance evaluating an investment’s operational risk. You can reach us at info@digopp.group.
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