Custody Services for Digital Assets
Technology, security, and compliance – these are the main barriers standing between digital assets and asset custodians. Traditional asset custodians simply are not equipped to manage digital assets with as much confidence as they have in bonds, cash, real estate, equity shares, and other legacy financial vehicles. Alexandre Kech is trying to change that.
On the new episode of Blockchain Beyond Hype, we sat down with the Onchain Custodian CEO to discuss his past experience in the financial industry, what drew him to the Blockchain world, and the many challenges ahead for digital asset advocates and the financial sector writ large.
Laks: We’re here today with Alex. Welcome to Blockchain Zoo. We’re excited to have you here to discuss custody services in a digital asset world.
Institutional funds require institutional-level custody. Third party custody services for traditional assets such as bonds, cash, real estate, and equity shares are already long-established, standardized, and regulated. But, this is not the case for digital assets. Bitcoin and cryptocurrencies are very different from traditional assets. Is that why the custody service has to be reinvented?
Alexandre: There are two main reasons why traditional custodians are not ready to do custody of crypto assets. The first is the technology. Blockchain digital assets are maintained and managed differently than traditional assets through private keys, which we’ll talk about that a bit later.
Second is compliance. These types of assets are relatively new. The compliance departments at traditional custodians clearly do not feel comfortable securing, managing, or taking into custody the assets like cryptocurrencies for any number of reasons – various fraud at the beginning of the industry, and because of the very big market fluctuations. Although traditional asset managers express interest in cryptocurrencies – be it Bitcoin or other types of tokens – traditional custodians are not yet ready to do that.
Laks: So, the custody services for digital assets seem to be on at a very early stage of development. Even though it’s challenging, it gives you a chance to be one of the pioneers. Could you share your reasons for leaving a great career at Swift for the sake of joining a rather small team?
Alexandre: I think I saw the light about four years ago when I was looking at digital assets, but saw blockchain more as a technology than the crypto side. I fell in love with the technology first, then started investing in Bitcoin just to understand how it worked, and realized quickly that managing private keys was quite complicated, especially for individual investors like me. I actually lost one private key one day – fortunately, not on a big position.
So when I was given the opportunity to run this company by the founder of Onchain Custodian, Da Hongfei, the founder of NEO, I jumped at the opportunity. We had a nice exchange during the interview where we discussed strategy. I was able to apply my traditional custody knowledge onto the space and convince them that I could bring something to the company. I’m also hoping that I can bring something to the industry in general.
Laks: Since digital assets are built on Blockchain, they are highly secure. But wallets are not. So for institutions, the risk of financial loss is significant. Over the past few years, many cases of stolen or lost bitcoins were encountered due to hacking or fraud. How do you see this problem of investing in digital assets being resolved?
Alexandre: Well, focus is the challenge, and those players do not focus on custody. Their core business is not to be asset custodians. Their core business is intermediating buyers and sellers when they are investing when they are crypto funds, for example. And, they don’t want to take the time, nor spend the money, to establish good operational and technological environments to take custody of those type of assets. That’s where third-party custodians come to play.
That’s why this gap is being filled by companies like us who believe that they can serve the industry better by preserving those assets, ensuring that they are safe, that they are not cyber-hacked anymore, or lost by simply by misplacing private keys during operations – as we’ve seen.
You cannot imagine the stories I’m hearing from customers. I’m talking to a family office at the moment where the manager of the office – the main person of the family is keeping all the private keys and sending them by email when they need to do a transaction. This is the situation that we need to solve. I am also hearing horror stories from crypto exchanges where they actually have one USB stick for all their cold storage, and that’s how they manage the custody of the assets of their customers.
Laks: Not very secure.
Alexandre: Exactly. So there is a clear gap, and I think we can bring professionalism to this industry by applying the traditional custodial way of doing business, and ensuring that we invest in the most-secure technology.
Laks: Apparently, institutional investors have particularly challenging needs with respect to custody. What are they?
Alexandre: Three major ones. The first is security.
That would be covered by good technology and a good operational environment ensuring that no one person has access to private keys, for example, within the custodian. The second one is compliance. If they invest on behalf of customers, they need to be able to report to those customers on a regular basis. Having a third party – a neutral, independent third party – doing that is reassuring to their investors. The third one is around insurability. It has been a challenge, actually, for custodians like us to find insurers that are ready to insure. But we’re getting there, and more and more custodians are being insured for the assets that they hold for customers.
Laks: It seems like there is no 100% safe solution. Hot storage and online wallets usually have a pleasant UI and it’s easy to transact digital assets. While cold storage, the wallet connected to a hard drive device storing private keys offline, can be lost like you said, or damaged by some force majeure like a fire. How should the choice be made? Are there hybrid options?
Alexandre: Yes. There are a lot of advancements, changes, and progress in this industry. We currently, in our version one, do cold storage using a multi-sig environment with multiple devices. Customers have the choice to keep one of those devices to sign transactions or to delegate all the power to us. So that’s a trust that is established, but it’s only a version one.
It’s not very easy. It’s not very accessible in cold storage. You can’t just extract or withdraw tokens in a few minutes. It can take hours sometimes, which is not very efficient. So we are looking at a hybrid solution that I call, “warm storage,” which is as secure as cold storage in the sense of storing the private keys into hardware devices like hardware secure module – HSM as we call them in the industry – where those assets can be accessed in a more automated way while keeping them very secure. There is a lot of research and development in that space. Companies are proposing to store those assets on the blockchain itself and shard it in multiple nodes on the blockchain.
There are also solutions, software solutions – special types of Intel chips called Intel SGX – that can store those private keys, and they say impossible to break. But, this is still experimental, so today cold storage remains the more secure way of doing it – even though it’s not efficient enough. By the end of the year, we will be able to implement warm storage as I call it, which is more accessible and more automated.
Laks: Ok, but doesn’t it create another point of centralization of the supposedly decentralized system? Looks like history is repeating itself – we are leaning on the service provider, who will take part of the responsibility for our assets – and indeed power. What are your thoughts on the centralized nature of the custody services?
Alexandre: Well, it’s a very good question, but when you look at blockchains today, they are very centralized themselves. When you look at a blockchain like the Ripple blockchain, 60% of the assets are still under management by the Ripple Foundation. So you have those types of centralization within blockchain environments themselves.
Exchanges are very centralized as well. There is a concept of a decentralized exchange that’s slowly but surely emerging. We’re not there yet, but I think it’s a natural step towards maturity for the industry. It’s not easy to be fully decentralized, and in the case of custody, I think we’re not really talking about a must-be decentralized versus must-be centralized. It’s a choice for the investors.
Some investors will not want to take care of multiple private keys for the multiple blockchains they are connected to. They will not want to connect to multiple blockchains. They will want to have service providers giving them access to multiple blockchains, giving them access to multiple assets they can invest in and give them the possibility to have reporting on all of their assets from one place. Others will want to do self-custody, and that’s absolutely fine, doable, and possible with blockchain – and this is what makes it interesting compared to other technology. I think it’s a question of choice more than a question of will, I would say, from the industry.
Laks: A wave of new financial service providers for digital assets creates room for bright, innovative solutions. But it also creates room for poor services that may damage the overall view of such a young niche. What should be minded by the institution when choosing a custodial service provider?
Alexandre: They should look for independent third-party custodians. So third-party custodians who are focusing on custody and are not doing something else like crypto exchanges or crypto funds who pretend to be at the same time market makers, OTC brokers, crypto exchange etc. etc. You see that everywhere. ICO advisors – now STO advisors – because it’s the new thing to be.
Always focus on providers who are focused on what they are doing, is the solution in my view. Choose the best crypto exchanges because they are the best crypto exchanges. Choose the best crypto funds if you need to invest some of your assets or money into crypto because they are only doing funds services. Choose third-party custodians that are only doing third-party custody because they are the best at what they are doing.
Laks: So you are on the front line of promoting this service, and you know the ecosystem in APAC. How many competitors are there? How many exchanges or potential customers? Could you give us some insights on the opportunities, and the supply and demand, in your market?
Alexandre: So, custody is a clear gap in the industry, and we’ve seen a lot of new custodians emerging in the past month, or at most one every week. In Hong Kong, there are quite a few. But I would say there are four to five that are serious competitors to us. In Singapore, two or three serious. One of them is Onchain Custodian. For the rest, in Thailand, Indonesia, or Malaysia, it’s still very early stage crypto.
It’s going fast, but I haven’t seen a lot of custodians emerging, so we are getting a lot of questions and a lot of inquiries from players in those markets. When I took the job, I was wondering when we would start making money and actually getting traction. I was hoping for 2020, and actually, it’s 2019 and it’s already happening. We launched about a month and a half ago and are already onboarding twelve customers – two crypto exchanges, crypto funds, family offices, and one high net worth individual.
And that’s just expressing the gap and the demand that is out there. I guess the reputation of our company is good as well. The fact that the management is all traditional capital market veterans, I would say, that I have moved to the other side and it’s helping, but I think in general I think my competitors also have this demand and this need for custody as we speak.
Laks: The financial industry is going through exciting and rapid change. And you are leading the standardization of custody services for digital assets. What are the next steps which should be taken toward institutional mass adoption for the blockchain technology?
Alexandre: Standardization, as you shared. We need more standardization. So if you are an institutional investor who needs to connect to multiple custodians, what you should probably do is not only take one, you take many to diversify or limit your risk. You want to connect using an API, for example. You have different sets of APIs per players — the same for exchanges. If you want to connect to multiple exchanges using an API, you’re going to have different standards to implement. That’s a problem because it’s creating friction in the way you connect to different players.
We launched an initiative through Global Digital Finance, which is an industry group looking at the code of conduct for the industry, around standardization of APIs as simply as that. Can we use an existing standard, in this case, the ISO20022 standard built for building standardize messaging, to apply it for the crypto world and to build up APIs, so messaging APIs, that can be used by all players to facilitate connectivity? It’s as simple as that. I think the code of conduct is also an important step towards regulation because regulation is not yet very clear. From country to country it’s different. It’s not always very clear how you have to operate as a custodian, and having clarity in terms of regulation will be required. In the meantime, doing self-regulatory initiatives like the code of conduct for the industry will be a first good step towards institution investments.
Laks: OK. Well, this has been very interesting, thank you for telling us about Onchain Custodian and custody services for digital assets. We do like to ask all of our guests, how do you envision blockchain changing the world?
Alexandre: Well, it will change the world. I’m a strong believer in the tokenization of the economy and capital market as well because it’s a way to make accessible assets that today are reserved to privileged people. Let’s take the example of real estate. We’re talking a lot about tokenization of real estates in Singapore, for example, which gives access to very quality assets to investors like you and me, when today you cannot really invest in those type of instruments or those type of assets. You can even imagine in the future the tokenization of art which is happening today. I will in a month invest in a Picasso painting. I won’t have it in my living room, obviously because it’s a bit too much, too expensive.
Laks: A little bit.
Alexandre: But I will be able to place, I don’t know five thousand into tokenized portions of a piece of painting that a museum wants to, instead of selling completely, wants to distribute partially, for example, to get the liquidity to refurbish the roof which is leaking, for example. So those type of possibilities exist with blockchain and tokenization, and I want to be part of it.
Laks: All right. And how do you think the market for blockchain-based solutions will evolve?
Alexandre: It will have to consolidate, I think. Today there is still a lot of different blockchains, different protocols, different standards. It’s OK, it’s normal. It’s the beginning, so a bit like the beginning of the internet to the 90s with the tens of thousands of companies hoping to be the next Google, the next Facebook. That’s the stage we are in in the blockchain. You don’t have a clear winner on which blockchain will prevail or which company will prevail. That will be in five years probably. In the meantime, I think we need to work collaboratively together towards a more standardized and easier to use blockchain environment for the users.
Laks: OK. Well, this has been fascinating. Thank you again for coming to speak with us at Blockchain Zoo about the way that blockchain technology is being used in the financial service industry.
BBH Guest: Alexandre Kech, CEO of Onchain Custodian
Alexandre has spent more than 20 years dealing with the capital market. He left the role of Head of Securities & FX Asia at SWIFT to stay on top of a changing reality of the financial world and work with custody services for digital assets. He believes that tokenization of economy and capital market through blockchain is the evolutionary stage for banking and financial services. His current focus is on launching a global Digital Asset Custody business in Singapore.