Four Crypto Gospels, 1/4: Custody

In Christian tradition, the Four Evangelists are Matthew, Mark, Luke, and John. Their recollections are commonly referred to as the Four Gospels in the New Testament.

Cryptocurrency’s own prophets during 2018 described the Four Gospels of Crypto:

1. Custody
2. Professional Funds
3. Regulatory Clarity
4. Financialization

These prophets include Mike Novogratz, Dan Morehead, and Thomas Lee, and the Gospels were to usher in a huge wave of institutional adoption best embodied by the catchphrase: “the herd is coming.”

Well, as we near the end of 2018 let’s look back at each of these and break it down one by one. This article will focus on Custody.

Custody

When we refer to custody, we refer to the concept that a user, either individual or company, buys digital assets (BTC, XRP, ETH, etc) and then sends it to a custodian for safekeeping. The custodian does the key management, fork claiming, transaction management, and accounting/financial statements. We’ve witnessed a slew of announcements here so far in 2018 (Fidelity, Bakkt), some of which combine the functions of buying and custody into one.

Consider me a skeptic when it comes to custody’s long-term value proposition for crypto as a whole. Custody without insurance is security theatre — you are simply swapping out one holder of your private keys for another. Moreover, custodians having a better legacy brand doesn’t imply they would be any better at custody than longtime custodians such as Xapo (run by Bitcoin OG Wences Casares) or BitGo. To the extent that I want someone to hold my keys, I’d trust an OG over a multi-faceted legacy corporation any day of the week. Many of these are not dissimilar from the large corporations that regularly lose customer data on the order of hundreds of millions of customers. To this day Xapo still quietly guards 7% of BTC supply and has done so for over half of Bitcoin’s life.

Regarding insured custody, this does not appear socially scalable and is also extremely expensive. What exact cases are covered and is it truly comprehensive? Who insures the insurer? What would it mean if 30% of BTC supply were held in insured custody and then the insurance company goes bankrupt? Non self-custody breaks most incentives in Proof of Stake governance, but it also poses challenges for BTC in fork choice.

I’ve heard the argument that jurisdiction-specific custodians with custom reporting/accounting tools will ease the entry of institutions. I disagree. The profit motive is sufficient enough, and enough tools already exist today. Many family offices who believe in the BTC investment thesis have already done so on their own in highly discreet and effective ways.

The real reason for excess investment into custody offerings is the excess capital poured into investment funds seeking to invest in the “picks and shovels” of crypto. This is coupled with the pressure for legacy financial companies to provide a “crypto offering” to both get a piece of the pie as well as attract free marketing for their existing business. What better way to get the news buzzing about you than to announce a crypto product?

Most importantly, custody breaks 2 of 4 value propositions of BTC: censorship resistance and anti-confiscation. Imagine a Chinese company storing their BTC with an American custodian, or vice versa. What would happen to the ability of the customer to access his funds in conditions of extreme global stress? As we saw in the recent censorship of Iran-related addresses, the specter of gating or sudden non-fungibility is a constant risk. As we migrate more and more crypto value to trusted custodians, we have taken something whose chief value is to occupy an orthogonal plane to the existing financial/social system — and then relocated it back within that system.

I’m pleased to see funds and legacy financial players delve into cryptocurrency-related businesses and think it is a long-term positive sign for the space. It also is true that some entities cannot hold crypto without a custodian. However, when it comes to the herd, is it possible that the herd is already here, in the idea of custody itself?