Crypto for Advisors: Digital Asset Custody’s Future

Colton Dillon, the CEO of Hedgehog Technologies, discusses the advancements in digital asset custody, highlighting the trend towards individual self-custody in the industry and emphasizing the role of advisors in facilitating this transition.

One potential way to rephrase this: At Sound Advisory, the knowledgeable Jessy Gilger addresses queries regarding holding bitcoin directly in Individual Retirement Accounts (IRAs).

–S.M.

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Not Your Client’s Keys, Not Their Coins: The Future of Digital Asset Custody

Web3 rails will eventually swallow traditional finance, and there’s no question about it.

As a researcher studying the financial landscape, I’d like to share an intriguing observation. The digital asset sector, with its impressive $2.3 trillion market capitalization, is yet to reach the mammoth size of the stock market, valued at approximately $110 trillion. However, it’s essential not to overlook the significant strides being made in this domain. Major players like Blackrock, Stripe, and Franklin Templeton have recently invested substantially in real-world assets (RWAs) and stablecoins.

As a crypto investor, I’m excited to see how traditional securities are being gradually adapted for the blockchain world. Firms are working on creating digital versions of money market funds and mutual funds that can be easily transferred between peers without intermediaries. It’s just a matter of time before regulators follow suit and allow us to trade popular assets like Fortune 500 stocks or exchange-traded funds (ETFs) in the same seamless way. The future looks promising as every traditional asset will eventually become an on-chain asset, providing more investment opportunities for me and fellow crypto enthusiasts. All we need is patience and a little more time for the regulatory framework to catch up with the market’s pace.

So, what does that mean for custodians?

Last June, Chainalysis revealed that the number of personal cryptocurrency wallets was rapidly growing, contrary to the declining trend of assets being transferred to exchanges on a quarterly basis. Both individual and institutional investors are opting to retain control over their digital assets directly on the blockchain instead of relying on custodians who could potentially become the next FTX or expose their funds to intricate webs of rehypothecation. Wouldn’t you prefer keeping your funds outside of Silvergate’s bankruptcy proceedings?

As a seasoned crypto investor, I’ve noticed an emerging trend among Web3 asset holders: once they reach a certain level of sophistication, they’re increasingly choosing to take custody of their own digital assets instead of relying on exchanges like Coinbase, Kraken, and Gemini. Although institutional adoption is moving more slowly, the shift towards self-custody is clear.

As trusted advisors and fiduciaries, it is our responsibility to be ready when clients request assistance with self-custody solutions. Self-custody options abound, ranging from multi-signature accounts to account abstraction (AA) smart contract wallets, institutional hardware wallets, and multi-party computation (MPC) wallets. Each choice comes with its own security benefits and usability challenges, as well as cost implications.

Multisig

As a crypto investor utilizing Ethereum-based networks, I can attest that the Gnosis Safe is an invaluable tool for managing multi-signature wallets. It’s the original and most commonly used solution for transactions requiring agreement among multiple people. On other blockchains, you may need to explore alternative options like Shamir’s Secret Sharing through dedicated wallet software.

Account Abstraction

For now, this is an EVM-centric approach, but theoretically, any blockchain capable of hosting smart contracts can adopt the standard. Account abstraction enables skilled developers to add extra permissions and functions on top of a regular account. Specific signatories are then restricted to approving only specific types of transactions. Additionally, several platforms utilize these features for transaction batching, non-native gas tokens, and transaction forgiveness among other advantages. Notable examples include Gnosis Safe and collectives like ZeroDev, Biconomy, and Fun.

Institutional Cold Storage

Several custodians provide cold storage services, ensuring your assets are protected using advanced hardware security modules and strong physical security akin to Fort Knox’s gold vaults. These solutions utilize expensive, hard-to-hack chips for generating private keys and signing transactions securely on your behalf without the agility and swiftness of hot wallets. Depending on the specific provider, additional features such as multisig, AA, or MPC solutions are incorporated, but the expense often includes double-digit basis points, substantial minimum balances, and ongoing account maintenance fees.

Multi-party Computation

One of the most adaptable solutions in the crypto sphere, Multi-Party Computing (MPC) doesn’t adhere to a particular network through a smart contract. Instead, it necessitates trust in potential hidden collaborators. MPC operates closer to the fundamental layer of cryptocurrencies, as all users in an MPC wallet pool together to regenerate the private key, distinct from having separate private keys each providing their individual valid signatures. For those with advanced technical knowledge, there are Qredo and Lit protocols that offer fully decentralized alternatives. However, for advisors preferring a more hand-held approach and open to collaborating with trusted intermediaries, Anchorage’s enterprise solution, Porto, and my company Hedgehog’s MPC account management product catering to fund administration, sub-advisory, and turnkey asset management programs have recently emerged.

It’s clear that Nathan McCauley, Anchorage’s CEO, succinctly expressed their reasoning for selecting Multi-Party Computing (MPC) as a solution.

Currently, numerous individuals are turning to self-custody methods to broaden their range of actions on the blockchain. We view this trend as progressive and supplementary.

As a trusted advisor, it’s essential to adhere to the Custody rule and ensure that you don’t hold unlimited access to withdraw from your clients’ accounts. The specifics of certain account structures are still underdiscussed, leaving some ambiguity regarding which multisignature, autonomous agency, or threshold signature protocol truly equates to significant control over client funds. However, it’s crucial to navigate this terrain and progress, lest we fall behind in the competitive landscape for our clients.

– Colton Dillion, CEO, Hedgehog Technologies

Ask an Expert

Q. Can you hold bitcoin in an IRA account?

As a crypto investor, I can tell you that there are various methods to acquire bitcoin exposure in traditional and Roth IRAs. The most convenient approach is investing in one of the publicly traded spot bitcoin exchange-traded funds (ETFs) on major brokerages. However, it’s important to note that this method solely offers U.S. dollar exposure to bitcoin price fluctuations rather than actual ownership of the physical coins.

Bitcoin investors often prefer setting up an Individual Retirement Account (IRA) with a specialized provider that enables direct ownership and storage of bitcoin within the account. The significance lies in maintaining control over the private keys, which grants you full ownership and authority over your bitcoins without relinquishing it to a third-party custodian. This choice minimizes the risks associated with centralization and counterparties that come with alternative methods.

Q. What’s the benefit of holding bitcoin in an IRA?

As a crypto investor, I see the primary advantage of investing in bitcoin through an Individual Retirement Account (IRA) lies in the ability to grow my bitcoin holdings as a long-term store of value while reaping the tax benefits this account type offers. Given that bitcoin is considered by many to be a superior form of savings due to its potential for substantial growth, aligning it with retirement accounts, which have a longer investment horizon, makes perfect sense.

One way to rephrase this in clear and natural language is: A key advantage is the potential for tax-deferred or tax-free growth with traditional or Roth accounts, enabling your bitcoin investments to increase more effectively over long periods. Bitcoin’s historical pattern of appreciation every four years could mean substantial tax savings if you can realize those gains without taxes, potentially bringing your retirement closer.

One way to rephrase the given text in a more conversational and clear manner is:

– Jessy Gilger, CCO & Senior Advisor, Sound Advisory

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