Custody Trends And Considerations For The Post Covid Days – Are you Ready?

Blockchain, News, Opinion | April 30, 2020 By:

With the financial services sector suffering setbacks due to the current global pandemic, blockchain-based assets are showing more promise than ever. Examples are numerous. One may want to look at the quantitative analysis of the S2FX model, enabling the valuation of different assets like silver, gold and BTC with one formula.  

Additional evidence can be found by the changing German Banking Act (Banking Act – KWG) allowing now the custody of digital assets, and therefore enabling 40 banks in Germany explore custody of digital assets

One more example relates to the Japanese revised versions of the PSA and FIEA, tightening restrictions on crypto custodians and yet acknowledging their legal status as valid asset classes. 

Using these and many other unmentioned examples, it is safe to predict that digital asset custody is on a safe road to becoming mainstream in 2020. This article will explore some of the advancements of this dynamic market and their possible implications on custodians of digital assets. 

Types of Digital Assets Custody

Firstly, it’s worth clarifying the different types of custody and what they mean in the field. There are 3 types of custody related key management paradigms for digital assets: full custody, partial custody, and non-custodial approach. 

Full Custody 

Using the full custody approach, the entrusted institution holds all the asset keys and manages them – acting on the customer’s behalf, without his/her direct involvement. 

Partial Custody

Using the partial custody approach, the custodian holds the approval rights (keys or key shares), alongside with the investor as an active participant in the signing process. 

Partial custody approaches vary in terms of level of investor’s and third-party’s involvement. Addressing the need to involve external approvers, many of them offer additional safeguards, such as multi-party approval policies and backup services that are managed by 3rd parties. 

From a regulatory perspective, partial custody providers may not be considered full custodians if they do not hold/control most of the assets being held. 

Non-Custodial

Non-custodial solutions rely on the investor to hold the key or at most, the provider will hold up to 50% of the approval power, shifting the responsibility back to the end-user. 

Safeguarding Staking Pools

Protection and management of staking pools is the next immediate digital asset evolvement for 2020. Staking pools allow multiple stakeholders to unite their staking power with Proof-of-Stake (PoS) assets in the process of verifying new blocks, so all stakeholders can share the larger block reward. 

As Proof of Work (PoW), Proof of Stake (POS) also aims to solve confirmation of the decentralized consensus. It is an alternative to POW and works without energy consumption. PoS works by simply keeping the coins in a staking wallet. Storing PoS assets, an investor will help the network confirm transactions and be rewarded for that.

Hardware and Software in One Comprehensive Environment 

Hardware-based and cold blockchain key security and key management is the current gold standard for digital asset custodians. However, the market is expanding beyond the basic hardware-only notion. 

With a hardware based, cold-only infrastructure, physical access and manual action are needed to execute any transfer of digital assets from offline wallets. 

When multiple signers need to approve a transaction, all of them need to physically arrive at the facility where the cold wallet is stored. This process typically takes 12-48 hours and does not facilitate signing workflows that involve distinct parties such as client and service provider. 

The essence of cold storage is how difficult the signing process is – and is, indeed, why it’s become the cornerstone of security best practices and regulatory requirements for custodians, both fiat and digital. 

That being said, current digital asset custodians are increasingly expanding their offering to include both cold and hot wallets, in one comprehensive environment. Without a central key management system, this leaves an operational headache for the custody provider – since each wallet type typically has its own governance policy. 

Future-ready custodians will aim to make their combined wallet systems not inseparable, but interoperable. In practice, this means a comprehensive key management and security platform that integrates seamlessly with hardware and software. 

In addition, custodians should consider additional features in an interoperable key management layer with a software component. Blockchain key management systems of the future would more easily be able to be automatable, scalable, and flexible – and will be programmed with hierarchical, complex, risk-based policies to enforce internal and external compliance and regulation requirements. 

Dancing between the ol’ reliable hardware-based “cold” storage and a “warm” or “hot” software-based key management structure will bring an era of functionality to digital assets on par with current standards in the fiat world/traditional financial services sector. And that future is getting closer. 

Multi-Party Computation: Leveling Up Multi-Sig

Multi-Party Computation (MPC) will be the music behind the software-hardware tango, and the technology is already making waves on the forefront of digital asset key management technology today. 

MPC is a complex cryptography concept which only recently made the jump from academia to the business sector, but the short version is that it enables cryptographic keys (and blockchain keys) to be interoperable without revealing information about the data itself. 

In the case of blockchain transactions, MPC is used for securing the blockchain private keys and executing the sign operation using key shares held by multiple signers. Because keys always remain split into multiple shares throughout their lifetime – starting from key generation and even while in use – it is possible to establish advanced approval quorums without the complexity and cost of multi-signature (multi-sig) systems.

With little custom development and a short deploy time, the better MPC-based systems on the market are capable of handling complex approval groups, which can be separated by role type (i.e. built-in segregation of authority controls); risk-based policy enforcement which can be, for example, automated for low-risk transactions and manually managed, with cold wallets, for high-risk transactions. 

With all the tools at the custodians’ disposal, MPC is the beat that can make the software-hardware tango happen. And it can happen without the usual security missteps that come with any particularly complicated interoperability protocol. 

To summarize it all, 2020, although starting with the hiccup of Covid-19, at least for the digital assets market seem to entail many exciting advancements, market and technology based.