The State Of Digital Asset Custody In 2020

The majority of early adopters operate on the mantra “Not your keys, not your coins”, or the notion that the users should be in possession of their own private keys rather than trusting a third party to do so.

The problem: this position is not ideal for all users nor is it possible, at least in the U.S., for institutions managing more than $150 million that are required by law to have their assets safeguarded by a registered custodian.

For this reason, custody is a critical link for the institutional adoption of digital assets. 2018 and 2019 saw a surge of custody firms and services entering the market aimed primarily at institutional investors. Since early 2018, “institutional” custody vendors have been formed, many backed by the most prominent traditional firms which include the likes of the New York Stock Exchange, Fidelity, and Goldman Sachs.

So, let’s examine the custody space dating back to 2012, how it has evolved, and what it’s like in its current form.

Here are the big takeaways:

? Custody of digital assets has seen approximately $1.3 billion in investment, with approximately $419 million allocated to pure crypto custody firms

? Pure custody companies saw capital injections during bear market conditions following large swings in the price of Bitcoin. In 2014 and 2018, investment saw an increase of 7,404% and 1,300% YoY, respectively

? With more custody suppliers than institutional demand, the market seems ripe for M&A transactions this year akin to Coinbase’s acquisition of Xapo’s Institutional service in 2019 

Digital assets like Bitcoin present novel challenges that legacy financial firms aren’t equipped to handle. Digital assets are, essentially, digital bearer bonds, and the ownership of these assets is intrinsically linked to the possession of private keys.

Due to these unique needs, the ability to properly safeguard private keys is particularly critical – indeed, paramount – to the success of a digital asset custodian.

Outside of safeguarding these assets, many of these tokens can, and arguably should, be actively participating in their respective networks for consensus (staking) or voting purposes. Investment funds have been compelled to make the difficult decisions on whether they should assume the risk of actively staking their tokens or opting-out of participation while accepting that their position will be diluted by some percentage.

Over the years, digital asset custody solutions have received $1.3 billion in investment, with $419 million of it representing pure custody companies. The focus of custodial services has shifted from consumer to institutional as shown by the percent of custody companies founded with a focus on the latter.

Today, there are more custody providers than there is of institutional demand, and some firms are beginning to position themselves to take advantage of acquisition opportunities. Most recently, Anchorage, the institutional custody provider backed by the likes of Visa, Andreessen Horowitz, and Khosla Ventures, expanded its services by acquiring Merkle Data, which helps clients detect manipulative behaviors and other risks in the digital asset market.

2019 was the first year that saw a major custody acquisition deal. Coinbase acquired Xapo’s institutional business for an estimated $55 million. This could be the beginning of a larger M&A trend in the broader industry.

With a wide assortment of institutionally-focused custodians established in 2018 and 2019, and not an overwhelming demand for their services, consolidation in the space is not out of the question with activity similar to Coinbase’s acquisition of Xapo’s Institutional Custody service.

Two technology giants, Microsoft (M12) and Google (GV) have each made an investment through their ventures arms, with Microsoft betting on Bakkt, a futures exchange and custody provider and Google betting on the wallet and exchange provider Blockchain. Samsung, the electronics conglomerate, invested in Ledger, producer of the most popular hardware wallet and a provider of institutional custody services through its Ledger Vault service. Samsung also opted to invest in ZenGo, a non-custodial wallet for digital assets. 

There are two state-owned entities that have invested in digital asset custody companies. Government of Singapore Investment Corporation or GIC is Singapore’s wealth fund responsible for allocating over $100 billion, made an investment in Coinbase. Swiss Post, the national postal service of Switzerland, made an investment in METACO, a digital asset management provider.

The formation of custody companies often coincided with Bitcoin price increases, which could explain why early-stage venture capital dominated in 2013 and 2014.

In 2014, BitGo raised a $1 million seed funding round and a $12 million early-stage venture capital deal. Xapo received a $20 million early-stage VC investment. After 2015, investment in new custody ventures dried up and instead late-stage venture capital investments dominated from 2015 to 2017.

During this time, Coinbase was scaling, raising capital and was largely responsible for late-stage investment dominance. In 2015, its $75 million later stage VC deal represented 72% of the approximate $102 million in investment. In 2016, its $10.5m raise was the only investment, and in 2017 its $108.1 million raise was one of two investments that made up the majority of dollars invested. Blockchain’s $40 million investment was the other. 

2018 and 2019 saw investments in early-stage and seed round custody ventures increase. Some of these particular ventures in no specific order include Ledger, Knox Custody, Unchained Capital, BitGo, FireBlocks, ZenGo, Argent, Vo1t, Hex Trust, MyCrypto, Casa, Onchain Custodian, Aegis Custody, Curv, and Anchorage.

What this tells us is that the landscape of digital asset custody is primed for growth and consolidated action. This can also fuel renewed interest in instituional products like ETFs. See the current state of ETF applications below: