Building a cryptocurrency market structure to last

Cryptocurrencies have revolutionised the financial system, but when it comes to institutional investment, cryptocurrencies require traditional controls. Financial systems are built on checks and balances that legitimise and make the management and storage of funds possible. The same is necessary for digital assets.

Institutional finance, whether fiat or crypto, requires some centralisation, according to Tom Pageler, chief security officer at BitGo.

The objective of market structure is to create opportunities for traditionally regulated institutions to enter the market and invest in the emerging asset class. This means supporting institutional investment in digital currencies while maintaining the efficiency of the decentralised networks on which they are built.

Blockchain technology and cryptocurrencies empower individuals to be their own bank by making it possible to hold, manage, and secure their assets without oversight or permission from regulators. Without a doubt, this has been transformative.

Security becomes more essential when financial institutions hold funds because the scale is significantly increased and assets are stored based on trust. When responsibility and liability become factors, regulation is necessary; those holding other people’s funds must be held to a higher standard to ensure safekeeping. This means having in place all of the necessary checks and balances to prevent a custodian, exchange, or an external party from acting maliciously with funds, as well as protect investments from hacks and other threats.

While relying on a third-party introduces an element of centralisation to a system based on decentralisation, it also introduces the ability to regulate management and security practices. Institutional finance, whether fiat or crypto, requires some centralisation. Employed moderately so that trust and security can be measured, centralisation allows a market to grow by providing assurances that companies will act in good faith with client funds. It’s a case of establishing guardrails for digital assets. Like a race track, not slowing them down, but defining their path of use while offering safety.

Centralisation poses extraordinary threats to the security and integrity of markets. This is something we see with some exchanges when they both hold and manage client funds. This was evident with the recent Quadriga, Coincheck, and Mt. Gox scandals. Risk becomes inherent with over-centralisation; the organisation becomes an attractive target for hackers creating an enormous single point of vulnerability. Within traditional finance, we would never see an institution operate this way. The New York Stock Exchange would not be permitted to custody funds while also trading them. The risk and opportunity for mismanagement is just too high.

As an industry, we celebrate cryptocurrencies because decentralised networks provide greater transaction autonomy, security, and a more open global financial system. Blockchain has proven to be a revolutionary technology that should not be burdened by undue risk. The cryptocurrency capital market infrastructure requires decentralisation of key roles, with clear separation between exchanges and custodians. Having established entities such as these allows for necessary checks and balances. Keeping them separate mitigates internal and external threat vectors that we’ve seen within traditional finance, particularly in the cases of Bernie Madoff and Lehman Brothers.

Putting trust in cryptocurrencies means supporting a market structure that employs checks and balances. As a financial services industry, we do this by combining new technology with tried and true practices. Regulatory controls within traditional finance should be understood for their individual value and be applied prudently to use of digital currencies.

Further, for the institutional market, it’s imperative that investors seek a regulated qualified custodian with comprehensive insurance coverage for client assets. With these protections, institutional investors can be assured that the custodian has been subjected to rigorous audits to certify that security practices and procedures meet the necessary requirements. This supports future development of the industry, establishing clear standards for security measures.

As companies within the cryptocurrency industry build their products and services, the market simultaneously develops. Strategic use of centralisation and regulation will help to maintain the integrity of cryptocurrency while legitimising and making these new products and services usable by institutional investors. The financial market structure of tomorrow focuses on the security of the client, as well as the strength and stability of the crypto companies that serve them.