Cryptocurrency exchange giant Coinbase has launched its own custody offering in a bid to make trading digital assets just like any other financial product for institutional investors, and part of the platform’s plans involve teaming up with traditional custodian banks.
Coinbase has won over retail investors during the cryptocurrency boom, but as institutional investors eye up an entry into the space, the platform wants to make trading digital assets feel like trading any other traditional financial product.
For institutional investment money to begin pouring in, a familiar-looking market infrastructure needs to be in place, from regulatory clarity to custody.
Sam McIngvale, product lead at Coinbase Custody, spoke with The TRADE Crypto in Vienna about what the company is doing as institutional investors are on the brink of moving their money into the space.
Jonathan Watkins: What’s the aim in speaking to the world’s custodian banks here in Vienna?
Sam McIngvale: I don’t think CoinBase Custody or CoinBase institutional really wins if all we ever service is crypto-first hedge funds and family offices; our goal is absolutely to service mainstream finance across the globe. Step one is make sure everyone knows we exist and is educated on what we are offering and why, along with our background. Our goal is to make our offerings look and feel like traditional finance; we want the crypto asset class to look like any other asset.
The second aim is to meet some of the major global custody, prime brokerage and financial players that we might potentially partners with. We’re not going to take over the world on our own, we know that. We think we understand what our value proposition in this space is, but we understand that global custodians that operate across the world and have trillion dollar balance sheets – that’s not something we can compete with. We look at that and say ‘let’s partner up, we’re experts in the technology and servicing of these assets and you bring some different value to the table’. It’s hopefully a great partnership.
JW: The demand – or at least interest right now – seems to be creeping in from institutional investors, so why are custodians holding back on committing to saying they will provide services for cryptocurrencies?
SM: Fundamentally it’s just a lack of understanding of the asset class. I think a couple of misconceptions are still common. Obviously the regulatory uncertainty is debilitating in this space.
One misconception is that these assets are predominantly used for illicit activities. When you run the data on the transactions that are going on, it’s a very small percentage, much smaller than fiat. The other easy excuse is that institutional infrastructure doesn’t exist, custody is a common claimed missing component. I do think that’s false. If you look at groups like Xapo, they have been storing Bitcoin on behalf of others since 2014 or even before and have never had an issue. Securely storing crypto assets is a well-known thing, but how to do that within regulatory regimes is a bit more difficult.
There are a lot of convenient excuses out there, but as folks understand these more they will look at the profits that the crypto exchanges and providers are making and they will look to get into this, especially as client demand continues to grow.
These are non-revocable instruments, and there is a 24/7 liquid market for them everywhere, which is so fundamentally different from any asset class that a traditional custodian deals with, and it is really hard to grasp. What that means is that those entities should not try to store these themselves, they need to partner, buy or acquire expertise in this space. Hopefully we can be a trusted provider, but even CoinBase with six-years’ experience has a lot to learn, we are improving every single day on how we store these assets. Cold storage is a combination of technology and process, it’s not just getting technology right.
JW: If something ever did go wrong, the reputational impact would be disastrous, and ultimately this will still be a very small percentage of what they hold, meaning they may wonder if it’s worth it. Do you think this is another reason traditional custodians are tentative?
SM: The repercussions for not getting this right are so severe, that’s probably why groups are scared of this. There is so much downside but they don’t understand the upside yet.
The way I think about it is that when you look across traditional hedge funds globally in the next five years, hopefully we are seeing 1-3% in their portfolios. That would be a huge win for this space and that would take it from a couple of hundred billion to trillion. But to your point, that is still a very small percentage of the total assets that these groups are servicing.
JW: Are you talking to some of the major custodians about partnerships?
SM: Yes. One thing I will say is that they are remarkably well-educated. Not only are they thinking about it, most of them are actively planning how they are going to come into this space. I don’t expect that to happen imminently, but I do think that a lot of those major players are laying the groundwork now to come into the space, at least in the US.
We look at ourselves as the best and we will win a lot of the space for crypto-first hedge funds, but we’re not going to compete with the balance sheet of Goldman Sachs, JP Morgan or State Street in the US, we’re not going to try.
JW: What happens to the retail space when institutional investment money comes into cryptocurrencies?
SM: We’re in the process of re-architecting our exchange; part of that is to look and feel more like a traditional equities exchange, which will allow institutional investors to come in. Over time this asset class is going to look much more like any other asset class that is dominated by institutional investors.
I certainly expect institutional money to be the vast majority of investment and trading activity and hopefully that’s a net positive for the industry overall.
JW: What’s your strategic plan and what will your custody offering entail?
SM: There’s not really first party custody in traditional finance, everything is third party where your custodian holds all your assets. There is first party in crypto in that you can own your private keys, and a lot of crypto custody offerings are providing you technology so you can own your private keys. We are purely third party though. CoinBase controls all the private keys and we think that is the right approach to deal with institutions. If you’re first party, you’re more of a technology provider.
Part of our strategy is to be the most trusted and part of that means we are the most compliant. We are taking the highest road that we can and setting the highest bar from a regulatory and compliance perspective. That means we are going to move a little slower with regards to how quickly our platform expands and comes to market, but ultimately we think that’s what is required to win the trust of the large institutions.
JW: What kind of timeline do you see for institutional investors coming into this space?
SM: The most interest right now is from crypto first investors, two predominant groups – hedge funds and family offices. Family offices is a much larger segment than people give them credit for right now. The next wave of institutional investors are pensions and endowments. They are starting to ask questions now, but they could be six months away. Then at some point in the future you will see the more traditional asset managers – an example in the US would be the Vanguards and BlackRocks of the world.