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Cryptocurrencies for Advisors: The Future of Digital Asset Custody
Digital asset custody is evolving, whether it’s the technology itself, the plethora of new tokenized investment products, or the risks, real or perceived, of leaving assets to service providers like centralized exchanges.
Colton DillionCEO of Hedgehog technologiesanalyzes evolutions in digital asset custody, focusing on the shift of wealth towards self-custody in space and how advisors need to support this shift.
The Web3 tracks will sooner or later swallow up traditional finance, and there is no doubt about this.
With an impressive market capitalization of $2.3 trillion, the digital asset sector still has some development to do before it can surpass the $110 trillion stock market, but in case you haven’t been paying attention, real world assets (RWA) and stablecoins have seen some recent big bets from major players like Black rock, Band, Franklin Templeton and other.
These companies are slowly cloning traditional securities like money market funds and mutual funds for on-chain consumption and seamless peer-to-peer transfers, and it’s only a matter of time before regulators reach the market to allow traditional securities, such as Fortune 500 stocks or exchange-traded funds (ETFs), to be traded in the exact same way. Eventually every type of traditional asset will also be an on-chain asset. All we need is time.
So, what does this mean for custodians?
While Coinbase, Kraken and Gemini all support at least one of the spot bitcoin ETFs as primary custodian and institutional use cases are migrating more slowly, there is a clear trend for Web3 asset holders to start moving their wealth across It self-care once you reach a certain level of sophistication. Once insurance methods adapt to wallet compromise, we expect that most individuals and institutions will choose to directly manage the segregation of their accounts and require control of their private keys.
As advisors and trustees, it is our duty to be prepared for the day when clients come to us asking us to support self-custody solutions. There are many options available to intrepid self-custodians, from multi-sig accounts to account abstraction (AA) smart contract wallets, from institutional hardware to multi-party computation (MPC) wallets, but each comes with its own security trade-offs and usability, as well as cost considerations.
THE Safe Gnosis is the original multi-signature solution for Ethereum-based networks and comes with some useful tools for managing your treasury in a wallet where multiple people must agree before a transaction can take place. On other chains, you have to find other solutions, such as dedicated wallet software that supports Shamir secret sharing. For less than $500, you can set up a wallet with m of n signatures (e.g. 2 out of 3 or 8 out of 9 must sign for a valid transaction), but the authorization on these accounts is less robust without including the new abstraction of the account proposals, in particular ERC-4337. If you have one of the signatures, you can help waive any privileges on the Safe account.
This is another EVM-only solution for the time being, but in principle, any chain that supports smart contracts can support the standard. Account abstraction allows an experienced developer to layer additional permissions and functionality on top of a standard account so that certain signers can only sign on certain types of transactions. Many providers also leverage these features to add transaction batches, non-native gas tokens, transaction forgiveness, and more. These players include Gnosis Safe and similar groups ZeroDev, Bieconomy AND Fun.
Institutional cold rooms
Many custodians offer a cold storage solution that leverages hardware security modules and robust physical security to keep your assets as safe as gold bars under Fort Knox. Using specialized chips that are extremely expensive to crack, they can generate private keys and securely sign transactions on your behalf without the flexibility and speed of a hot wallet. Depending on the provider, these solutions are often combined with a multisig, AA, or MPC solution, but the cost usually amounts to double-digit basis points with high minimum balances and account maintenance fees.
One of the most flexible options available, MPC is not limited to a specific network by a smart contract, but requires trust in potentially opaque partners. MPC is closer to the basic layer of cryptography, private key entropy, and all participants in an MPC wallet participate together to recreate the private key, instead of having multiple private keys submitting their own valid signatures. There is Qredo AND Illuminated protocols for those who are more technically savvy, which are completely decentralized solutions, but for advisors who want a little more white glove treatment and are willing to work with trusted third parties, Anchorage has just released its business solution, Portoand my company Curly has just launched an MPC account management product focused on fund administration, secondary advice and turnkey wealth management programs.
Obviously we agree with Nathan McCauley, CEO of Anchorage, when he summarized the reasons that led to the choice of MPC as a solution:
“Right now, a lot of people are looking for self-custodial solutions to allow them to do a variety of more flexible tasks on the blockchain. We really see this as expansive and additive.”
Whatever you choose as an advisor, it’s important to keep the custodial rule in mind and make sure you don’t have arbitrary withdrawal privileges on your clients’ accounts. There is not much guidance for some of these account structures, and there still remains some clarity as to the extent to which a particular multisig, AA or MPC protocol qualifies as substantial control over customer funds. However, we must chart a path forward or be left behind in the dust of our customers.
Q. Can you hold bitcoin in an IRA account?
Yes, there are several ways to gain exposure to bitcoin in both traditional and Roth IRA accounts. The simplest method is through one of the spot bitcoin ETFs traded on the main brokers. However, this path only provides US dollar exposure to bitcoin price movements, not direct ownership of the actual coins.
For many bitcoin investors, the preferred option is to open an IRA through a specialized provider that allows direct ownership and storage of bitcoin within the account. Key control is crucial here: the ability for you to keep private keys means that you have full ownership and control of the bitcoin in your IRA, without entrusting it to a third-party custodian. This avoids the centralization and counterparty risks of other options.
Q. What is the benefit of holding bitcoin in an IRA?
The main benefit is the ability to invest in bitcoin as a long-term store of value while enjoying the tax advantages of an IRA account. Because bitcoin is seen by many as a superior form of savings, it aligns well with the long-term horizon of retirement accounts.
Specific benefits include tax-deferred or tax-free growth (traditional or Roth), allowing your bitcoin holdings to grow more efficiently over decades. Bitcoin has historically appreciated in steady 4-year cycles, so earning these tax-free gains can significantly speed up your retirement timeline.
Holding bitcoin in an IRA also allows you to make distributions in bitcoin itself rather than having to sell it for dollars and make taxable gains. For clients who desire full sovereignty, key control over IRA bitcoins is critical to avoid third-party custody risks. The downside is reduced liquidity and increased rules and age limits compared to a standard brokerage account. But for long-term investors convinced of bitcoin’s role as hard currency, the tax benefits of an IRA can outweigh this.