ETFs May Be Exciting, But Custodians Hold The Keys To Bitcoin

by Sebastian Widmann, Head of Strategy at Komainu

Sebastian Widmann, Head of Strategy at Komainu is a Forbes Digital Assets Contributor. The article below was originally posted on Forbes Digital Assets on 27/03/24.

The SEC’s approval of spot exchange-traded funds for Bitcoin this year was an exciting moment for the entire digital assets industry. For some, this excitement is simply about broader access to digital assets, but for the finance industry, the focus is on the institutionalization of bitcoin and its role as a gateway to further opportunities across the digital asset ecosystem.

Custodial security infrastructure is key to institutionalizing digital assets

A physical BTC ETF requires 5 key partners: Issuer, Trustee, Administrator, Authorized Participants and Custodian. The custodian’s role may sound simple – hold and secure the underlying crypto assets. However, unlike custody in traditional finance, which is primarily a record keeping activity for securities like stocks and bonds, with digital assets, which are bearer assets, security becomes critical as the threat of cyber-attacks leading to an irreparable loss is significantly higher than traditional financial assets, requiring additional capabilities from an operational, technical, and legal standpoint.

For issuers of digital asset ETFs or exchange-traded products that specifically provide exposure to cryptocurrencies, institutional-grade custody ensuring the highest level of security sits at the core of their offering.

Qualified custody is a key requirement for ETF issuers

As I’ve covered in the Institutional Guide for Securing Digital Assets there are several best practices that asset managers and institutional investors should look out for when appointing a digital asset custody partner. To recap, these best-practices include regulatory compliance, independent third-party audits, institutional-grade security measures, and a segregated wallet infrastructure. However, with the significant growth of Bitcoin ETFs – amounting to around $75 billion in AuM at time of writing – diversification of custody providers that meet these best-practices should also become a consideration, especially when the majority of existing Bitcoin ETF issuers currently rely on only one, and the same, provider.

A Multi-Custodian approach is the new normal

For digital assets ETF and ETP issuers, even when they have settled on the right custodian, the journey should not end there. Issuers partnering with a custodian with the best possible security protocols and infrastructure still have the opportunity to reduce concentration risk, either by working with more than one custodian or by working with custodians that can provide access to a network of institutional-grade suppliers and hold assets in segregated wallets, maximizing security for end-clients.

In the same way that any asset manager holds a portfolio of investments to diversify their risk, an ETF issuer can diversify their risk by working with a range of trusted custody partners. This arrangement is commonplace in traditional financial services and products, and digital asset ETF issuers should look to replicate these institutional-grade standards.

A watershed for digital assets?

The SECs approval of Bitcoin ETFs has undoubtedly been a catalyst for renewed interest, as digital assets become truly institutionalized, but it should not be viewed as the seminal moment for this emerging asset class. Yes, the approval is a signal from the world’s largest market that digital assets are here to stay, but to avoid the mistakes of the past and ensure stability the right custodial infrastructure set-up and protocols need to be in place.

In the end custodians hold the keys – literally and figuratively - to digital asset adoption.

Custodians therefore sit at the core of the digital asset ecosystem, and with the expected increase in institutional capital flows, trusted custody has never been more important.

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