The Digital Asset Space Needs a Technological Solution to Custody

The solution to the underlying security problem must be technological. Such a solution has to support tiered access controls, multiple authorizations and rapid exchanges, without compromising security.

Gunnar Jaerv By Gunnar Jaerv on 10 April 2019

Digital assets are vulnerable in a way that traditional physical assets are not. For contrast, consider the case of bullion. Secure custody of $1m in bullion is a matter of physical security: the gold is placed in a vault, locked and guarded.

By contrast, digital assets can be abstracted from custody electronically or by various forms of fraud. Losing or stealing tens of millions of dollars’ worth of digital assets is relatively simple, and whereas $1m of bullion is massive, $1m of digital assets can be carried on a cold wallet the size of a pen lid.

This fact is central to the very nature of digital assets. However, as the market for this asset class has grown exponentially, so the value invested in it — and the appeal to bad actors — has also grown. Now, the need for secure and functional storage of digital assets is impossible to ignore.

The past: Exchanges, hacks and the hot/cold wallet system

The first generation of solutions to this issue were created ad hoc by the community of digital asset investors and developers themselves, in response to the realization that centralized exchanges were the weak spot in the otherwise impregnable defenses of a system based on immutable, auditable ledgers. Blockchains couldn’t be hacked, but web-based exchanges could: and they were.

To protect themselves, users created the hot/cold wallet system. The bulk of assets would be stored on a cold wallet, separated from the web. Cold wallets contained data but had no inbuilt means of connecting to the internet, so they couldn’t be hacked unless they were plugged into a device. Liquid assets would be kept on a hot wallet, connected to the web. Some users sought defence in depth, using multiple hot and cold wallets necessitating multiple additional security credentials and asset transfers.

We have discussed the issue of hot and cold wallets previously on the Legacy blog. For now, let’s be brief. This is a system with grievous flaws. The requirement to airgap cold wallets deprives the user of one of the greatest advantages of digital assets — the ease with which they can be instantly exchanged. (The wallet itself can also be stolen, or simply lost. In 2013, James Howells accidentally threw away a hard drive containing 7,500 Bitcoins, worth $7.5m then and $39.1m now.)

Cold wallets are barely adequate as a security system for individual users — which is what you would expect from a system devised on the fly by a community not devoted to creating new hardware. They’re totally inadequate for institutions. And many institutions that claim to use cold wallets don’t use them anyway, while some that do appear to use them to commit crimes against their users.

So what is the solution to secure digital asset storage?

The future: Technological support for multi-agent, multi-role asset management through trusts

Historically, the solution to secure storage of assets has been separation: a trust safely and securely separates legal ownership and beneficial ownership, then separates trusteeship from custody. Assets are custodied by accredited custodians under oversight and instruction from the trustee, acting in the interests of the beneficial owner .

But while this pattern is tried and tested, it’s impossible to port it to the world of digital assets without a technological framework. Digital asset custody that doesn’t address the technological question to which hot/cold wallets are a partial, inadequate response, can never be an answer.

What’s required is a technological basis for a multi-agency custody, access and ownership model, such as that provided by Ledger Vault. (Disclosure: Legacy recently entered into partnership with Ledger to provide secure digital asset custody for investors including institutions and HNWIs.)

The organizational aspects of custody are one part of the puzzle, and separation of custody is a security measure in itself, among other things. But the technology to replicate organizational structures in a secure way on the storage medium itself is required if trust-and-custody arrangements are to provide the required agility for a volatile market as well as real security.

To provide this level of agility and security, Legacy has partnered with Ledger Vault. Ledger provide the technology that delivers security; Legacy provides the trust arrangements, including custody. To talk more about how Legacy and Ledger can help you manage your assets, please get in touch. We’d love to hear from you!

Disclaimer:

Disclaimer: This publication is general in nature and is not intended to constitute any professional advice or an offer or solicitation to buy or sell any financial or investment products. You should seek separate professional advice before taking any action in relation to the matters dealt with in this publication. Please note our full disclaimer here.

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