Economic research

National Bureau of Economic Research article features custody issues

In a new article titled “Blockchain Analysis of the Bitcoin Market,” Igor Makarov and Antoinette Schoar of the National Bureau of Economic Research detail the state of Bitcoin. In the document, a section on custody piqued the interest of a fintech CEO, as it highlighted concerns he has long exposed.

“It’s hidden, but it’s there,” said Richard Gardner, CEO of Modulus, an American developer of high-performance trading and surveillance technologies that powers the global equity, derivatives and digital asset markets. . “Around the middle of the newspaper, it is a question of the current state of police custody. Even beforehand, he explains how, in practice, exchanges and wallets often do not differ significantly. Both have a custodial aspect, but, if we’re talking about the future of digital assets, I don’t think you can argue that custodial providers are all they should be. In fact, it’s quite the opposite. We should expect much more from child care services.

On page ten, the newspaper notes:

“Cryptocurrency exchanges such as Coinbase, Binance, or Kraken, and online wallets such as Blockchain.info and BixIn are one of the primary types of entities where Bitcoin can be stored and traded. Exchanges theoretically provide platforms to trade Bitcoin for fiat currencies and other coins, while online wallets specialize in custody services. However, in practice, the difference between exchanges and online wallets is often slim. In many cases, both types of entities provide both functions.

The document goes on to discuss custody as it relates to Bitcoin ownership, saying:

Determining ownership concentration is more complicated than simply tracking the holdings of the wealthiest addresses since not all large addresses represent individuals. Many public entities, for example exchanges and online wallets, hold Bitcoin on behalf of other investors. Thus, the first step in our analysis is to differentiate addresses belonging to retail investors from those belonging to intermediaries. When market participants deposit their bitcoins with exchanges or online and custody wallets, they are giving up their bitcoins in favor of the exchange. Exchanges usually mix all deposits and store them in so-called cold wallets – Bitcoin addresses stored on special devices not connected to the Internet for security reasons. A given intermediary usually only has a few bitcoin addresses that make up their cold wallet, but these addresses hold very large balances. For example, Binance’s cold wallet, which is one of the largest cold wallets, contains 300,000 bitcoins at the end of June 2021. 23 However, not all exchanges have a cold wallet as distinct as the Binance cold wallet. Since cold wallets usually consist of a few addresses and rarely send and receive funds, the default clustering algorithm in many cases does not link them to the exchanges’ corresponding hot wallets. Therefore, identifying cold wallets presents a significant challenge.

“While the journal’s concern is to identify the ownership status of Bitcoin, there is a larger custody issue. Since the early days of the industry, exchanges have been hacked. Most of the losses were due to the inability of the exchange to properly utilize cold storage best practices. When an exchange is in charge of custody, those decisions are made at the macro level. Custody, at this time, is an afterthought. There are only a handful of custodial providers, and most of them have major security issues,” Gardner noted.

Modulus is known in the fintech segment as a leader in the development of ultra-high frequency trading systems and blockchain technologies. Modulus has provided its exchange solution to some of the most profitable digital asset exchanges in the industry, including a well-known multi-billion dollar cryptocurrency exchange. Over the past twenty years, the company has built technology for the world’s most notable institutions, with a client list that includes NASA, NASDAQ, Goldman Sachs, Merrill Lynch, JP Morgan Chase, Bank of America, Barclays, Siemens, Shell, Yahoo! , Microsoft, Cornell University and the University of Chicago.

“All you have to do is read the news. A leading custodial service provider has been mired in a lawsuit that accuses it of being responsible for the loss of $70 million in digital assets. $70 million in losses. Is this the company you want to protect your assets? It’s time for the industry to recognize that it has to adapt. Custody must be a priority if digital assets are to reach their full potential. Child care providers must put safety first. If you can’t protect your assets from malfeasance or incompetence, what are they really worth? asked Gardner.