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Institutional Custody Will Challenge Retail-Oriented Crypto

The bearer nature of digital assets presents challenges to institutions getting into crypto. The need for greater security will likely impact the whole industry.

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The institutions are coming. The herd is arriving. Institutional participation in the digital asset market is imminent. 

As this happens, it’s worth considering how the entry of highly regulated financial companies will change the marketplace infrastructure for crypto, which, until now, has been largely oriented to retail investors. Institutions will have different and higher requirements across the transaction chain, notably in the custody of digital assets. 

Phil Mochan is the co-founder and head of Strategy & Corporate Development at Koine, an international digital assets custody and settlement platform.

Digital assets are bearer assets, raising implications for trading and safeguarding, and surfacing considerations for institutional asset managers looking to allocate capital to a digital asset fund.

Bearer assets

With a bearer asset, ownership is determined by possession alone. If I hold a $10 note, it’s mine. If I hold a $300 million bearer bond, it’s mine. In the same way, if I hold a private key to a bitcoin wallet that holds 10 BTC, then it’s mine (probably).  

We say “probably” because most bearer instruments are difficult to copy. Various counterfeiting measures have been built into them such as serial numbers, holographic images, stamps, ultraviolet threads etc. A private key for a bitcoin wallet, on the other hand, is simply a string of 32 alpha-numeric characters that can be copied with a pencil, an iPhone camera or a good memory. A $10 note would have to be stolen to be usable, whereas a bitcoin private key can simply be copied. 

Private keys are therefore the most vulnerable form of bearer asset, and once they have been exposed to a human, it is impossible to prove unique ownership. They may have been copied and there will be no record of the copy having been made. 

One very large crypto fund revealed to me that it holds the private key across three bits of paper, held by three individuals.

The safeguarding of these private keys thus becomes a critical issue for digital assets. The original design for a blockchain record of assets is based around a wallet model. The use of the word wallet indicates the security issue. In practical terms, why would you want to store more value in a digital wallet when you would feel comfortable in a physical wallet? Owners may feel that they have cryptographic security, but do they have physical security?  

There are numerous examples of people who have been robbed of their digital assets under physical threat. It may be a shock to learn that one very large crypto fund revealed to me that it holds the private key across three bits of paper, held by three individuals. I advised them that for their personal safety never to reveal their methodology again to another person. To illustrate how unsafe, it is perhaps sufficient to say that crypto exchanges in aggregate lose the entire contents of their hot wallets roughly every six months.

Various technical solutions have emerged with the objective of making the wallet more secure, including MPC technology. But while reducing the risks (supposedly), these fundamentally don’t address the nature of the risk. Robbing $1 billion from a bank remains a high-cost, high-risk exercise. Robbing a bitcoin owner with $1 billion held in a personal wallet is significantly easier and with much lower risk. 

Industry implications

The first implication for safeguarding is that the wallet model is inadequate for high value (>$1,000). Its design and architecture leave it too vulnerable, and no technological improvements, however innovative, will ever resolve this challenge. “Better” is never going to be “sufficient.” 

One alternative model is the account structure where a trusted third party takes control of the assets and separates the authorization processes from the private key management. This is how a bank works and it requires trust, regulation and governance, most of which are anathema to the progenitors of the cryptocurrency world.  

See also: Crypto Custody – Unique Challenges and Opportunities

The second problem arising from the bearer nature of digital assets is proving unique ownership. The only solution is to ensure (and prove) that no humans ever come into contact with a private key. Given that cold stores (the most common form of long-term storage for digital assets) require humans to move assets across the air gap (with the commensurate risk of collusion and poor scalability) it would seem such solutions are unacceptable. 

A third issue relates to regulatory rules around bearer instruments (which vary by country). In the U.S., any fund of more than $150 million in size is obliged to “dematerialize” bearer assets and record them on a register of ownership maintained by a custodian. This is why nearly all traded bearer assets are dematerialized onto electronic registers normally held by regulated depositories whose records are legally deemed the “truth.” 

Given these rules and existing models, it is therefore likely that all digital assets would be similarly dematerialized, in this case onto a digital ledger (not for operational reasons likely to be a blockchain) with ownership rights attached, in order to fulfill existing regulations.  

Just the beginning

The institutionalization of the digital asset trading environment is just beginning. The next couple of years will determine whether we have an efficient unitary solution such as for the bond markets, or a more fragmented approach such as exists with the FX markets. 

There will be a shift from crypto evangelism to capital market pragmatism.

DBS, Standard Chartered and Northern Trust have already launched in-house custody solutions, with the larger banks still considering their options. Should a group of four or five coalesce around a core infrastructure in 2021, the market is likely to develop more rapidly, and the high-frequency trading funds will drive volumes by many multiples. 

For the existing mainly retail exchanges, such as Binance and Coinbase, catering to institutions will require a considerable transformation. The changes might rapidly overwhelm some of them because their technologies are mostly unsuited to the behaviors of high-frequency traders.  

As the ratio of spot to derivatives is low, the cash-settled derivatives exchanges appear to have the most to gain if they can become institutionally compliant, accessible and cost-effective.

There will be a shift from crypto evangelism to capital market pragmatism, and the anticipated mass adoption of blockchains will become more grounded in operational reality. Capital markets infrastructure will lead that realignment.

Disclosure

Source: https://www.coindesk.com/institutional-custody-challenge-retail-crypto

Blockchain

Research Reports ‘Altseason’ Upon Us, But Not For XRP or EOS

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In its latest ‘State of the Network’ bulletin, industry data provider Coin Metrics has delved into altcoins and their impressive performance so far this year.

It acknowledged that many of the hot altcoins that surged during the 2017 crypto boom are now ‘dead and gone’, and have been replaced by a new breed of DeFi assets. It added that with new capital flowing into Bitcoin and Ethereum, some of that money may start flowing into altcoins.

The report acknowledged that institutional investment has largely been behind the current rally and institutions are very wary of altcoins.

“Altcoin investing is largely considered a retail phenomenon. Similar to penny stocks, it’s often driven by individual investors looking for outsized gains.”

XRP and EOS Missing The Party

Looking at returns since the beginning of December 2020, Bitcoin and Ethereum have outperformed most other Layer 1 blockchains, it noted. However several high-cap crypto assets have also performed well hitting their own all-time highs.

There are two notable exceptions to this trend; Ripple’s XRP and Block.one’s EOS.

The glaring red charts for these to former darlings of crypto show that XRP has lost 54.6% since December 1, and EOS has dumped 7.5% over the same period.

Ripple’s problems started when it finally lost the battle with the SEC and the selloff began. Since its late November high of almost $0.70, XRP has dumped almost 60% to today’s sub $0.29 prices. There have been reports of Ripple executives selling their stashes, while Grayscale dissolved its XRP Trust as confidence in the company dwindles.

Block.one’s problems have not been as bad, but they have had them. Company CTO Dan Larimer announced his resignation earlier this month and there has been very little on the development or product front for the project.

Over the past year, EOS has lost 23% on a chart that has been flat for months. Since its February 2020 high of $5.40 it has dumped 50%, and since its giddy all-time high in April 2018 of over $22, EOS has been smashed 87%.

Top Altcoins so Far in 2021

Those that are enjoying the altseason sun include Polkadot, Binance Coin, Chainlink, and of course Ethereum, though it shouldn’t really be termed an altcoin any longer.

Coin Metrics highlighted Cardano, Decred, and Dogecoin as three that have made three figure gains since December one, outperforming Bitcoin itself.

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Source: https://cryptopotato.com/research-reports-altseason-upon-us-but-not-for-xrp-or-eos/

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Perpetual Protocol emerges as sixth-largest DEX after just one month

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Perpetual Protocol, a DeFi project offering decentralized perpetual contracts using the layer-two Ethereum scaling solution xDai, has emerged as the sixth-largest DEX by weekly trade volume after operating for only one month.

Based on data from Dune Analytics shared by Perpetual Protocol, the DEX’s weekly trade volume of more than $299 million would rank the project above the likes of Synthetix, dYdX, and Kyber, and below Balancer.

The milestone was shared in a blog post celebrating the project’s first month of operation — a period in which the DEX drove more than $500 million in total volume and generated more than $500,000 in trading fees.

All trading fees generated by the protocol are currently sent to an insurance fund designed to secure the protocol, with the project planning to divert 50% of fees to PERP stakers once its staking pool has launched.

In the blog post, Perpetual Protocol noted that it spent only $183 to execute 179,000 transactions as gas fees on xDai are just one-one-hundredth of those on the Ethereum mainnet. With Perpetual Protocol covering the gas fees of its traders, the DEX would have had to pay out $18,300 in fees if it was operating directly on Ethereum.

XDai is one of several L2 scaling solutions that are offering an alternative to the heavy fees associated with operating directly on the Ethereum mainnet, with Synthetix recently launching the first stage in its transition to optimistic roll-ups.

Looking ahead, Perpetual expects to introduce limit order functionality during the first quarter of 2021, and will also launch staking in February.

Decentralized exchanges emerged as a cornerstone of the crypto ecosystem during DeFi’s Q3 2020 boom, with leading DEX Uniswap now processing almost $1 billion in volume each day and regularly surpassing many major centralized exchanges by trade activity.

Despite the booming volume, the DEX sector is currently dominated by a handful of platforms — with roughly half of the combined DEX trade activity taking place on Uniswap, and 90% of combined volume transpiring on the four largest platforms.

DEX market share: Dune Analytics

Source: https://cointelegraph.com/news/perpetual-protocol-emerges-as-sixth-largest-dex-after-just-one-month

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TA: Ethereum Corrects Lower, Why Dips In ETH Remain Attractive

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Ethereum traded as high as $1,437 before starting a downside correction against the US Dollar. ETH price is approaching a key support at $1,340 and $1,320.

  • Ethereum surged above $1,400 and traded towards the $1,440 zone.
  • The price is currently correcting lower from $1,437, but it is well above the 100 hourly simple moving average.
  • There is a major declining channel forming with support near $1,340 on the hourly chart of ETH/USD (data feed via Kraken).
  • The pair could correct further, but the price is likely to remain stable above $1,340 and $1,325.

Ethereum Price is Correcting Gains

Yesterday, we saw a sharp increase in Ethereum above $1,350 and $1,400. ETH price traded above the $1,420 resistance, and traded as high as $1,437 before starting a downside correction.

There was a short-term downside correction below the $1,400 level. There was a break below the 23.6% Fib retracement level of the upward wave from the $1,215 swing low to $1,437 high. Ether is now trading below the $1,380 and it is approaching a couple of important supports at $1,340.

Ethereum Price

Source: ETHUSD on TradingView.com

There is also a major declining channel forming with support near $1,340 on the hourly chart of ETH/USD. An immediate support is near the $1,325 level, where the bulls are likely to take control.

The 50% Fib retracement level of the upward wave from the $1,215 swing low to $1,437 high. If there is a downside break below $1,325, there are chances of a drop towards the $1,280 level. The 100 hourly simple moving average is also near the $1,280 support zone. Any more losses could lead the price towards the $1,250 and $1,220 support levels.

Fresh Increase in ETH?

If ethereum remains stable above $1,280 support zone, it could start a fresh increase. An initial resistance is near the $1,400 level and the channel upper trend line.

A close above the channel resistance could open the doors for more gains towards the $1,440 level. A clear break above the $1,440 zone could clear the path for a push towards the $1,500 resistance zone in the coming sessions. The next key target could be near the $1,550 and $1,580 levels.

Technical Indicators

Hourly MACDThe MACD for ETH/USD is now slowly gaining pace in the bearish zone.

Hourly RSIThe RSI for ETH/USD is correcting lower below the 50 level.

Major Support Level – $1,280

Major Resistance Level – $1,400

Source: https://www.newsbtc.com/analysis/eth/ethereum-corrects-lower-eth-1280/

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