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With traditional banks acting as custodians, is crypto’s decentralized nature under threat?

  • Over $200 billion worth of bitcoins have been lost so far. Do people need a better way to secure their digital assets?
  • “Not your keys, not your coins,” say crypto traditionalists, arguing the space is meant to be free of banks, with a fundamental ‘one’s own bank’ philosophy.
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With traditional banks acting as custodians, is crypto’s decentralized nature under threat?

As the world of cryptocurrencies is booming, everyone wants a piece for themselves. American brick-and-mortar banks are increasingly looking to offer crypto custodial accounts. While this may be seen as an encouraging development, it forces one to reflect on whether such institutional involvement contradicts the basic thesis of cryptocurrencies — with banks acting as custodians, is crypto’s decentralization under threat?

US Bank is the latest to offer crypto custodial accounts. The bank’s offering enables fund managers to store private keys for Bitcoin, Bitcoin Cash, and Litecoin, with assistance from sub-custodian NYDIG. The bank finds the asset class to be of increasing interest to its customers and believes it will continue to gain relevance in the future. 

Custodial accounts allow investors to store their crypto assets safely with a third-party service provider. These assets are generally distributed between hot and cold wallets. This allows some to be available for trading and transactions, while others securely sit and gain value. 

“Our clients are getting very serious about the potential of cryptocurrency as a diversified asset class,” said Gunjan Kedia, vice-chair of US Bank’s wealth management and investment services division. “I don’t believe there’s a single asset manager that isn’t thinking about it right now.”

Kedia also revealed that Ethereum compatibility can be expected soon.

The desire to be ‘one’s own bank’ is strong in crypto circles, and those propagating it jealously guard crypto’s decentralized nature, with a strong desire to keep third-party handlers out of the game. 

However, people are just not that great at being their own bank.

Chainalysis, a blockchain research and analysis company, found that of the existing 18.5 million bitcoins in circulation today, some 20% — worth north of $200 billion — appear to be in lost, or otherwise stranded, wallets. This means that by the time all 21 billion bitcoins are mined in the year 2140, a lot of the digital wealth will simply be missing. 

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As bitcoin prices fell and rose again recently, these owners jogged their memories for lost keys. Earlier this year, Wallet Recovery Services, a firm that helps people find lost digital keys, disclosed it had been receiving 70 requests a day from people who needed their assistance - thrice the number for the previous month. 

Crypto owners store their wealth in wallets, which can be hot or cold. A hot wallet is stored on the internet, which, although making it vulnerable to cyberattacks, makes it easier to transact with. People often store their currency with online exchanges, which is considered even riskier, because the threat is not only from hackers but also from the exchange going under, like Mt. Gox, which filed bankruptcy in 2014 after hackers stole crypto worth $473 million at the time, and QuadrigaCX in 2019, which outrageously shut down when its owner died, leaving 76,000 investors out of around $124 million.

A cold wallet is hardware-based and protects against attacks. But since it’s not connected to the internet, transactions are cumbersome. Both hot and cold wallets are locked by keys, which, as we have learned, people are not that great at storing themselves. 

With more traditional forms of wealth, owners use banks to store them. As custodians, banks protect the valuables, be it gold or cash or anything else, and also make sure people can regain access to their wealth even after losing passwords (an older form of keys). Custodial accounts are a safekeeping service used by institutional fund managers to store capital. In this model, banks are serving other institutions to safeguard their crypto assets.

But when banks try to offer custodial accounts in the crypto arena, they are met with the ‘not your keys, not your coins’ mantra -- a saying becoming increasingly popular in crypto circles, which means that you don’t truly own your crypto wealth unless you’re the only one who can access it.

Some argue that by providing banks custody of their bitcoins, people are essentially moving the system towards centralization. The very thesis of blockchain revolves around there not being a need for banks, and for no central authorities to be in control of a large chunk of bitcoins. 

“As soon as you give your keys to a third party, which is required for them to store your crypto, you are giving control to a centralized entity,” said Will Foulkes, head of blockchain at Stephenson Law. 

He believes that the design and nature of cryptocurrencies allow individuals to hold their wealth themselves, to keep big institutions out of the game. “This 'decentralized' way of storing crypto removes the power of central banks to negatively affect our economy by taking highly leveraged bets on unverified and unstable assets (what happened in the credit crunch and what brought the world to its knees),” he told Tearsheet.

Custodial accounts offered by banks, while centralizing control on some level, also present their own benefits. Such accounts make crypto investing safer and attract more players, who may previously have been spooked by the threat of loss in the blockchain.

“Marrying a well-known bank to crypto will likely attract new consumers who will now view investing as a safer bet,” said Daniel Polotsky, founder and advisor at CoinFlip. “However, this also runs the risk of creating a snowball effect that can very quickly lead to crypto being controlled by traditional banking institutions.”

But, is it really that easy to tear down bitcoin’s decentralized nature?

Not really.

As cryptocurrencies become more popular, they attract more investments, which necessitates more laws and regulations to monitor the space and protect people. Crypto has become easier to participate in, with numerous different coins now being traded across various exchanges. The space has become very commercial. Polotsky called the threat ‘definite’, saying, “some experts and investors believe this change is inevitable in due time.”

Bitcoin and most cryptocurrencies today, by their very design, are decentralized and will continue operating as such without central banks or governments being able to enforce much control over them. “The way bitcoin and other major cryptocurrencies work will never change - they are inherently decentralized. The only thing that can change is people’s options for accessing them,” Polotsky said. 

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