Financial institutions are continuing to offer blockchain and crypto related services, with hundreds more slated to begin offering custodial services soon. This is a boon for greater consumer education around crypto related issues, paves the way for mass adoption of blockchain and crypto applications, and integrates these applications into financial markets. An issue that needs to be discussed, however, is how the Law of Private Keys factors into these developments.
Adding some context to this technical conversation, the Law of Private keys is a crypto paradigm in which if an individual or institution does not self-custody private keys, the actual ownership of this crypto comes into question. Private keys are the unique identifier that – for some cryptocurrencies – are the only true proof of ownership that is available. To satisfy this Law, crypto holders would need to self-custody private keys; what does that actually mean?
Such a relationship might seem a little abstract, so an analogy might help; this is similar to stating that in order to truly own positions in equity or debt instruments the investor in question would need to self-custody the stock or bond certificates themselves. This is technically correct, but as a practical matter it simply has not been an arrangement many investors have been interested in entering into.
The most interesting part is that while receiving quite a bit of attention in some circles of the blockchain and crypto marketplace, this Law is not something that has hindered greater adoption and integration of cryptoassets. Highlighted by the rise of Coinbase, a centralized crypto trading and exchange platform that provides custody of private keys for platform users, this Law of Private Keys has seemingly been ignored by the majority of retail investors and media analysts.
Now, simply ignoring something does not make it lower risk, but this bifurcation in the crypto space is worth revisiting as an increasing number of financial institutions are becoming active players in the space. Let’s take a look at a few of the implications of the ongoing debate between proponents of the Law of Private Keys, and those individuals more accepting of centralized solutions.
Custody must be clarified. The primary issues at hand around this conversation is how custody, provenance, and ownership are to be determined. Under traditional centralized financial custody solutions the general understanding is that clients see a representation of funds via a portal or other type of application. This representation, however, is just that; direct ownership of the underlying stock lies with the institution, with clients (in essence) being entitled to what amounts to an unsecured claim on the funds held at the institution. A simplified explanation to be sure, but one that works for this comparison.
Offering crypto banking services to retail investors and the mass market is one thing, but in order to secure endorsements and buy-in from sophisticated investors in the space, there may eventually be the need for multiple custodial options. Such differentiation in both institutions and services provided by providers can already be seen the rise of state specific legislation like in Wyoming, or by the launching of digital asset banking institutions.
Cybersecurity risks will rise. Growing pains and cybersecurity concerns exist for any fast growing sector, and there have been any number of incidents in the crypto sector that point out just how critical addressing these issues continues to be. Clearly the issues around trading and asset management are not limited to crypto based institutions, with fiat based institutions also experiencing an array of problems.
That said, the continuing lack of investor education and experience with crypto related trading issues, and the ability of retail investors to perhaps inadvertently gain…