What it takes to keep crypto safe
Part one of a five-part series on strengthening Canada’s blockchain ecosystem
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Independent custody key to supporting security and market growth
Cryptocurrency news continues to arrive at a furious pace, reflecting the ongoing growth of this asset class‘s appeal as well as rising trust in blockchain, crypto’s foundational technology.
“Nearly every financial institution is looking to add crypto to what they offer to clients,” says Jerome Dwight, president of Brane Capital. “However, crypto is also going through some growing pains, and investors are facing risks that we need to address.”
For Brane, a Canadian blockchain innovation company offering institutional-grade custody solutions to regulated financial institutions, the current moment represents a “transformational opportunity for Canada and the world,” says Mr. Dwight. “We’re in the midst of a digital revolution in financial services, at a stage where we need leadership and co-ordination between governments, the private sector, regulators and companies like ours.”
As a fintech company working to bring institutional standards to the emerging crypto ecosystem, Brane is “on a mission to ensure Canadians can invest in cryptocurrencies with confidence in the safety of their underlying assets,” he explains. “This takes a combination of robust technology along with specialized risk management and a purpose-built regulatory framework. After all, public trust is hard to earn and easy to lose.”
“We are seeing one of the greatest asset transfers of our time, as everybody from retail investors and high-net-worth individuals to institutions are looking to add cryptocurrencies to their portfolios.”
Why the surge in interest?
“One reason cryptocurrencies are so appealing is that they’re not correlated to traditional currencies, like the Canadian or U.S. dollars, which are losing purchasing power due to inflation,” says Mr. Dwight.
History clearly shows that when governments print more money, this leads to price inflation and declines in value of traditional currencies, he notes. “Since bitcoin – and cryptocurrencies in general – are not correlated to these traditional currencies and have a limited supply, many institutions and investors see crypto as a hedge against inflation.”
All this contributes to mass adoption, says Mr. Dwight. “We are seeing one of the greatest asset transfers of our time, as everybody from retail investors and high-net-worth individuals to institutions are looking to add cryptocurrencies to their portfolios.”
The path forward
Canada made global news when Purpose Investments launched the first Bitcoin ETF, which surpassed $1-billion in assets under management within one month. With a slew of new market participants, Canada now has an opportunity to lead by enhancing safety and security while encouraging innovation, believes Mr. Dwight. “We have a chance to do it right, with regulations that foster responsible market participants along with much-needed education for investors.”
As investors and institutions grow their crypto holdings, Mr. Dwight says, all participants need to be confident in the safekeeping of their underlying crypto assets.
In the traditional financial market, custodians play an integral role in safeguarding securities and ensuring timely settlement of transactions. But the significance of safe custody is arguably heightened when it comes to crypto – because if an investor’s private keys aren’t managed properly, their assets can be lost permanently.
“By the very nature of crypto assets, it’s important that private keys are kept safe by a trusted, independent entity,” says Mr. Dwight. “In our view, custodians must be conflict-free and exercise a fiduciary obligation to keep investor assets safe.”
Learning from past crises
During the 2008 global financial crisis, Mr. Dwight was CEO of BNY Trust Canada – the Canadian arm of Bank of New York Mellon – and advised the Government of Canada on liquidity measures and financial sector reforms designed to safeguard the economy and public.
While Canada generally fared better in the crisis than the U.S., Mr. Dwight stresses that lessons shouldn’t be forgotten. Back then, custodians played a key role in stabilizing the marketplace by working with regulators and market participants to restore public confidence in the markets. Today, he believes, the crypto market needs stable, reliable custodians that form a buffer against sudden market declines and loss of liquidity.
“A loss of value in the crypto market can have ripple effects in broader financial markets,” he adds, noting that the 2008 crisis began in the U.S. mortgage market but triggered a global recession.
In the crypto context, Mr. Dwight argues, custodians must remain independent of the exchanges where crypto assets are traded. “Independent custody means the custodian isn’t owned by, controlled by or beholden to a crypto exchange that is directly exposed to market volatility and liquidity challenges,” he says.
Many crypto exchanges have proven vulnerable to risks, including hacking, fraud and market volatility. In the past decade, hackers have compromised dozens of exchanges – while the 2019 collapse of QuadrigaCX cost some 76,000 investors a collective $169-million through misappropriation of funds.
For cryptocurrencies, arm’s-length custody can mitigate these risks. “If history is any indication, independent custodians have a key role in protecting crypto assets,” Mr. Dwight says. “Even if an exchange collapses or is shut down, investors are better protected when their assets are held by independent custodians.”
The question of custody in Canada
There are currently no fully independent custodians in Canada, and Brane’s mission is to fill this role.
At present, a single U.S. company dominates the Canadian market for crypto asset custody, Mr. Dwight says. “This needs to change, with a sound regulatory framework for independent, reliable, made-in-Canada crypto custody.”
Brane has created “a highly secure, arm’s-length vault solution for securing crypto assets,” he states. “While an exchange or investment dealer buys or sells these assets, Brane will enable secure custody, transparent reporting and confidence for all market participants.”
Vibrant, regulated and safe
Canada’s financial industry is working with regulatory bodies to create a secure and vibrant ecosystem by bolstering infrastructure and regulations for crypto market participants.
“We spend a lot of time with regulators to make the case for independent custodianship and provide our perspective on protecting market participants,” says Mr. Dwight. “Canada’s regulators are working hard to get it right, and we’re here to do our part.”
In a nutshell, the aim is to avoid the kinds of conflicts of interest that can destabilize the economy, he adds. “We want our economy to grow. We want crypto as an asset class to flourish as a means for creating generational wealth for Canadians.”
For more stories from this feature, visit globeandmail.com
To view the full report as it appeared in The Globe's print edition: Cryptocurrency Series 2021