3 critical responsibilities of digital asset custodians
Blockchain technology is moving beyond experimentations and use in payments. Recent advances in cryptographic, security and distributed ledger techniques have opened the door to the widespread use of decentralized ledgers to create sovereign currencies, stablecoins, digital securities and other types of tokenized contracts.
At Hex Trust we provide an enterprise platform which allows financial institutions to use blockchain to integrate digital assets into their business operations in a highly secured, scalable and compliant solution.
While we agree with market estimates that widespread implementation could still be several years away, Hex Trust believes that the size of the digital assets market could reach US$ 10 trillion by 2023, causing a big shift in the overall structure of financial markets. Banks and other financial intermediaries will soon be forced to devise and implement new digital asset strategies.
Custodians: the foundation of a successful digital asset solution
The role of custodians will be a critical building block for the new financial markets infrastructure and will be necessary for the widespread adoption of digital assets. We believe there are three critical responsibilities for digital asset custodians: safekeeping, connectivity and compliance.
Securely custodizing digital assets protects the private keys and develops secure workflows to support transactions in and out of custody (deposits and withdrawals). So far, custodians have relied on cold wallets created and managed in air-gapped environments to provide the clients with an acceptable level of security. Conversely, most hacks have concentrated on hot wallets, used to provide clients with quick access to their assets. Multi-signature wallets and wallets based on threshold algorithms such as state space search (SSS) and model predictive control (MPC) mitigate some of the risks of hot wallets. In addition to storage of the private keys, custodians must build their technology architectures to manage cybersecurity risks when interfacing with a public blockchain to facilitate transfers of these assets.
As the blockchain market becomes institutional, the current wallet implementations will not be scalable enough to cater to the requirements of financial intermediaries. A new approach will be required to offer custody solutions which can scale and process thousands of transactions per second with the necessary levels of security.
Hex Trust’s custody platform, Hex Safe™, was specifically engineered leveraging IBM Hyper Protect Virtual Servers and IBM LinuxONE to enable trusted cryptographic transactions and to deliver the highest level of security and scalability. In addition to a holistic protection compliant to FIPS (Federal Information Processing Standards) 197 and FIPS 140-2 Level 4 HSM (Hardware Security Module) standards, the IBM Z environment has memory enclaves with common criteria EAL (Evaluation Assurance Level) 5+ rated separation between partitions. Hex Safe integrates additional security measures to enhance the security of assets such as automatic encryption, hardware-bound signing, and immutable customized compliance workflows, protected by tamper-proof secure boot and Secure Image Build, defend the system from malware contamination or coding attacks.
At Hex Trust we believe that a key responsibility of digital asset custodians lies in simplifying the underlying complexities of blockchain technologies and creating a standard access layer to connect capital and service providers across the ecosystem. This is a critical building block to extract the maximum value that blockchain networks can offer to its users and an opportunity to design a new financial market structure fundamentally different from the current one.
Hex Trust is spearheading this transformation by providing its clients an open platform that can be used to securely store assets and to access services offered in the digital asset ecosystem, focusing on integrating brokers, prime brokers, exchanges, lending and borrowing platforms, staking solutions and other custodians.
In addition, Hex Trust is committed to providing a secure bridge between the traditional financial world and the new digital asset ecosystem, allowing banks and other traditional financial institutions to access and serve clients in the digital asset space. As an example of this effort, Hex Safe integrates a SWIFT (Society for Worldwide Interbank Financial Telecommunication) interface to create a seamless communication channel with traditional financial institutions.
Following the dramatic rise in cryptocurrency investments and trading activities over the last few years, regulators are setting their sights on this growing part of the financial services industry. An example of the regulatory interest is the new guidance published in June 2019 by the Financial Action Task Force (FATF) on how its 37 members should regulate cryptocurrency exchanges. Unlike regulated financial institutions, most cryptocurrency exchanges, and other digital asset operators, do not currently have a legal or technological framework to obtain, hold and transmit identifying information for their transaction counterparties. In addition, while there has been clear progress in various jurisdictions with respect to digital assets, service providers operating in different countries have different regulatory expectations with very limited global consensus on cross-border activities.
At Hex Trust, we believe that digital assets custodians will play a critical role in facilitating the adoption of regulatory and compliance frameworks in the industry. This role consists of various responsibilities including monitoring clients’ transactions to prevent AML/CTF (Anti-Money Laundering/Counter-Terrorism Financing) activities, reporting identified and transaction information to regulators, protecting clients’ data and providing clients and regulators with tools to perform their compliance activities.
Hex Safe has been specifically designed to meet the complex compliance requirements of our target clients — banks and other financial institutions. Examples of features include on-chain and off-chain account segregation, full audit trails, integrated AML/KYC (Anti-Money Laundering/Know Your Customer) tools to prove ownership and source of funds, and regulatory and internal reporting capabilities. Further, data privacy regulations can add additional levels of complexity, as custodians must be able to collect and transmit data without accessing and storing sensitive third-party data.
In line with our collaborative approach to the digital asset market, Hex Safe has already integrated third-party tools to enhance our blockchain analytics functionalities, with a long term objective of connecting various compliance platforms to satisfy the requirements of our clients and the jurisdictions they operate in.
Looking towards the future of the digital asset market
As blockchain technology and digital assets become mainstream, the role of the custodian is evolving from simply providing a secure wallet to providing bank-grade security and transactional capability, securely connecting services and capital across the market, and ensuring compliance with relevant regulations and legislations in various jurisdictions. These responsibilities pose a complex challenge to invested entities and will ultimately define the future of the market infrastructure. Hex Trust, with IBM infrastructure, is well-positioned to lead the transformation in this area and offer digital assets players the first bank-grade solution to access the digital asset market.