3 Critical Responsibilities of Digital Asset Custodians

3 Critical Responsibilities of Digital Asset Custodians

August 7, 2020

From time to time, we invite industry thought leaders to share their opinions and insights on current technology trends to the IT Infrastructure blog. The opinions in these blogs are their own, and do not necessarily reflect the views of IBM.

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.

Safekeeping

Securely custodizing digital assets protect the private keys and develop 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.

Learn more about the security capabilities of IBM LinuxONE

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 holistic protection compliant to FIPS (Federal Information Processing Standards), 197 and FIPS 140–2 Level 4 HSM (Hardware Security Module) standards[1], 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.

Connectivity

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.

Compliance

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)[2] 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 the 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 legislation 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.

Article guest-authored by Alessio Quaglini for the IBM blog on July 8, 2020. Read the original article here.

Learn more about the security capabilities of IBM LinuxONE and IBM Hyper Protect Virtual Servers.

About The Author

Alessio Quaglini is the co-founder and CEO of Hex Trust and has over 15 years of professional experience, developed in banking, regulatory bodies, and management consulting. Prior to founding Hex Trust, Alessio was the Head of Strategy Asia for BBVA, overseeing the overall business development and geographical footprint in Asia. Among the responsibilities, Alessio helped the Bank set up branches and obtain regulatory approvals in Taiwan, South Korea, Australia, and Japan. Alessio was subsequently Director of Financial Institutions at First Abu Dhabi Bank, where he was responsible for developing the bank’s business with Financial Institutions and Non-Bank Financial Institutions in North Asia. Alessio also worked at the Italian Financial Services Authority (Consob) in Rome, where he was responsible for the supervision of public equity and derivatives markets in the market abuse department. Alessio is an early adopter of cryptocurrency and set up Arepo Capital, a cryptocurrency hedge fund in 2016. Alessio speaks four languages English, Spanish, Italian, Chinese — Mandarin, and earned his bachelor’s and master’s degrees in telecommunication engineering from La Sapienza University in Rome, his MBA from IE Business School. He has also earned a Quantitative Finance diploma from Stanford and is a CFA Charterholder since 2012.

About Hex Trust

Hex Trust is the leading digital asset custodian for the banking sector. The platform, Hex Safe, provides compliance-focused custody infrastructure, deployment flexibility, and seamless integration with third-party service providers in the ecosystem such as exchanges, OTCs, lending, and staking platforms. Headquartered in Asia, Hex Trust is fully licensed and has offices in Hong Kong, Singapore, Vietnam, and Germany.

[1] FIPS 140–2 Security Level 4 provides the highest level of security defined in this standard. At this security level, the physical security mechanisms provide a comprehensive envelope of protection around the cryptographic module with the intent of detecting and responding to all unauthorized attempts at physical access. See https://csrc.nist.gov/projects/cryptographic-module-validation-program/standards and https://csrc.nist.gov/Projects/cryptographic-module-validation-program/Certificate/3410. [2] The Financial Action Task Force (FATF) is an independent inter-governmental body that develops and promotes policies to protect the global financial system against money laundering, terrorist financing and the financing of proliferation of weapons of mass destruction.

Alessio Quaglini
Alessio Quaglini
CEO & Co-founder
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