Crypto Risk Management: Safeguarding Your Assets
Of all the many ways in which crypto asset management differs from traditional finance, custody is perhaps the most fundamental. The deceptively simple question of where and how to store your crypto turns out to be anything but simple, especially for institutions. While cryptocurrency transactions themselves are recorded on the blockchain – transparent, immutable, disintermediated – every crypto portfolio manager needs to solve the problem of how to store the keys that give them access to those assets. Here, they face a risk management trade-off between convenience and security.
The key dilemma at the heart of custody risk management in crypto
Every crypto portfolio manager needs to deal with the problem of safeguarding their private keys. The immutable nature of blockchain transactions, combined with the lack of consistent regulation, means that crypto investors who hold assets in self-custody wallets or with an unlicensed custodian typically have no recourse if their assets are stolen or misdirected. (While in certain jurisdictions custodians are fully regulated and provide customer safeguards, that is unfortunately not the case everywhere, leaving customers with the burden of determining what protections may or may not apply.) For asset managers, however – who must add regulatory and auditing risks to the usual worries about loss or theft – the problem has even more dimensions.
In crypto asset management, it is necessary to decide between self-custody and external custody providers, as well as balancing the use of hot and cold wallets; that is, wallets that are connected to the internet (with concomitant security risks) and those that are entirely offline. While a hot wallet may be a pure storage solution (i.e. an app), trading accounts at crypto exchanges or brokerages also fall under this category, and may need to be pre-funded.
Retail crypto investors will typically manage both cold storage, for long-term balances, and hot wallets that hold and transact operating capital, but institutions may prefer to use brokers and over-the-counter trading desks. The greater protection they offer comes at a cost, though; besides sometimes steep fees, they may also offer less trading flexibility, in terms of speed and access to the full range of platforms.
When it comes to cold storage, using internally maintained and secured offline storage demands sophisticated expertise, controls, backup and contingency arrangements, bearing in mind that availability of the assets is as crucial a concern as protection. In other words, prudent risk management demands that you avoid a single point of failure – custody provision cannot rely on any individual. Integrity of wallets (in case of physical damage or cryptographic failure) is a further risk.
The complexity of managing these considerations at an institutional level has given rise to a plethora of external custody solutions. Institutional custodians are typically sector specialists, or in some cases banks, which may themselves rely on either an in-house or third-party custody solution. Other custody providers are technology platforms that harness security measures such as multi-party computation or hardware security modules.
By nature, either of these options offers specific advantages that can be crucial for organizations: using a conventional login setup, they avoid complicated key management, as well as the need to physically connect a wallet to the internet in order to transact. Custodians should also be able to provide features such as multi-party approvals, disaster recovery, and insurance cover. However, institutional custodians may provide less flexibility for trading, and may not provide access to the full range of trading and investment platforms available (such as DeFi exchanges).
Crypto asset management risk considerations
The availability of institutional-grade third-party storage for digital assets resolves a number of issues for portfolio managers. However, active trading throws up a host of further risks.
Given the fragmented nature of the global crypto market, it is likely that organizations will be active on multiple platforms, exposing them on multiple fronts to risk of an incident such as a hack, fraud, or bankruptcy; such events are sadly familiar in the digital asset sector. While the industry is evolving and many participants are working to bring about greater stability and regulatory protection, it has been made clear that at this stage of market maturity, even the largest, most apparently stable exchanges cannot be considered entirely safe.
While off-chain settlement networks such as BitGo can enable users to trade on multiple exchanges with just one middleman, arguably, that brings us back round to the problem of concentrated risk. Spreading trading capital across multiple platforms should be considered an essential tactic to diversify risk, as well as to gain access to a wider variety of assets. As with other diversification strategies, asset managers will need to continually review and rebalance the spread of holdings across trading platforms.
How Nuant supports effective digital asset risk management
Diversifying portfolio risk across multiple wallets and custody platforms is one way of offsetting risk, but it also creates an urgent need for crypto portfolio managers to have at-a-glance insights into their digital asset holdings across their entire portfolio – all exchanges, trading platforms, custodians, wallets and staking pools. Nuant’s innovative crypto portfolio management system solves this problem, with a streamlined dashboard that brings together all platforms and wallets, providing the oversight to facilitate better crypto risk management.
One standout feature in this regard is the exposure chart, which allows you to easily assess your exposure to different platforms in a visual format using various dimensions – for instance, within a particular portfolio, or across multiple custom portfolios.
In addition to displaying or filtering all holdings by exchange, and across multiple portfolios, the Nuant PMS can of course provide a range of detailed analytics to support other risk management and performance criteria for cryptocurrency investors. The elegant, intuitive design and powerful customization features make it an invaluable tool for getting the most out of any digital asset portfolio. Book an appointment today for a discussion and demo.
