The future of custody is a race to zero fees, says BitGo’s CEO. Here's why.

Quick Take

With custodian Xapo rumoured to be on the market, there’s an underlying debate around the future of crypto custody businesses
Tellingly, third-party custodians themselves say they’re unlikely to keep charging customers to store funds in the long-term, though not everyone’s convinced “zero fees” means truly “free”
We also explore the rise of self-custody and how this will affect third-party providers

If there's anyone who knows a thing or two about crypto custody, it's Mike Belshe - CEO of BitGo, one of the ecosystem's biggest custodians.

But of late, Belshe has been reflecting on where the industry is headed amid increasing saturation and ever-diminishing fees (and returns).

The basic rules of economics state that competition (and increased supply) brings lower pricing. Yet some experts - including Belshe - say fees for custody won't just fall, but actually crash to zero.

To be fair, zero-fees in custody isn't such an alien prospect; Xapo already offers free storage for its customers' $5.5 billion of cryptocurrency. But it's still very much an anomaly among its peers, having had an early-player advantage.

However, if others follow Xapo's lead, what does that mean for BitGo, a business whose sole source of income is charging customers to store their reported $2 billion in assets? What does that mean for customers? And when - if ever - should we expect the custody business to turn on its head?

The zero-fees camp

If fees are really heading en masse to zero, it's important to understand how.

At its heart is the belief that it's just a matter of time before major banks start offering crypto custody. David Mercer, CEO of LMAX Digital, says the entrance of players like Goldman Sachs will force exchanges like his to abolish the 1% annual custody fees to lure customers to their trading platforms. Institutions like Fidelity are already slowly entering the hyper-competitive fray, while crypto-exchange Bakkt is set to launch with its own storage-capabilities.

Belshe agrees, predicting that having banks as customers as well as custodians will also disrupt the price.

"I do believe it's driving towards a very low price, maybe zero," the former Google engineer told The Block. "As we start to interact with institutions, they're going to say 'we don’t want to pay that much. We wouldn’t pay a lot to store other assets.'"

Indeed, by way of reference, equity custodians like Fidelity or Schwab effectively don't charge for storing $4 trillion in assets. They make their money elsewhere, selling supporting technology, manufacturing ETFs and management fees.

And Belshe is similarly pragmatic about this prospect. He says custodians like his will just adapt and build additional services, with BitGo having already begun eyeing the launch of prime-broker and settlements services. As for exchanges, lending could be a revenue option he says, or they'll go the decentralised route (known as DEXs).

The long game

A zero-fee future is good news for the customer too, but don't get too excited - yet; the necessary infrastructure and the risk-appetite is still a while away.

"I would love [banks like] Goldman Sachs to jump in today. But the reality is they’re not doing that," Belshe said. "People don’t appreciate how much time it takes to get comfortable with this stuff."

He also hypothesized that if Goldman shot into the market by taking on $10 billion in assets, the price of those assets could feasibly shoot up by a factor of 10 in a matter of months, making their downside extortionate.

"Then they'll be sitting on $100 billion, with a new technology, that's untested. So they’re gonna do responsibly. Only when they're really confident will they take more assets. It will be incremental," he said, giving BitGo a lifeline.

"At BitGo, custody is all we do. So we’re going to just keep building...Our business model is pretty healthy. As long as you're solving problems, you’ve got value," he said, saying the next focus would be capital efficiency – allowing users to store and move funds across different exchanges.

The fees-forever camp

Still, not everyone is convinced that custody will stop being pay-to-store.

There are two central pillars to this school of thought. Firstly, current US regulation instructs institutions with over $150 million to have an external, qualified custodian. Necessity creates a price-tag which businesses can tap into and cater for.

Secondly, they believe that custodian that loan users' crypto-assets out to generate revenue will be an unattractive model for big investors.

“Custody is different [to banking]...I as an investor, I don’t want that [money] being lent out," says Ali Hassan, a former Goldman Sachs trader turned crypto hedge fund manager. Indeed, custodians, unlike banks, must legally ask permission to lend out assets. Thus, charging clients to create revenue seems fair (and obvious).

Hassan also highlights the fact that no-fees custodian Xapo is reportedly on the market suggests the no-fee model did not work as a business model.

"Fees will come down as competition gets tougher and technology gets better, but it will never be free," Hassan noted.

But where exactly that price-point will settle is up for debate. Lex Sokolin, former director at Autonomous Research, predicts crypto custody fees will "land on some low, 10 bps per year kind of level" plus extra charges and software add-ons. Like Belshe, he expects this will follow the arrival of big funds, who will trigger a "price-war" between Fidelity and Coinbase as they battle it out over the top clients.

The other variable to bear in mind is self-custody. Currently, self-custody is primarily used by retail customers who do not trust exchanges to store their assets. But in time, as it becomes more robust, it could also be an important option for institutions and a possible alternative to external providers - free or not. In practice, that would mean firms building out their own custody solutions; perhaps white-labelling others or using a hardware cold-wallet option.

"At some point, native custody-less (self custody) solutions may get good enough and accepted enough by managers that the need to have a third party relaxes," Sokolin noted.

Still, all in moderation. Even self-custody advocate Sharon Goldberg says third-party custodians are not going away, saying we may never get comfortable storing "billions" ourselves. Rather, she says crypto users will have the unique option of choosing from an array of custody solutions.

"There’ll be a lot of different ways to do it [even if banks come in with custody]...Innovative self-custody solutions will make their way in. Regulation will come down," the co-founder of security startup Arwen told The Block.

As for fees? She said if banks get involved there's an even slimmer chance that custody would be free as these institutions "constantly find ways to charge."

Custodian customers then seem resigned to the fact they may always pay for the service in some way - regardless of what the providers say. They believe custody fees will simply be diverted elsewhere. For instance, even if exchanges don't charge directly for custody, they will compensate with larger trading or withdrawal fees. Meanwhile, custodians will charge for side-services like set-up fees or overseeing operational controls if not for the custody itself.

As the old saying goes, there's no such thing as a free lunch.