Bakkt’s custody ambitions could trigger market consolidation

At The Block, Frank Chaparro usually writes about the glamorous crypto derivatives that generate much fanfare, while I cover the far less sexy crypto custody. 

Thanks to Bakkt, our two worlds intertwine. On Monday, the famed bitcoin derivatives platform said it will officially open up its institutional custody business. 

The announcement itself should not be a surprise to avid readers of The Block, although what surprised me is the straightforwardness with which Bakkt COO Adam White started the announcement. He wrote:

“A critical link - perhaps the critical link - in the institutional adoption of bitcoin is custody" - or, read: custody is the last hurdle to onboard the Goldman Sachs' of the world.

So now the least sexy topic in finance suddenly becomes the hotshot tasked with bringing in that elusive institution the crypto industry has been wanting. 

Bakkt is not the only one who figured out that custody plays a significant role in institutional adoption. According to The Block’s research, 18 “institutional” custody vendors were formed over the past two years. Along with the older brands like BitGo and Kingdom Trust, there are a total of 23 “institutional-only” custody providers that The Block identifies. 

Now, maybe it‘s just me, but it seems immediately obvious that none of these “institution-only” businesses will be successful if, say, there are no institutions. And since there are probably more custody suppliers than there is institutional demand, the entire crypto custody industry has been struggling with the problem of compressing custody fees over the past few years. 

Meanwhile, Bakkt is coming into the market with some seriously appealing features, including an up to $125 million insurance policy, a tech team partly consisting of crypto custody firm DACC, and nearly zero fees, according to several sources. 

To put it another way, here we have a brand name like Intercontinental Exchange, which probably has relationships with all the institutions, has a lot of cash ready to be spent on developing the custody technology itself or buying out other firms, and comes with a fee that may be lower than what a lot of the smaller firms charge. If custody was really institutions’ last barrier to entry, that barrier should be gone soon. 

Bullish for Bakkt, that’s for sure, but not so much for other firms. 

The Goldman Sachs' of the world, which other custody vendors have been actively courting, are not coming into crypto simply to hold some bitcoins. They are coming into crypto because some brand-name custodians like Bakkt distance them from weird digital assets that live on blockchain while still giving them exposure to this new asset class. If they come into crypto because of firms like Bakkt, they most likely will stay with firms like Bakkt. 

For the smaller firms, there are two paths: being acquired by companies like Bakkt, Fidelity or other brand names, or expanding their business lines.

When you really think about it, how hard can it be to hold a piece of paper with your private key written on it for safe-keeping? The services built on top of custody are what help custody businesses retain their traction in an age of fee compression. Therefore, we see that quite a few companies are offering value add services to take the sting out of the fees they are charging: Anchorage with staking and on-chain governance, with others like BitGo trying out lending and brokerage. 

What we see time and again in other markets when larger players enter without mature enough technology (such as in telecom, gas stations, and airlines) is acquisitions - buying out all the firms that they either want to possess, or ones they resent because they are in the way. In the end there will be fewer firms but each firm's offerings will be more comprehensive. 

At the end of the day, cryptocurrencies are designed to give people total autonomy over their assets by simply holding a string of numbers - the private key. A third-party custodian, be it Bakkt, Fidelity, or Anchorage, is not what the technology demands.

Like a crypto fund manager once said to me, “It pains me thinking that I spent so much money on something like custody." He stressed the word "custody," disdainfully.  

That said, the consolidation of the crypto custody market may have just begun.