Valkyrie Investments has taken a major step forward on custody innovation in the cryptocurrency ETF realm.
The firm's recently launched spot Bitcoin ETF (BTF) implements a diversified custodian approach, storing assets across leading platforms Coinbase and BitGo.
This marks the first Bitcoin ETF to balance custodial responsibilities rather than relying on a single entity. The move could prompt other issuers to rethink custody conventions in crypto ETFs.
Valkyrie's Crypto Fund Offerings
Valkyrie burst onto the crypto asset management scene in 2021 with a mandate to develop institutional investment vehicles focusing on digital assets and decentralized finance (DeFi) advancement. The firm has moved swiftly to deliver on this mission, securing approvals for both Bitcoin futures and spot exposure products available to public markets.
Key Milestones:
- October 2021 - Launched Bitcoin Strategy ETF (BTF) with CME futures exposure
- January 2023 - Secured green light for Spot Bitcoin ETF (BTF) holding underlying assets
Valkyrie's Chief Executive Officer Leah Wald emphasized that spot Bitcoin exposure allows removing basis risk associated with futures-based offerings. The new fund directly reflects Bitcoin market price movements.
Wald has industry experience across crypto funds and financial services including Blockchain Capital, Wells Fargo, and TokenSoft. Her perspective shaped Valkyrie's approach to the pioneering custody structure for BTF.
Assessing Custody Improvements in Crypto ETFs
Storing digital assets securely presents unique challenges given crypto's nascency and underlying technology. This is especially true for regulated fund vehicles like ETFs carrying strict rules around controls and reporting.
Yet crypto custody solutions have advanced considerably through platforms like Coinbase Institutional and BitGo Trust to meet sophisticated investor demands.
Wald views the BTF custody approach leveraging both leaders as a prudent way to mitigate risks:
"We believe this multi-custodial model is important for investors and functionally prudent from a security standpoint across platforms."
But why does custody matter so much for crypto ETFs in the first place?
Importance of Qualified Custodians
Exchange-traded funds carry intensive management, compliance and operational overhead to stored assets safely on behalf of shareholders.
This means implementing security practices like cold storage while still supporting liquidity needs to manage inflows, outflows, and accurate pricing.
Crypto ETFs heighten custody challenges through asset characteristics and regulatory scrutiny. Qualified custodians must provide:
- Secure Cold Storage - Utilize offline storage, multi-sig authorization
- Insurance Coverage - Comprehensive insurance around theft, loss
- Whitelisting - Strict counterparty controls
- Proof of Reserves - Auditability to confirm holdings
Failing to satisfy expectations around these areas and more could lead to fund suspension or dissolution.
Spot Bitcoin ETF Custody Requirements
- Secure Cold Storage Solutions
- Comprehensive Insurance Coverage
- Counterparty Whitelisting
- Proof of Reserves & Auditability
Top custodians invest heavily in meeting these standards. Distributing responsibilities across two leading platforms promotes even greater oversight and distribution of duties.
Valkyrie's Differentiated Custody Methodology
ValkyrieBTC holds Bitcoin directly, making its net asset value (NAV) intimately linked to $BTC price performance. Appropriate custody controls enable this exposure.
The fund stands as the first spot Bitcoin ETF to balance custodial functions using Coinbase and BitGo rather than concentrating with a single provider:
Coinbase: Leading US exchange and custodian founded in 2012. Manages over $180 billion in assets across 20 million customers. Offers institutional cold storage solutions.
BitGo: Originally founded in 2013. Currently processes 20%+ of all Bitcoin transactions. $64 billion assets in custody. Known for multi-signature technology.
This dual approach de-risks storage and transaction execution across two highly reputable platforms. Consistently strong rankings from analysts like Forbes Advisor and CryptoCompare reinforce both as top-tier industry custodians especially among US entities.
Wald summarized the intention behind splitting custody duties:
“We believe this multi-custodial approach is important for investors and functionally prudent from a security standpoint across platforms."
Let's analyze the potential benefits of dividing custody in this manner.
Enhanced Security
Both Coinbase and BitGo already implement best-in-class security around cryptographic systems, offline storage infrastructure, access controls and more. Each conducts regular audits to verify holdings and internal protocols.
Spreading assets across dual platforms creates additional layers of redundancy. Single points of failure get avoided to limit impact radius if any incidents occur. Cyber threats and technical issues have lower probability of jointly compromising dual independent custodians simultaneously.
Geographic diversification also improves contingency planning for physical disasters, outages and other force majeure events. Coinbase and BitGo operate storage facilities across separate regions. This frustrates location-based disruptions.
Streamlined Operations
Splitting asset handling duties allows optimizations around execution pathways tailored to differential platform strengths.
For example, BitGo's multi-signature support facilitates oversight of withdrawal transactions. Coinbase's integration of various DeFi protocols eases support for assets beyond Bitcoin like tokenized stocks or stablecoins.
Future operational enhancements can evolve across platforms independently while still coordinating under the same fund mandate objective. This flexibility would prove more cumbersome relying on just one custodian.
Decentralized Governance
Concentrating control in a few hands is anathema to crypto market principles. Dispersing custodial power across multiple entities better aligns with the decentralized ethos.
Shared custody dilutes individual provider influence over fund decision making. No single platform can exert as much sway over holdings, limiting censorship risks. Governance disputes have lower potential for disruptive unilateral actions.
Constructive regulation helped shape Valkyrie's model here as well...
How Regulations Shaped Valkyrie's Custody Innovation
Navigating the complex ETF regulatory environment posed challenges for Valkyrie, but ultimately led to better outcomes through constructive collaboration.
Wald credited SEC feedback during the review process with helping guide BTF's custodial approach:
"The SEC provided great commentary around enhancing elements of the custody solution throughout the filing process. This enabled bringing Coinbase and BitGo together in a way investors can appreciate.”
Ongoing discourse between issuers and authorities continues smoothing the runway for novel crypto fund launches. Learnings get incorporated on all sides.
Trust Through Compliance
Of course, custody innovation was not the only area needing attention for Valkyrie during application discussions.
Wide-ranging compliance topics included:
- Verifying provider qualifications
- Engaging third party support
- Amending fund documentation
- Clarifying operations flows
- Enhancing shareholder disclosures
- And more
Constructive focus on these topics ultimately strengthens protections for investors participating in a rapidly evolving asset class. Transparency and accountability have become hallmarks of Valkyrie's approach partly fueled through cooperative regulatory oversight.
The SEC aims to open investment access to cryptocurrencies for public market investors. Simultaneously ensuring appropriate guardrails are in place shapes the way forward responsibly as crypto adoption accelerates.
Differential Edge Through Custody
Launching differentiated products is crucial for ETF issuers seeing rising competition across crypto offerings.
Valkyrie's dual custody model provides a standout structural advantage that could elevate its position amongst Bitcoin ETF ranks as assets accumulate. The mechanism bridges to crypto's roots through decentralization while still satisfying regulatory reporting obligations.
Wald suggested continued iterations around crypto financial mechanisms may further embrace elements of distributed governance and responsibility:
"As someone with experience across both crypto native companies and traditional finance, I think we'll see more hybrid models emerge that combine aspects investors are comfortable with alongside principles of decentralization."
Increased transparency and redundancy instituted through divided custodial duties exemplifies one such cross-pollination of capabilities.
Future Crypto Custody Trends
As the number of asset management solutions targeting digital assets continues rising, product differentiation will grow more pivotal. Valkyrie's use of a multi-party custody arrangement sets an early precedent in the evolutionary timeline.
"We believe this is an important development for investors to know their assets are safeguarded to the highest degree across leading platforms."
We'll explore several directions and custody solutions might expand next.
More Diversification
Adding more custodians could further de-risk storage responsibilities. However, diminishing returns arise with each additional platform. Reaching consensus also becomes operationally unwieldy at a point.
But exploring a trusted triumvirate across custody, transactions and oversight duties has merit. Creative configurations can emerge based on provider strengths like DeFi accessibility, staking integration, reporting standards and other variables.
Increased Automation
Another potential direction leverages smart contract capabilities for automated custody rotations based on algorithms rather than manual intervention. This model provides continuous evaluation cycling assets across an array of providers based on evolving rankings.
Auditability still holds importance so investors can verify holdings. But minimizing centralized authority over custody decisions counters individual judgments. Code-based protocols govern distribution based on specified metrics like volumes, regulations, fees structures and security scores.
Custody Evaluation Criteria
- Storage Volumes
- Regulatory Compliance
- Insurance Coverage
- Security & Infrastructure
- Staking Integration
- DeFi Connectivity
- Reporting Standards
The range of variables attesting custodial qualifications keeps expanding alongside maturing industry infrastructure. Quantifying these attributes supports programmatic allocation strategies.
Conclusion
Valkyrie has taken a significant step forward for the crypto ETF segment by diversifying its Bitcoin holdings across Coinbase and BitGo custody. This innovative structure could prompt competitors to revisit their own custody arrangements by incorporating decentralization principles.
ETF issuers continue navigating regulatory expectations around security and controls for these novel investment vehicles. Optimizing frameworks to balance investor safeguards with convenience will further drive adoption.
Custody represents just one area primed for ongoing customizations that enhance user experience while satisfying compliance duties. Expect more experimentation ahead as the crypto ETF ecosystem evolves through technical integrations and financial hybrid models.
What custody solutions would you like to see further improved in ETF products going forward? Which aspects matter most in your eyes?