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Hong Kong startup makes crypto custody play

HEX Capital’s gambit shows the pathways and pitfalls in making digital assets safe for institutions.



A Hong Kong-based startup is throwing its hat into the crypto-custody ring, hoping its bespoke approach will vault into becoming an Asian version of Coinbase for investors in digital assets.

HEX Capital began existence in 2017 as a crypto fund run by Alessio Quaglini, an ex-banker (BBVA, First Abu Dhabi Bank). He teamed up with Rafal Czerniawski, a bank technologist and entrepreneur, to found HEX Capital in March of this year because they saw the lack of institutional-level custody as well as to advise corporations on their blockchain strategies.

HEX Safe, the division dedicated to building custody, is being built to meet asset managers’ requirements, but specifically for a crypto environment. Another division, HEX Technologies, advises big companies on how to develop blockchains.

For now, most versions of custody involve cold storage off-chain, often in a hardware solution like Ledger, but these do not provide the reporting and fund accounting services that a traditional custodian would offer. Nor do they allow asset managers to segregate their assets among different portfolio managers and analysts (with different access permissions), nor by portfolios and sub-funds held by a single client.

“We spoke with traditional asset managers about what they’d want a custody platform to look like if it were built from scratch,” Quaglini said.

Everybody’s doing it
The ultimate goal is to create an offer that will become competitive within Asia, which assumes that the nascent industry will cohere around a handful of big regional players – in which someone like HEX could become something akin to Coinbase Prime, which retains a largely U.S.-centered clientele.

There are competitive challenges to a company like HEX being able to achieve that kind of status. Competitors have already emerged from both the classical world as well as from boutique trust companies that are spinning themselves now as digital vaults.

What’s a custody platform look like if it were built from scratch

On the classical side, Nomura has teamed up with Ledger and U.K. asset manager Global Advisor to offer prime broking (custody plus balance-sheet support for trades), while Northern Trust has introduced new, bespoke tools for helping traditional hedge funds trade and administrate digital assets.

Meanwhile, a number of small trustee companies that cater to family offices and rich individuals have begun digital-safekeeping operations, hoping to capitalize on the fact that family offices are the vanguard of institutional investment in crypto. This includes Fusang and Legacy Trust in Hong Kong, along with the likes of Kingdom Trust in the U.S. and Vo1t in the U.K.

Crypto fund managers in Hong Kong didn’t express much enthusiasm for these services, perhaps because they aren’t designed by blockchain experts: these companies may need to partner with outsiders to offer a digital-asset solution. (Fusang and Legacy did not respond to DigFin communications.)

Licensed versus pure
But they have something HEX does not: traditional trustee licenses, including those to deal in or advise on securities.

(There are other reasons why crypto funds may look for other solutions: one investor based in Hong Kong says there are tax disadvantages to using admin services here onshore.)

Henri Arslanian, PwC

Quaglini acknowledges licensing is a hurdle. He notes there is no existing license framework in Hong Kong for crypto-currencies that are not securities. “We definitely want to get a license as soon as possible,” including one for dealing in securities or for trusteeship, but the firm is still finalizing an initial funding round. “We will have all the right requirements in place to obtain [a license once one is available].”

Although licensing issues are short-term obstacles to pure digital plays, they may prove temporary – and possibly a distraction to more fundamental requirements to sustain a custody play.

“Investors and providers of digital-asset safekeeping should not focus solely on licensing,” said Henri Arslanian, fintech and crypto lead for Asia at PwC. He argues it’s more important to institute the right governance and control frameworks.

The to-do list
Obviously security is what custody is all about, but beyond this there are other considerations. Traditional custodians cut NAVs, but how do you ascertain an asset’s value in the 24/7 world of digital? What’s fair value when, so far, “utility” tokens are being used to speculate rather than for their purported underlying services? So rules and metrics need to be put in place.

Another overlooked area is insurance. HEX Safe, for example, has traditional theft insurance to cover the loss of private keys. Other players such as Altairian Capital have introduced custody based around cyber insurance. It’s too soon to know how investors and regulators will appraise these efforts.

Lastly is the structure of the safekeeping itself. In the decentralized world, the challenge for custody is the immutability of the ledger. In the classical world, errors such as an incorrect Swift message, the wrong counterparty or a fat finger happen all the time.

This is costly and manual to reverse: indeed, a selling point of decentralization is to cut out the need for so much reconciliation. But it can be reversed. Errors conducted in crypto cannot be: a lost private key or coins sent to the wrong account mean the money is gone, forever.

Therefore, security takes on a different meaning. In a decentralized situation, the ledger is distributed, and therefore it can’t be hacked. There’s no need for a big bank to spend zillions on defending its servers against hackers. The challenge is on reducing transaction errors.

Cold and hot
HEX Safe tries to address this through two versions. One is a cold wallet that is “air gapped”, meaning one device has no connection to the internet. Transactions are agreed to offline, and then broadcast to the blockchain network being used (e.g., Bitcoin) through the client’s own node. This suits long-only investors; Quaglini says HEX Safe already has some clients using this service.

In September it will unveil its hot-wallet version, which (like many other solutions in this space) relies on an algorithm called Shamir’s Secret Sharing: a secret, such as a transaction or a private key, is divided (or “sharded”) among three or more distinct parts, which must be reassembled to reveal the cryptographic hash. This is a more robust version of mulit-signature protocols because it can be applied agnostically to any distributed ledger.

HEX Safe is working with a Hong Kong-based trust company to safekeep the third shard; Quaglini declined to name the partner.

He says these hot- and cold-wallet protocols are standard, as everyone needs to rely on academically proven cryptography. What varies is the level of service and client understanding, including things like user experience and reporting capabilities. HEX Capital is building something it believes will appeal to institutional investors – rather than adapt a classical model or a solution originally designed for retail investors (such as Coinbase’s).

HEX Safe will also offer trading and execution capabilities: it isn’t trying to be an exchange, but to face crypto exchanges via its HEX Technologies arm on behalf of its custody clients, so they don’t need to build many interfaces.

Will investors go for this, over a licensed player or an offering backed by a traditional bank? Can HEX and others build into regional champions, or will everything gravitate to a few global giants in the U.S. and Europe? Right now, there is so much demand for a solution that it seems likely every entrant will win some clients. “And then it will be a war,” Quaglini said.

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