When it comes to the potential of crypto, some see it as a futuristic concept that’s going to transform the financial landscape. Yet despite accelerating innovations, if you want to keep your assets secure, sound financial principles will still apply.
One of those fundamental principles is to manage risk by having a complete understanding of where you keep your assets, and what risks are associated with the management of those assets in custody. This doesn’t change when dealing with assets that range from stones to stablecoins.
Consider how this might be relevant to crypto – though the blockchain infrastructure you put your digital assets on may be secure, the custodian of those assets may be exposing them to unwanted high-risk reinvestment opportunities.
The Difference Between a Bank and a Trust
For many consumers, the first place they think to put their money is in a bank, because it feels safe. But why? Perhaps because banks have been around for centuries, it’s become easy to think of them as the center of the financial system. But remember, banks are also businesses seeking to make money. They offer the kinds of services many customers want – whether seeking a loan, a mortgage or an interest rate on deposits. Trust companies have existed for almost as long, and though they may be mistakenly thought of as being similar to banks, the differences are significant, and first among them is this:
A bank is a financial intermediary, accepting deposits into their reserves, and making loans against those reserves.
A trust is an arrangement that allows a third party or trustee to hold assets or property for a beneficiary or beneficiaries, but does not allow for the trust to use those reserves to facilitate other business.
Unlike a bank, a trust company does not lend your assets out – it holds your assets bankruptcy remote, fully segregated from corporate assets. Kept in a bank, your assets will likely be used to make loans, and should the bank go out of business, the insurance on your assets is capped at $250,000 by the Federal Deposit Insurance Corporation (FDIC). If your assets are held in safe custody by a trust company, and that company were to go out of business, your funds are held away from creditors, and fully redeemable at any time.
Why This Matters to Your Digital Assets
Understanding this basic difference between banks and trusts can change one’s perception of the volatility of digital assets. It’s easy to blend all cryptocurrencies together when speaking casually about the marketplace, but a digital wallet issued by a payment provider or banking entity that does not hold your assets in bankruptcy remote accounts may not be as secure as a digital wallet issued by a regulated trust company where every stablecoin lives up to its name.
While FDIC insurance is a reliable and welcome market stabilizer, holding assets in custody with oversight from a prudent regulator is the best way to ensure crypto assets are only as volatile as marketplace value dictates.
With a prudent reserve strategy in place, required transparency about the nature of the reserves becomes an expectation – driving even more transparency.
In the future, banks and other financial institutions will remain at the center of the consumer marketplace, and as they expand their offerings to include crypto, definitive reserve strategies are going to be best served in partnerships with trust companies and experienced crypto brokers.
As a regulated trust company offering crypto brokerage services, Paxos has worked for over a decade to bring a unique, best-in-class solution to banks and others interested in offering crypto.
Learn more about Paxos Trust Company and our crypto brokerage offerings here.