Custodying crypto is very difficult.
With the infamous Mt. Gox, less-infamous Quadriga, and a handful of other crypto companies that have gained mainstream attention for losing millions of dollars of customer funds, we have years of evidence that custodial services for cryptocurrencies are apparently quite difficult. And yesterday, we received even more evidence.
In the morning of June 22, the crypto custody giant BitGo terminated its acquisition of rival Prime Trust. By that afternoon, Nevada’s Financial Institutions Division (FID) ordered Prime Trust to cease all activities, alleging that the company’s overall financial condition had considerably deteriorated. Yesterday, Nevada’s FID filed a request to place Prime Trust into receivership.
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This situation escalated quickly for what seems to be a good reason: Prime Trust allegedly owes its clients $85 million in fiat currency and has only about $3 million in fiat currency on hand. The company also owes a further $69.5 million in cryptocurrencies, with $68.6 million in crypto on hand.
- Gary Gensler and Congress have both failed the U.S. crypto industry.
- Bitcoin and other digital assets experience a late surge in Q2 due to the euphoria surrounding spot Bitcoin.
- Prague is brewing.
It’s not just the mismatch in numbers that has caught people’s attention, but also the way Prime Trust ended up in this predicament.
According to the FID filing, Prime Trust is unable to access “legacy wallets.” Prior to 2020, Prime Trust managed its customers’ cryptocurrencies in its own wallets. In 2020, Prime Trust transferred customer assets to Fireblocks, an institutional custody and security firm, to have Fireblocks manage crypto assets on behalf of Prime Trust’s customers.
Then, in 2021, after Prime Trust experienced changes in its management team, it implemented something called “legacy wallet forwarding” for clients and had funds sent back to Prime Trust’s old pre-2020 wallets, following issues with the Fireblocks platform. As it turned out, this decision was a huge mistake.
In December 2021, Prime Trust discovered that it couldn’t access those “legacy” wallets. Here’s the bombshell from the filing: “It is understood that from December 2021 to March 2022, to satisfy the withdrawals from the inaccessible Legacy Wallets, Prime Trust purchased additional digital currency using customer money from ‘omnibus customer accounts’.”
There are two major takeaways from this.
First, it is incomprehensible that a custodian like Prime Trust doesn’t have access to wallets. The whole purpose of a custody service is to pay someone to be better at safeguarding cryptocurrencies than you are. This incident completely undermines the marketing pitch and business case used by third-party custodians — the claim that people aren’t smart or brave enough to hold their own crypto, so they should trust a custodian. After all, they’re the experts. Apparently, that wasn’t the case with Prime Trust.
And to preempt any claims, don’t let anyone tell you for a second that Prime Trust is some second-rate firm. Prime Trust was known to be a legitimate, young company with promise. It raised over $100 million in a funding round last year that included FIS, Fin Capital, Mercato Partners, and Kraken Ventures. It also counted several crypto firms, including Swan Bitcoin and Coinbits, as clients.
Second, and here’s the main issue: Seriously, how difficult is it to provide custodial services for cryptocurrencies on behalf of others?
It should be straightforward. You give me crypto, I hold it for you, I give it back to you when you want it, and you pay me for those services. This is something individuals are fully capable of achieving on their own in the world of self-custody. This should be a cakewalk for sophisticated companies that have received nine-figure venture funding.
The Prime Trust story is still developing, so I’ll refrain from making final judgments until we know the full story. However, there are a few things that need to be clarified. How exactly did this happen, and what exactly was the “additional digital currency” that Prime Trust allegedly purchased using customer money? Was Prime Trust trading crypto in the hopes of making up the difference and repaying customers without any issues?
If this is the case, then we are entering an entirely new world for this story. The counterparty risk associated with custodians is that they might lose your crypto, but there shouldn’t be an additional risk associated with the custodian trying to make it all back in one trade after they lost your crypto.
From a broader perspective, this is bad news, not just for Prime Trust customers. If we’re being honest, the situation sends the message that this kind of basic failure is the norm in the crypto industry, rather than the exception.
See also: Binance Crypto Custody License Application Denied by German Regulator BaFin
Despite the financial losses being significant, the bigger concern lies in the apparent concealment by Prime Trust, which was exposed during its failed acquisition negotiations. (By the way, who did they think they were fooling on the other side of the table? And how?)
Cryptocurrency already has a dubious reputation in mainstream circles, and this incident serves as yet another example of questionable behavior. Considering Prime Trust’s background, it raises immediate concerns about other companies – perhaps even those with a trusted reputation – that may be engaging in risky practices with user deposits.
It’s possible that they are, but hopefully they are not. However, during crypto bull markets where unknown tokens can increase in value by a factor of 100 or 1,000, it’s plausible that some companies have engaged in such behavior and managed to escape scrutiny.
The problem for the industry is that stories like Mt. Gox, Quadriga, and FTX dominate its reputation, casting doubt even on the reputable firms. And simply advising people to be cautious will not be effective.
