Crypto News
Bitcoin and Grain: a tale of two custodies
FTX’s collapse demonstrated the wisdom of segregating the activities of market making on the one hand (Alameda) from those of running an exchange (FTX) and a custodian (FTX again) on the other. However, the question of whether to segregate the activities of operating an exchange and a custodian is more nuanced. Large banks often run their trading businesses and their custody businesses in the same legal entity, using information walls to control for conflicts of interest and ensuring that their own assets are segregated from those of their clients. This paper will use the experience of the US grain industry in the late nineteenth century to illustrate the importance of controlling the risks between custody and execution activities.
Cryptoasset Custody
Cryptoasset custody is a complex undertaking involving, among other things, managing information security risk to protect private keys and keep transactions secure. Custodians also act as a form of payment service provider, receiving cryptoassets and sending them based on the instructions of their clients.
Many of the early cryptoasset exchanges bundled custody with execution for their largely retail client base and some continue to do so. When they first launched, the exchanges had to build the capability to safeguard their own assets. Extending this capability to their largely retail client base for free created much stickier client relationships and was an oblique way of monetising the sunk cost of their in-house custody arrangements.
Since FTX’s failure there have been both private sector and public sector efforts to change this model. The private sector has seen wider adoption of ‘Off Exchange Settlement’ (OES) by the large exchanges, often in response to the demand of institutional clients. OES seeks to mitigate counterparty risks by removing the need for clients to keep their cryptoassets at exchanges. This, incidentally, is how Zodia Markets was designed from inception. In the public sphere, there have been regulatory measures such as those by the SEC calling for Investment Advisors to only use Qualified Custodians for their clients’ cryptoassets. There have also been consultations such as the one by HM Treasury in the UK, which signalled support for the segregation of client assets from those of the exchanges those clients use.
Cryptoasset Exchanges
Cryptoasset exchanges and traditional exchanges had similar origins insofar as most began as informal venues for retail customers. On the cryptoasset side, Coinbase started as a private service to buy and sell Bitcoin through bank transfer, while Mt. Gox started as a trading service for card collectors. In the traditional world, the LSE started out as a private association of traders based in John’s Coffee House in the City of London, while in medieval Belgium traders convened at the Huis ter Beurze, a tavern, which gave its name to the term ‘bourse’, as in Deutsche Börse. Taking a broader perspective, exchanges are designed to fulfill five functions:
Standardization, such as through weights and measures or consistently designed trading contracts,Protection of property rights, such as through rule books,Enforcement of contractual agreements through sanctions for bad actors, Mitigation of information asymmetries by disseminating information, often through a transparent order book and Providing public goods by ensuring rules are adhered to.
Judicial and legislative sanctioning of these rules by the state tended to follow, rather than the other way round.
Omnibus and Segregated: Elevators and Sacks
The development of grain exchanges in the late nineteenth century United States, particularly the Chicago Board of Trade (CBOT), helps illustrate the tension between custodians on the one hand and exchanges on the other. During the late 1840s and early 1850s, the quantity of grain shipped to Chicago grew dramatically as the United States expanded west. Storage elevators operated by warehousemen were large, specialized warehouses where grain was kept in bins before shipment. In a sense they are equivalent to omnibus cryptoasset custodians where the assets of various owners are commingled in a single wallet.
The CBOT started out as a sleepy organisation, even having to encourage attendance at its meetings in the 1850s by providing free meals. The exchange grew to play a role in standardizing the grading, inspection and weighing of commodities, including grain, which is function 1 in the list above. The warehousemen who operated the elevators were at odds with the traders and shippers of the grain, who were more aligned with the exchange.
The storage of cryptoassets involves, among other things, the indexing of the chains and asset screening. Blockchain indexing eases the process of finding information stored in the blockchain rather than analyzing data block-by-block. It does this by parsing and storing the data in a centralized database where it can then be queried. Indexing is a form of confirming the on-chain property rights of the custodian’s client. This is function 2. Certainly, clients could do this themselves, but it is much easier to pay a custodian to do it on their behalf.
Screening and scoring are a financial crime monitoring measure that has no real equivalent in traditional finance, since it is specific to blockchains. Private firms provide scoring services to assess the financial crime exposure of a particular asset or wallet. If an asset or wallet has recently interacted with an address that is known to be associated with criminal activity, then the score is adversely impacted. This means that the notion that cryptoassets are perfectly fungible is not strictly accurate. Different wallets and assets have different scores. Where custodians operate omnibus wallets, so this affects the score of the overall holdings by commingling assets of different scores.
The same was true of grain in that it is not nearly as fungible as one might imagine. There are different grades depending on the growing area, such as Russian Rye wheat, River Plate wheat, East India wheat and so on. Other grading criteria included, for example, moisture content, foreign matter, and damaged grains.
The challenge in the United States was the scale and sophistication of the custodial infrastructure that collected grain into elevators before being transported. This was different from countries like Argentina where the infrastructure was less sophisticated, and grain was parceled into sacks for shipping.
Custodians that operate separate wallets for each of their clients are analogous to the grain sacks of Argentina. Omnibus grain elevators created economies of scale through quantity and scale. However, this came with the trade-off of making it harder to track quality compared with using grain sacks that could be tagged with a particular grade from the point of packing to arrival at the end customer. In cryptoassets omnibus wallets also create economies of scale, such as reducing on-chain transaction costs, but the scoring of individual sets of assets becomes more challenging if not impossible.
The Risks of Comingling and Custodians trading on own account
The commingling of grain allowed the warehousemen to engage in unscrupulous practices. For example, they could receive a shipment of grade one grain and then mix it with grade two to the point that it was still just within the acceptable range for a one grade. As a result, the warehouse was able to improve the quality of grain on its own account to the detriment of others. This of course resulted in a dead weight loss for those who had high-quality grain stored at the elevator. This discouraged farmers from ensuring their grain was of the highest quality. Further down the supply chain, shippers engaged in mixing to be as close to the threshold between grades, so the loss to the warehousemen would be minimized. In some senses there is a Gresham’s Law at work, with poor-quality grain driving out good quality grain. In summary, standardization and the protection of property, functions 1 and 2, became flawed.
One key difference between cryptoassets and the grain markets is that the grading and scoring of cryptoassets is conducted by third party private sector companies, since the data is public and anyone can do it. However, omnibus wallets do limit this capability since a great deal of trading activity can take place off-chain and then net settle to the omnibus wallet.
Another source of tension revolved around function 4. Warehousemen, who could trade on the exchange but also traded off the exchange in private transactions, had information about supply and demand as well as the qualities of grain in storage, thus creating a conflict of interest. While this information was their property and the treatment of information as property does act as an incentive to owners to produce and sell that information, there is a counterargument that mandatory disclosure can help prevent insider trading, market abuse and adverse selection.
What is key is where the warehousemen were able to commingle their own assets with those of their clients and where they were able to trade on their own account, they had the temptation to engage in abusive and illicit practices, which put them into conflict with the CBOT. It is no surprise that the responses to HMT’s consultation calling for firm and client assets to be segregated were overwhelming.
The CBOT had a long-running conflict with the warehousemen as it struggled to apply the same standardization of weights, measures, and grades as it had in other assets such as lumber. In 1906 the CBOT implemented the Call Rule that required that any private trades concluded off the exchange had to be at the closing price for the day. The warehousemen were more afraid of expulsion from the exchange than the costs of adhering to this rule so they adhered to it. The rule was also given judicial backing on this important market function. This allowed the CBOT to manage the conflict of interest around the warehousemen being able to trade on their own account, but critically that was not done by banning them from trading.
All of this meant that the economies of scale of elevators could be retained, while allowing for the conflicts of interest and other issues of tension to be managed. What is readily apparent is that banning elevators or preventing warehousemen from trading was never a realistic option. Technology and the economies of scale that it brought was held to be a fundamental good. Yes, it introduced new risks but over time the market and the regulators were able to manage these novel risks under a model that has operated for over a hundred years. One hopes that the same attitude can be brought to bear in the cryptoasset markets.
This is a guest post by Nick Philpott. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.
Using grain as an historical example, the importance of not having the same entity that hold funds in custody handle trade execution is demonstrated.
Bitcoin banks are going to happen. We already have a few of them. We’re going to have more of them. Existing legacy banks are going to start offering services. New banks are going to be founded around Bitcoin. This is completely unavoidable at this point. Bitcoin doesn’t scale. Even absent that, people value other services that inherently require other parties. Debt being the chief one.
This is an inescapable reality.
Even if we could snap our fingers and roll out every well specified opcode and covenant proposal at once, it would still take a lot of time to begin building out self-custodial layers that could compete with something like credit unions and banks offering bitcoin accounts at scale. That is not a problem that can be trivially solved overnight.
So what can we do? We need to embrace a localist attitude around making interaction with your bitcoin easy. This requires a two pronged approach, one involving technical development and the other involving, I hate to say it, lobbying.
There already exist pieces of software like LNDHub or LNBits that allow people to offer custodial accounts for Lightning. We need a lot more software like this, and we need it to be miles better. It needs to not involve tinkering around on the command line and hooking up independent software, or perusing Github to follow manual installation instructions, or fumbling around trying to fix dependencies mismatches.
It needs to just work.
Click, sync to the network, done. It needs to be something that power users who are still not very tech savvy can run safely, and not lose other people’s money. It needs to support more than basic accounts for Lightning. Ecash offers privacy, which would be something important when it comes to small groups of people who know each other. You don’t want your friend seeing what you spend your money on. It needs to support things like Unchained or Nunchuck style on-chain self custody. People aren’t going to want to hold all their friends and family’s life savings, but holding a recovery key to safeguard them from their own mistakes is another matter.
We need the software that will actually scale this type of user interaction beyond a bunch of activist nerds online.
We also need a regulatory carve out. There needs to be a clear acknowledgement that running this type of software for friends and family with trivial amounts of money, say thousands of dollars, and without charging anything for it, is an unregulated activity. Helping friends and family interact with Bitcoin safely and easily, and for free, does not make you a bank. The idea of a few thousand dollars needing to comply with the regulations banks managing billions of dollars do is frankly absurd.
This is the path forward given the current constraints of Bitcoin, and the reality of growing and accelerating adoption, that leads us away from a system that eventually becomes completely captured and neutered by legacy financial institutions.
Instead of depending on them to deal with the current scaling limitations of Bitcoin, we depend on each other.
This article is a Take. Opinions expressed are entirely the author’s and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.
Bitcoiners shouldn’t sit around and wait for fiat banks and financial companies to offer services built on Bitcoin, we should do it ourselves.
Founder: Nicolas Burtey
Date Founded: September 2019
Location of Headquarters: United States
Number of Employees: 11
Website: https://www.galoy.io/
Public or Private? Private
Last week, Galoy launched Lana, software that enables banks to accept bitcoin as collateral for loans.
Lana helps community and challenger banks (the banks with which Galoy is looking to work) to offer bitcoin-backed loans to various types of customers.
“Some banks might want to use it to sell to retail, and some might want to use it to sell commercial customers or high-net-worth individuals,” Burtey told Bitcoin Magazine.
In offering such loans to a wide array of customers, Burtey believes that the high cost of borrowing currently associated with such products will come down.
“Today’s interest rates are 12% to 15% if you want to get a loan using your bitcoin as collateral,” said Burtey.
“The rates are high because there are so few financial institutions offering this type of product. We see an opportunity now that the regulations are allowing banks to do things with bitcoin,” he added.
“We think a lot of banks will want to enter this market.”
If Burtey is correct in his prediction that banks are keen to offer bitcoin-backed loans, this will not only lower rates for such loans, but it will also introduce open-source Bitcoin software into the world of banking, which could initiate a new trend in the industry.
But more on that in just a minute. First, some background on Galoy.
Galoy’s History: From Blink Wallet To Lana
Founded in September 2019, Galoy had intentions to enable banks to use bitcoin from the start, but it had to hold off on doing so due to an unfriendly regulatory environment.
So, instead, it focused its efforts on creating and supporting Blink wallet (which was originally called the Bitcoin Beach wallet and which Galoy recently sold), a custodial Bitcoin and Lightning wallet predominantly used at first in El Salvador and then in Bitcoin circular economies globally.
“Galoy’s mission was to onboard banks to Bitcoin five years ago,” said Burtey.
“But the regulatory environment was so bad during the last five years that we decided to create Blink. The reason we are now focusing on our original mission is because with the end of Choke Point 2.0 and the repeal of SAB 121, we think now is the perfect time to help banks adopt Bitcoin.”
Burtey spoke about his work in creating and growing Blink fondly and shared that he had to stop working on the project only because it would be too difficult to continue managing it while also aiming to serve a new type of clientele.
“Blink is a B2C (Business-To-Customer) play, and it’s hard as an early-stage startup to focus on too many things,” explained Burtey.
“Galoy is a B2B (Business-To-Business)-driven business, and we want to work with banks and financial institutions,” he added.
“It’s good to be focused on just one thing.”
And, as mentioned, that one thing will now be Lana.
How Lana Works
Lana is software that Galoy helps banks integrate and manage for a subscription fee. With this software, banks can issue bitcoin-backed loans under the terms they create.
“We’re not the ones deciding how much interest will be charged or anything like that,” explained Burtey.
“We give banks the platform to do this, and then they can figure out their cost of capital, the duration of the loan, the liquidation price for the bitcoin in the loan and the rate at which they want to lend,” he added.
“We’re giving you software, and helping you run and automate that software.”
Something else that Galoy doesn’t do for banks is custody the bitcoin provided as collateral for the loans they issue. Each of the banks with whom the company works is responsible for selecting their own custodian.
“You can go to BitGo or Fireblocks or each loan can have its own multisig,” said Burtey. “We’re agnostic on custody.”
With that said, Lana helps banks monitor the bitcoin in custody so that banks can be aware of whether or not collateral is nearing liquidation levels.
“A key piece of this product is risk management,” said Burtey.
“Bitcoin is volatile, and the bank will need a tool to show that it’s taking calculated risk. So, we’ll provide banks with a dashboard to monitor this risk,” he added.
Who Will Use Lana?
Galoy is targeting community banks and other smaller financial institutions with this new product mostly because they think these smaller players will benefit most from it — and because the big banks likely won’t need such a product.
“We don’t think JP Morgan will really want to work with us,” said Burtey. “They’re probably building something like this themselves, whereas a smaller bank, a credit union or small company probably isn’t.”
Burtey also understands that smaller lenders’ incorporating Lana as opposed to building something comparable themselves can save these financial institutions a significant amount of time and effort.
“Our goal is to say, ‘Look, you can develop this internally, and it will take you six months, a year or longer depending on how much you know about Bitcoin,’” said Burtey. “‘Or we have a lending product as a service for you, and you can launch it much more quickly.’”
And as Burtey and his team onboard their first round of smaller banks, they’ll not only be making history in enabling more banks to accept bitcoin as collateral for loans, but they’ll potentially be altering the trajectory of banking in general by introducing open-source software to it.
Open-Source Bitcoin Banking
Burtey’s long-term vision for Galoy is to do much more than just help banks issue bitcoin-backed loans. He’s looking to introduce open-source software into banking as more banks begin to embrace Bitcoin.
However, it’s important to note that Lana isn’t open-source just yet. It’s fair-source software, and, under such a license, code becomes open-source after two years.
“It’s a delayed open-source system, but it’s all available on GitHub,” said Burtey. “You can go and try it, test it, and play with it on your own.
Under the fair-source license, no company other than Galoy can sell the product to a bank right now, allowing Galoy to profit while still building with auditable code.
“We sell the deployment, and we help banks to plug in to their custodian,” explained Burtey. “We’re building in the open — but we also want to generate revenue.”
Beyond helping banks implement Lana, Burtey’s wants to develop open-source “core banking software,” as he’s looking to disrupt the “core ledger” oligopoly.
“The core ledger is where banks store the account data, customer information and transaction details,” said Burtey. “It’s the source of truth for banks.”
And only three companies — FIS, Fiserv and Jack Henry — have the core ledger market cornered.
“These are all like hundred billion dollar companies that you’ve probably never heard about because all they do is focus on selling software to banks,” said Burtey.
“Our long-term goal is to disrupt this industry by making something that is open source,” said Burtey. “Today, there is no company that does core banking with the idea of open source, and so we’re working towards this.”
Burtey envisions a world in which open-source software can make it much easier for someone to start a Bitcoin bank. (For those who wince at the words “Bitcoin” and “bank” being used in tandem, might I remind you that it was the legendary Hal Finney himself who wrote that bitcoin-backed banks would serve as a scaling solution.)
“To start a bank today is a very expensive and complicated process,” said Burtey. “You have to pay $100,000 plus just to purchase the core ledger technology.”
Burtey then referenced his own experience in starting Blink wallet, essentially a bitcoin bank run on open-source code, before continuing.
“I just went to El Salvador and started what was effectively my own bank because I wanted to,” said Burtey.
“We need to reinvent how core banking software is being made in the world of Bitcoin, and I think this is where open-source becomes relevant,” he added.
“This is really why I think the world of banking and Bitcoin will be very different from the world of banking with fiat, and I think we’re one of the companies at the forefront of this.”
Galoy founder and CEO Nicolas Burtey wants to help more borrowers use bitcoin as collateral for loans while introducing open-source software into the traditional banking stack.
Crypto News
The Future of Bitcoin: Scaling, Institutional Adoption, and Strategic Reserves with Rich Rines
Bitcoin’s evolution from an obscure digital currency to a global financial force has been nothing short of extraordinary. As Bitcoin enters a new era, institutions, governments, and developers are working to unlock its full potential. Matt Crosby, Bitcoin Magazine Pro’s lead market analyst, sat down with Rich Rines, contributor at Core DAO, to discuss Bitcoin’s next phase of growth, the rise of Bitcoin DeFi, and its potential as a global reserve asset. Watch the full interview here: The Future Of Bitcoin – Featuring Rich Rines
Bitcoin’s Evolution & Institutional Adoption
Rich Rines has been in the Bitcoin space since 2013, having witnessed firsthand its transformation from an experimental technology to a globally recognized financial instrument.
“By the 2017 cycle, I was pretty determined that this is what I was going to spend the rest of my career on.”
The conversation delves into Bitcoin’s growing role in institutional portfolios, with spot Bitcoin ETFs already surpassing $41 billion in inflows. Rines believes the institutionalization of Bitcoin will continue to reshape global finance, particularly with the rise of yield-generating products that appeal to Wall Street investors.
“Every asset manager in the world can now buy Bitcoin with ETFs, and that fundamentally changes the market.”
What is Core DAO?
Core DAO is an innovative blockchain ecosystem designed to enhance Bitcoin’s functionality through a proof-of-stake (PoS) mechanism. Unlike traditional Bitcoin scaling solutions, Core DAO leverages a decentralized PoS structure to improve scalability, programmability, and interoperability while maintaining Bitcoin’s security and decentralization.
At its core, Core DAO acts as a Bitcoin-aligned Layer-1 blockchain, meaning it extends Bitcoin’s capabilities without altering its base layer. This enables a range of DeFi applications, smart contracts, and staking opportunities for Bitcoin holders.
“Core is the leading Bitcoin scaling solution, and the way to think about it is really the proof-of-stake layer for Bitcoin.”
By securing 75% of the Bitcoin hash rate, Core DAO ensures that Bitcoin’s security principles remain intact while offering greater functionality for developers and users. With a growing ecosystem of over 150+ projects, Core DAO is paving the way for the next phase of Bitcoin’s financial expansion.
Core: Bitcoin’s Proof-of-Stake Layer & DeFi Expansion
One of the biggest challenges facing Bitcoin is scalability. The Bitcoin network’s high fees and slow transaction speeds make it a powerful settlement layer but limit its utility for day-to-day transactions. This is where Core DAO comes in.
“Bitcoin lacks scalability, programmability. It’s too expensive. All these things that make it a great settlement layer is exactly the reason that we need a solution like Core to extend those capabilities.”
Core DAO functions as a proof-of-stake layer for Bitcoin, allowing users to generate yield without third-party risk. It provides an ecosystem where Bitcoin holders can participate in DeFi applications without compromising on security.
“We’re going to see Bitcoin DeFi dwarf Ethereum DeFi within the next three years because Bitcoin is a superior collateral asset.”
Bitcoin as a Strategic Reserve Asset
Governments and sovereign wealth funds are beginning to view Bitcoin not as a currency but as a strategic reserve asset. The potential for a U.S. Bitcoin strategic reserve, as well as broader global adoption at the nation-state level, could create a new financial paradigm.
“People are talking about building strategic Bitcoin reserves for the first time.”
The idea of Bitcoin replacing gold as a primary store of value is becoming more tangible. Rines asserts that Bitcoin’s scarcity and decentralization make it a superior alternative to gold.
“I think within the next decade, Bitcoin will become the global reserve asset, replacing gold.”
Bitcoin Privacy: The Final Frontier
While Bitcoin is often hailed as a decentralized and censorship-resistant asset, privacy remains a significant challenge. Unlike cash transactions, Bitcoin’s public ledger exposes all transactions to anyone with access to the blockchain.
Rines believes that improving Bitcoin privacy will be a critical step in its evolution.
“I’ve wanted private Bitcoin transactions for a really long time. I’m pretty bearish on it ever happening on the base layer, but there’s potential in scaling solutions.”
While solutions like CoinJoin and the Lightning Network offer some privacy improvements, full-scale anonymity remains elusive. Core is exploring innovations that could enable confidential transactions without sacrificing Bitcoin’s security and transparency.
“On Core, we’re working with teams on potentially having confidential transactions—where you can tell that a transaction is happening, but not the amount or counterparties involved.”
As governments continue to increase scrutiny over digital financial activity, the need for enhanced Bitcoin privacy features will only grow. Whether through native protocol upgrades or second-layer solutions, the future of Bitcoin privacy remains a crucial area of development.
The Future of Bitcoin: A Trillion-Dollar Market in the Making
As the interview progresses, Rines outlines how Bitcoin’s economic framework is expanding beyond speculation and into productive financial instruments. He predicts that within a decade, Bitcoin will command a $10 trillion market cap, with DeFi applications becoming a significant portion of its economic ecosystem.
“The Bitcoin DeFi market is a trillion-dollar opportunity, and we’re just getting started.”
His perspective aligns with a broader industry trend where Bitcoin is not only used as a store of value but also as an active financial asset within decentralized networks.
Rich Rines Roadmap for Bitcoin’s Future
Final Thoughts
The conversation between Matt Crosby and Rich Rines provides a compelling glimpse into the future of Bitcoin. With institutional adoption accelerating, Bitcoin DeFi expanding, and the growing recognition of Bitcoin as a strategic reserve, it is clear that Bitcoin’s best years are ahead.
As Rines puts it:
“Building on Bitcoin is one of the most exciting opportunities in the world. There’s a trillion-dollar market waiting to be unlocked.”
For investors, developers, and policymakers, the key takeaway is clear: Bitcoin is no longer just a speculative asset—it is the foundation of a new financial system.
For more detailed Bitcoin analysis and to access advanced features like live charts, personalized indicator alerts, and in-depth industry reports, check out Bitcoin Magazine Pro.
Disclaimer: This article is for informational purposes only and should not be considered financial advice. Always do your own research before making any investment decisions.
As Bitcoin continues to dominate the financial landscape, Rich Rines of Core DAO explores its evolution—delving into institutional adoption, DeFi expansion, and its potential as a global reserve asset.
Nellie Bowles: The Triumph of the Plastic Straw Nellie Bowles
Stop Making Cents? Charles Lane
It Pays to Be a Friend of Donald Trump Joe Nocera
This is What Happens When You Try to Report Dirty Cops
THE IRON-CLAD PIÑATA Seymour Hersh
The Russell Brand Rorschach Test Kathleen Stock
RARE VIDEO: 1987 DC Hearing – NBC Warns Against Removing Fairness Doctrine – Learn Why It Matters
WATCH: CSPAN Caller Call Out the Resending of the Smith-Mundt Act – Learn Why That’s IMPORTANT
WATCH: 1975 Church Comitee Hearings on the CIA Mockingbird Media
-
Awakening Video1 year agoThis is What Happens When You Try to Report Dirty Cops
-
Substacks11 months agoTHE IRON-CLAD PIÑATA Seymour Hersh
-
Substacks1 year agoThe Russell Brand Rorschach Test Kathleen Stock
-
Substacks1 year agoA real fact-check of Trump’s appearance on Meet the Press Judd Legum
-
Substacks1 year agoLetter to the Children of Gaza – Read by Eunice Wong Chris Hedges