Summary
FTX’s collapse highlighted the importance of segregating market making activities from running an exchange and custodian. The question of segregating exchange and custodian activities is nuanced, with large banks often running both in the same entity. The US grain industry in the late 19th century illustrates the importance of controlling risks between custody and execution activities. The development of grain exchanges shows the tension between custodians and exchanges. Commingling assets can lead to unscrupulous practices, creating conflicts of interest. The article highlights the need for managing conflicts of interest and risks in the cryptoasset market, drawing parallels to the grain industry’s historical challenges.
Key Points
1. FTX’s collapse highlighted the importance of segregating market-making activities from running an exchange and custodian. The question of segregating exchange and custodian activities is nuanced, with large banks often combining them in the same legal entity with information walls to control for conflicts of interest.
2. Cryptoasset custody involves managing information security risks, acting as a payment service provider, and ensuring the security of private keys. The traditional model of exchanges bundling custody with execution for retail clients is being challenged by private and public sector efforts to promote segregation and qualified custodianship.
3. The development of grain exchanges in the late 19th century US illustrates the tension between custodians and exchanges. Commingling assets in omnibus wallets, like grain elevators, creates economies of scale but poses challenges in tracking quality and scoring individual assets. The risks of commingling, custodians trading on their own account, and conflicts of interest can be managed through regulatory measures and industry practices.