The Evolution of Custody: From Bearer Bonds to Blockchain

How we secure assets, whether they be securities, bonds or currencies, has been in a state of flux over the past century. As markets and the needs of individuals change, so do the mechanisms by which we secure and exchange assets. Central to all of this is the question of custody. How does an individual maintain control, or custody, of their assets without compromising security or the ability to access liquid markets for exchange?

How we secure assets, whether they be securities, bonds or currencies, has been in a state of flux over the past century. As markets and the needs of individuals change, so do the mechanisms by which we secure and exchange assets. Central to all of this is the question of custody. How does an individual maintain control, or custody, of their assets without compromising security or the ability to access liquid markets for exchange?

How we secure assets, whether they be securities, bonds or currencies, has been in a state of flux over the past century. As markets and the needs of individuals change, so do the mechanisms by which we secure and exchange assets. Central to all of this is the question of custody. How does an individual maintain control, or custody, of their assets without compromising security or the ability to access liquid markets for exchange?

Today, the blockchain enables self-custody of assets in a way that when combined with innovative technologies like Ethos Bedrock, provides cutting edge security, rapid access to funds and liquidity in a way unrivaled by any other time in history. Understanding how this came to be is best done through examining the evolution of asset custody over the last century.

When trying to understand custody, a great place to begin are with bearer instruments, like bearer bonds, which are issued on paper (or goatskin) and can be stored by individuals in a safe, under lock and key. When one has physical possession of a bearer instrument, they gain all the beneficial ownership right associated with the asset. Thus, safeguarding these documents is vital since they are unregistered, with no records maintained of the changes of ownership or of the current owner.

Naturally, some people don’t want to keep these at home for risk of theft and have historically turned to banks for storage in a safety deposit box for safekeeping. This is referred to as custodial possession. The customer could then be given a key so they could get into their safety deposit boxes and have access to the assets. Sometimes the bank would also have a key. When two parties have a key to gain access to the underlying asset, this is referred to as joint custody.

Looking Back

As financial markets grew through the 20th century, the management and transferring of stock certificates, bearer bonds and cash became very unwieldy. In the 1960s, the New York Stock Exchange saw securities trading volume more than double over a span of just 3 years.

Adjusted for inflation, it’s estimated that billions of dollars worth of securities were stolen or lost during this era. A consequence of poor record keeping, insecure mechanisms of transfer, and theft from centralized repositories

The overwhelming trade volume marked the start of the Paper Crisis, which illuminated that the standard deployed by brokers for transferring and record keeping on securities exchanges, which at the time relied largely on paper and pen, was ill-equipped to handle the growing trade volume. This crisis led to dozens of brokerage firms going out of business and the implementation of computers, alongside professional management, to handle the high volume of trading.

Present Day

Today, custody has legally been defined as “. . .holding, directly or indirectly, client funds or securities, or having any authority to obtain possession of them” (17 C.F.R. 275.206(4)-2). This definition, while applicable to the status quo, fails to encompass custody as enabled by the blockchain, which breaks away from the inherent relinquishment of control necessitated by current standards.

The blockchain provides a revolutionary means of tracking, efficiently transacting/exchanging and securely storing assets in a decentralized fashion, in turn offering a solution that can mitigate risks associated with centralized fund storage through the self-custody of assets.

In the following section, we will provide a brief technical overview of how custody of digital assets can function in the emerging digital economy, specifically highlighting how the Ethos Universal Wallet, through Ethos Bedrock, is able to deliver safe and practical solutions to consumers and institutions through building on industry standards.