Securing investments: Navigating the risks in the crypto surge

The potential for substantial returns is enticing, but the treacherous landscape of digital assets demands constant vigilance, especially for institutions grappling with the unforgiving nature of public blockchains.

The success of the digital assets industry has been rooted in retail investor adoption. For this reason, most solutions for safeguarding digital assets were designed for retail investors with direct exposure; individuals buying Bitcoin and holding it on exchanges, browser-based wallets, or retail wallet hardware devices.

Heightened risk environment

The distinction between institutional and retail wallets is not just technical but a matter of paramount importance. Institutional wallets, responsible for safeguarding significant sums, hold the assets of institutions and the investments of numerous retail clients. This dual role amplifies the stakes, necessitating a sophisticated approach to risk management.

Institutions grapple with cyber threats that commonly affect retail investors and face many other risks. Managing institutional wallets involves navigating complex regulatory frameworks, geopolitical uncertainties, and operational vulnerabilities. This heightened risk landscape underscores the urgent need for institutions to adopt institutional-grade solutions promptly.

To tackle these challenges, investors have three main options: use exchange wallets, leverage self-custody wallet technology, or outsource custody to a regulated institution. Each option has risks that need to be carefully considered.

Vulnerabilities of exchanges

Investors face notable risks in storing assets on exchanges. While meeting KYC (‘Know your customer’) and AML (anti-money laundering) guidelines, these platforms often lack tight regulation and use pooled assets for high-risk investments, risking insolvency and impacting withdrawals.

Vulnerable to advanced hacking, exchanges risk significant asset losses and generally have weaker governance than regulated banks, potentially misusing client assets. Furthermore, their limited insurance coverage and location in less regulated regions amplify risks related to geopolitical, legal and tax changes.

Errors and losses through self-custody

Self-custody wallets give investors complete control over their assets but with significant risks of loss due to human error, internal collusion, or hacking. Managing these wallets, particularly multi-signature ones, becomes more complex as asset values grow, requiring transparent governance and strict backup and recovery processes.

Implementing such governance is costly and needs expert professionals and detailed protocols. Importantly, no insurance policy covers losses in self-custody from errors or fraud. Finally, if wealth is to be delegated to a third person, error-prone instructions could pose a risk to the hard-earned crypto.

UAE – a great location for digital assets custody

Regulated custodians offer safer digital asset storage with solid governance. Still, reliability varies by jurisdiction; many lack expertise in digital assets, leading to oversight issues, as seen in Prime Trust’s collapse in 2023. Investors using foreign custodians face geopolitical risks, including sanctions, tax reporting obligations, and evolving legal complexities.

The UAE stands out for its neutral, non-interfering stance in geopolitical matters, positioning itself as a stable, trustworthy partner in international affairs. Below are four key benefits of using a regulated custodian in the UAE.

Governance

Strong governance reinforces the organisational structures and decision-making processes of regulated custodians. Detailed definitions of roles and responsibilities ensure thorough oversight, segregation of duties, and strategic coherence at every level of operation. A transparent governance framework empowers institutional investors to participate confidently and securely, knowing that accountability and authority are delineated.

Importantly, custodians employ segregated client wallets to maintain client funds separate from each other and company funds, thereby enhancing security and establishing a bankruptcy-remote structure. This arrangement significantly increases the safeguarding of client assets against creditors in bankruptcy.

Compliance

Regulatory compliance is essential for maintaining a solid operational ethos and ensuring strict adherence to laws, regulations, and industry standards. The Abu Dhabi Global Market (ADGM), recognised as one of the leading regulatory environments worldwide, is an international financial centre and free zone. Governed by the Financial Services Regulatory Authority (FSRA) – the UAE’s first regulator of digital assets since 2020 – custodians must implement stringent compliance measures in their daily operations.

The severe risks posed by non-compliance underscore the necessity for a steadfast commitment to ethical practices and corporate accountability. This dedication is crucial to meeting regulatory demands and maintaining integrity and trust within the financial services industry. A vital benefit of the FSRA is its clear regulatory framework, which helps institutions avoid the pitfalls of ambiguous rules or other jurisdictions and ensure smoother compliance processes.

Security

Regulated custodians must prioritise security to protect their assets, data, and infrastructure from potential threats. This involves implementing stringent cybersecurity measures such as advanced encryption protocols, rigorous access controls, and frequent security audits.

These practices enhance defence mechanisms against cyber threats and vulnerabilities, maintaining the confidentiality, integrity, and availability of systems and data. By prioritising security at every operational level, regulated custodians can earn and retain the trust of stakeholders and clients.

Insurance

For regulated custodians, maintaining a comprehensive insurance portfolio is crucial for financial protection against unexpected risks and liabilities. This portfolio should be tailored to meet specific needs, covering areas such as property, liability, cyber incidents, and professional indemnity.

In a security breach or other incidents, appropriate insurance coverage helps mitigate financial losses and supports the swift recovery and continuity of operations. By integrating insurance strategically into their risk management frameworks, regulated custodians enhance their resilience and ensure their organisation’s long-term sustainability.

Establishing dedicated, UAE-based digital asset custodians is essential for developing a robust institutional digital asset ecosystem in the country. These custodians should be autonomous and focused solely on custody services to avoid conflicts of interest from other business activities.

Unconflicted custody is the key to safeguarding investors’ funds effectively. The UAE’s position as a politically neutral and non-interfering nation enhances its reputation as a stable and reliable partner in international affairs.

A supportive environment in the UAE

It has been over a year since my convictions evolved beyond mere rhetoric. Together with my colleagues, we launched Tungsten Custody Solutions within the Abu Dhabi Global Market (ADGM) financial centre. Regulated by the Financial Services Regulatory Authority (FSRA), we have adhered to these principles from the outset and welcome other players looking to do the same.

Digital asset institutions licensed and incorporated in the UAE, supported by UAE investors, and comprehensively regulated within the local framework, will better foster growth in this ecosystem. This approach highlights the strategic importance of building a domestically anchored digital asset infrastructure rather than extending licences to foreign custodians.

As interest in cryptocurrencies grows, managing crypto risks remains essential. By embracing institutional-grade solutions, institutions can mitigate these risks effectively and ensure the security and integrity of their digital assets. The time to act is now.