With the infamous Mt. Gox, less-infamous Quadriga, and a handful of others, we have years of evidence that custodying crypto is apparently quite difficult. And yesterday, we got even more. On the morning June 22 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 the company’s “overall financial condition had considerably deteriorated.” Yesterday, Nevada’s FID filed to place Prime Trust into receivership.
This escalated quickly for what seems to be a good reason. Prime Trust allegedly owes its clients $85 million in fiat, and has about $3 million in fiat currency on hand. The company also owes a further $69.5 million in crypto, and has $68.6 million in crypto on hand. It’s not really the number mismatch that has caught eyes, but rather the way Prime Trust came to experience this shortfall.
According to the filing, Prime Trust is unable to access "legacy wallets." Before 2020, Prime Trust managed its customer’s crypto in its own wallets. In 2020, Prime Trust migrated 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 had turnover in its management team, it set up "legacy wallet forwarding," and had funds sent back to Prime Trust’s old pre-2020 wallets. This, it turned out, was a huge mistake.
In December 2021, Prime Trust discovered that it was unable to access its 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 here.
First, a custodian like Prime Trust not having access to wallets is incomprehensible; the whole point of a custody service is to pay someone to be better at it 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. They’re the experts after all. Apparently, that wasn’t the case with Prime Trust, which seemed to be a legitimate company. Last year, Prime Trust raised over $100 million in a funding round that included FIS, Fin Capital, Mercato Partners, Kraken Ventures and William Blair.
Second (and main) issue: Seriously, how difficult is it to custody crypto for others? It should be straightforward. You give me crypto, I hold crypto for you, I give it back to you when you want it, and you pay me for those services. This is something individuals are wholly capable of achieving on their own in the world self-custody. This should be a cakewalk for sophisticated companies that garner nine figures worth of venture funding.
The Prime Trust story is developing, so I’ll refrain from casting final judgment until we know the full story, but there are a few things that need to be fleshed out. How exactly did this happen and what exactly was the “additional digital currency” Prime Trust purchased allegedly using customer money? Was Prime Trust trading crypto in hopes it would make up the difference and pay back customers without a hitch?
If this is the case, then we enter an entirely new world for this story. The counterparty risk associated with custodians is that they might lose your crypto, there shouldn’t be an additional risk associated with the custodian trying to make it back in one trade after they lost your crypto.
Big picture, this is bad news, and 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 crypto, not the exception. As bad as the financial losses are, the larger problem is the apparent coverup by Prime Trust seemingly exposed during its failed acquisition negotiations. (By the way, who on the other side of that table did they think they were going to fool? And how?)
Crypto has a shady mainstream reputation and here’s yet another example of shady behavior. Given Prime Trust’s pedigree, it immediately makes you wonder who else – maybe even with a trusted name – is playing fast and loose with user deposits. Maybe they are. Hopefully they aren’t. But during crypto bull markets where no-name tokens can increase by a factor of 100 or 1,000, maybe they have and gotten away with it. Here’s to hoping that’s not true.
– George Kaloudis
@gckaloudis
george@coindesk.com
