Where is the future of digital asset custody heading? Can you hold BTC in your IRA account?

Author: Sarah Morton, Colton Dillion, CoinDesk; Translator: Tao Zhu, Golden Finance

The custody of digital assets is evolving, whether it is the technology itself, the plethora of new tokenized investment products, or the risks, both real and perceived, of leaving assets with service providers such as centralized exchanges.

Hedgehog Technologies CEO Colton Dillion breaks down the evolution of digital asset custody, focusing on the shift to self-custody of wealth in the space and how advisors must adapt to this shift.

In the Ask the Experts session, Jessy Gilger from Sound Advisory answers questions about owning Bitcoin directly in an IRA account.

Not Your Clients’ Keys, Not Their Tokens: The Future of Digital Asset Custody

Web3 will eventually devour traditional finance, there is no doubt about that.

With a market cap of an impressive $2.3 trillion, the digital asset industry still has some growing to do before it can surpass the $110 trillion stock market, but in case you haven’t been paying attention, Real World Assets (RWAs) and Stablecoins have seen some big bets from major players lately, like BlackRock, Stripe, Franklin Templeton, and more.

These companies are slowly cloning traditional securities like money market funds and mutual funds for on-chain spending and seamless peer-to-peer transfers, and it’s only a matter of time before regulators catch up to the market and allow traditional securities like Fortune 500 stocks or ETFs to be traded in the same manner. Eventually, every traditional asset will become an on-chain asset. All it takes is time.

So, what does this mean for custodians?

Chainalysis reported in June last year that while the amount of assets returned to exchanges decreased quarter by quarter, the amount held in individual wallets grew exponentially. Both retail and institutional clients are choosing to keep their assets on-chain rather than entrusting them to a custodian who could become another FTX or otherwise place their funds in a highly interconnected network of rehypothecations. You could probably avoid having your funds locked up in Silvergate’s bankruptcy proceedings, right?

While Coinbase, Kraken, and Gemini all support at least one spot Bitcoin ETF as primary custodians, and institutional use cases are slower to migrate, there is a clear trend among Web3 asset holders to begin transitioning their wealth to self-custody once their assets are in custody. A certain level of sophistication is reached. Once insurance methods catch up to wallet compromises, we expect most individuals and institutions will choose to handle the segregation of their accounts directly and demand control of their own private keys.

As advisors and fiduciaries, it behooves us to prepare for the day when clients turn to us to support self-custody solutions. For the brave self-custodian, there are many options, from multi-signature accounts to account abstraction (AA) smart contract wallets, from institutional hardware to multi-party computation (MPC) wallets, but each option requires a trade-off between security and usability, as well as being mindful of cost considerations.

Multi-Signature

Safe (originally called Gnosis Safe) is the original multi-signature solution built on the Ethereum network, and comes with some handy tools for managing vaults in wallets, where multiple people must agree before a transaction can occur. On other chains, you have to find other solutions, such as dedicated wallet software that supports Shamir secret sharing.For under $500, one can set up a wallet with m or n signatures (e.g., 2 out of 3 or 9 must sign for a valid transaction), but the permissions on these accounts are less powerful if new account abstraction proposals are not included, most notably ERC-4337. If you have one of these signatures, you can help sign away any privileges on the safe account.

Account Abstraction

This is another EVM-only solution for now, but in principle any chain that supports smart contracts could support the standard. Account abstraction allows savvy developers to layer additional permissions and features on top of standard accounts so that certain signers can only sign certain types of transactions. Many providers also leverage these features to add transaction batching, non-native gas tokens, and more. These players include Gnosis Safe and organizations like ZeroDev, Biconomy, and Fun.

Institutional Cold Storage

Many custodians offer cold storage solutions that leverage hardware security modules and strong physical security to keep your assets as safe as bars of gold under Fort Knox. By using specialized chips that are extremely expensive to hack, they can generate private keys on your behalf and securely sign transactions without the flexibility and speed of a hot wallet. Depending on the provider, these solutions are often combined with multi-signature, AA, or MPC solutions, but costs often run into double-digit basis points, and minimum balances and account maintenance fees are high.

Multi-party computation

MPC is one of the most flexible options and is not limited to a specific network for smart contracts, but it does require trust in potentially opaque partners. MPC is closer to the base layer of cryptography, namely private key entropy, and all participants in an MPC wallet jointly participate in recreating a private key rather than having multiple private keys send their own valid signatures. For those who are more tech savvy, there are Qredo and Lit Protocol, which are fully decentralized solutions, but for advisors who want more of a white glove treatment and are willing to work with a trusted third party, Anchorage Digital just released their enterprise solution Porto, and my own company Hedgehog just released an MPC account management product powered by Capsule, focusing on fund management, ancillary advisory, and turnkey asset management programs.

Obviously, we agree with Anchorage CEO Nathan McCauley, who summarized their rationale for launching a self-custodial solution:

“Right now, many people are looking for self-custodial solutions so that they can have more flexible activities on the blockchain. We do see this as expansive and additive.”

Whatever you choose as an advisor, it’s important to keep in mind the custody rules and ensure that you don’t have arbitrary withdrawal permissions on your clients’ accounts. There isn’t a lot of guidance on some of these account structures yet, and there are still some clear rules on the extent to which any particular multi-sig, AA, or MPC protocol qualifies as having substantial control over client funds. Nonetheless, we have to forge a path forward or we’ll be left behind by our clients.

—Colton Dillion, CEO, Hedgehog Technologies

Talk to the Experts

Q: Can you hold Bitcoin in an IRA?

Yes, there are multiple ways to get Bitcoin exposure in both traditional IRA accounts and Roth IRA accounts. The easiest way is through one of the spot Bitcoin ETFs traded at the major brokerage firms. However, this approach only provides USD exposure to Bitcoin price movements, rather than direct ownership of the actual coins.

For many Bitcoin investors, the first choice is to open an IRA through a specialized provider that allows for direct ownership and storage of Bitcoin within the account. Key control is critical here – your ability to maintain your private keys means you have full ownership and control over the Bitcoin in your IRA, without having to entrust it to a third-party custodian. This avoids the centralization and counterparty risk of other options.

Q: What are the benefits of holding Bitcoin in an IRA?

The primary benefit is the ability to invest in Bitcoin as a long-term store of value while enjoying the tax benefits of an IRA account. Since Bitcoin is viewed by many as a superior form of savings, it fits well with the long-term outlook for retirement accounts.

Specific benefits include tax-deferred or tax-free growth, allowing your Bitcoin holdings to compound more effectively over decades. Bitcoin has historically appreciated in four-year cycles, so taking these gains tax-free can significantly accelerate your retirement.

Holding Bitcoin in an IRA also allows for distributions in Bitcoin itself, without having to sell USD and realize a taxable gain. For clients who want full sovereignty, key control over their IRA Bitcoin is essential to avoid third-party custodial risk. The downside is reduced liquidity and increased rules and age restrictions compared to a standard brokerage account. But for long-term investors who believe in Bitcoin's role as hard money, the tax benefits of an IRA may outweigh that.

—Jessy Gilger, Chief CO Officer and Senior Advisor, Sound Advisory