Startup Anchorage invades cryptocustody turf coveted by banks
A pair of techies who built security technology for Square and Docker are launching a new cryptocustody company Wednesday in a bid against financial giants like Fidelity and Goldman Sachs that have said they want to offer such services but haven't because of regulatory concerns.
The new firm, called Anchorage, launches with $17 million Series A funding led by Andreessen Horowitz, with participation from Khosla Ventures, Max Levchin, Elad Gil, Mark McCombe of Blackrock and AngelList co-founder Naval Ravikant.
Anchorage follows in the footsteps of cryptocurrency exchanges and wallet providers like Coinbase, iBit and BitGo, and hardware crypto storage providers like Trezor, Ledger and digital bitbox, which store institutional investors' digital assets for them. But Anchorage is offering a different approach, forgoing so-called cold-storage solutions that store keys offline and instead embracing an online approach that uses hardware security and requires multiple users to authenticate a transaction.
Some early supporters see the firm as another sign of tech companies gaining an edge in financial services.
“In this new world, will custody be handled by financial services firms, nonbank cryptocustody firms, or new Silicon Valley companies?” said Chris Dixon, general partner at Andreessen Horowitz. “I believe it will be the new Silicon Valley tech companies. There will be thousands of digital assets and all sorts of interesting things you can do besides hold them; you can lend them out, for instance. My belief is that being a custodian in the cryptocurrency world will continue to evolve and require a company to be full of technologists that think in this futuristic way.”
The security infrastructure Anchorage’s co-founders built for Square weighed heavily in Dixon’s decision to invest in it.
“They also worked at Docker and are widely known and respected in the Silicon Valley community,” Dixon said. “We have a lot of respect for their background.”
Dixon is not put off by cryptocurrencies' recent volatility, which some refer to as the “crypto winter.”
“We’ve been involved for six years now and experienced one other major winter in 2014,” he said. “It will be a rocky roller coaster, we expect. Our fundamental belief is that blockchain architecture is a breakthrough in computer science. We’re seeing new companies use this architecture, and the way you get exposure to these companies is through crypto investment. Ten years from now, if someone on Wall Street wants to invest in the next Google, they will need crypto assets. We believe cryptocustody will grow along with that market."
Diogo Monica was completing a Ph.D. in computer science and Nathan McCauley had been doing encryption work for the military when they both started working at Square the same week eight years ago.
They spent four years designing Square’s encrypted card reader.
“During those four years, our relationship really flourished and we worked together day in and day out — it's a partnership forged in fire,” Monica said.
The two then went to Docker and started a security team there.
“We had all these opinions about security and how systems should be built, and now we got to add them to this foundational piece of infrastructure that was being adopted by every organization,” Monica said.
Friends who were starting crypto funds began contacting them for security help.
“They knew us from the information security space and said they knew we'd been working on private key management all our lives, and cryptocustody is a technical key management problem,” Monica said. “It just made sense for us to create a company that was an actual custodian to store keys for all of them.”
McCauley and Monica's new company has 25 full-time employees, many of whom worked with them at Square and Docker. They’ve built a cryptoasset security infrastructure that uses hardware security modules on the client’s side and on Anchorage’s side to generate and store private keys.
Rather than using user names and passwords or even SMS passcodes, the Anchorage platform requires multiple types of biometric authentication tied to user keys. Any change to a fund, such as a withdrawal or a policy change, requires approval from multiple users within the client’s organization. Anchorage staff also have to approve each transaction and software monitors all activity for anything anomalous.
“There's no single point of failure for humans; we enforce quorum systems,” Monica said. “On the client side, there are always at least two people required. There's never one person who can unilaterally act. The same thing on our side: There’s no single person who can move clients’ funds unilaterally.”
By contrast, most large custodians of digital assets use cold storage, where assets are stored on a device that is completely offline.
“Internally we call cold storage ‘pirate custody,’ ” Monica said. “Because the solution is exactly the same as the 1700s when pirates were storing these gold coins in treasure chests, burying them in an island and drawing a treasure map. Now instead of coins we have USB keys, instead of treasure chests we have safe deposit boxes, and instead of treasure maps we have a checklist of things to do.”
There is a certain clean logic to cold storage. If a piece of equipment is not connected to a network, hackers could not reach it unless they physically access the device.
But according to Monica, the approach raises questions about how anyone really knows the assets are there and the keys aren't lost. McCauley noted that in any university security course, cold storage is presented as a straw man.
“This is a system that works, except in the real world, so we're going to immediately discard it,” he said. “Unfortunately it passes for competence within cryptocustody right now.”
A benefit to Anchorage’s scheme is that if anything happens with an asset, for instance if there’s a vote on how a network should evolve or if a dividend is paid out, the asset holder can participate without having to wait for the asset to be recovered from cold storage, which in some cases can take 72 hours.
“The reality is you can't meet your fiduciary obligations of auditing and of generating yield if you put this in a treasure chest,” Monica said.
McCauley and Monica say they support dozens of assets now, but their system is built to be asset agnostic.
“We're adding assets as they come in and based on client demand,” McCauley said.
Clients so far are hedge funds, venture capitalists and family offices. The service is for institutional investors, there are no plans to take on retail.
An early client, Charlie Noyes, partner at the Silicon Valley hedge fund Paradigm (and a “crypto-wunderkind” who left high school at 16 to study at MIT, then got recruited to the Pantera hedge fund), is sold on Anchorage's technology.
“At the highest level, Anchorage’s security model is the industry standard,” Noyes said. “Coupled with a seamless and intuitive user experience, it was a pretty obvious choice.”
Paradigm will store a couple of hundred million dollars worth of assets with Anchorage.
“Institutional investors expect a higher level of quality in the services around crypto and this would be everything from the exchange side down to base custody,” Noyes said. “Ultimately, custody has been the sticking point beyond any other issues in the market. It’s critically important to our limited partners and other institutional investors that their funds are secure. We’re just now starting to see the really technically sophisticated and secure custodians out in market that have sufficiently good user experiences that it doesn’t feel like you’re tinkering with something experimental. Anchorage is in our experience at the forefront of that.”
Players like Goldman have said they want to enter the business, but regulatory worries have deterred them.
“One of the things [clients] ask me is ‘Can you hold our coins?’ and I say ‘No, we cannot,' " Justin Schmidt, head of digital asset markets at Goldman Sachs, said during a conference in November. “One of the things we have to take into consideration when we’re building out our business is what we can and cannot do from a regulatory perspective.”
The Anchorage pair say they are unconcerned about what happens when Goldman Sachs and others enter this space.
“The bank validation in this space is great for us,” Monica said. “It validates that this is a good business; it validates that the big players are also thinking about it.”