Omnibus vs segregated accounts in digital asset management

In the digital asset space, the choice between segregated accounts and omnibus accounts is one of the most fundamental financial decisions facing enterprises today.

Segregated accounts ensure a clear separation of funds, with each account maintaining distinct ownership and protection. Conversely, omnibus accounts consolidate funds and assets into a shared account, offering potential benefits like enhanced efficiency and liquidity.

As the financial landscape evolves and regulatory demands grow stricter, it becomes more and more essential to understand the benefits and limitations of segregated and omnibus accounts.

The origins of omnibus and segregated accounts

First, a bit of background. Like many things in cryptocurrency, the origins of segregated and omnibus accounts can be traced back to the traditional finance world.

Initially, banks adopted a segregated accounting structure, where each account was treated as separate based on ownership. Then, the rise of Central Securities Depositories (CSDs) and the Depository Trust Company (DTC) in the 1960s gave way to the omnibus accounting structure.

After the increasing number of transactions resulted in a paperwork crisis and the NYC stock exchange was forced to shorten its working hours, the DTC introduced the omnibus accounting model to improve efficiency and expedite processing.

Today, the same accounting structures still exist in the digital asset management space. This leaves many organizations wondering which structure is better for their needs.

What are omnibus accounts?

Omnibus accounts are custodial accounts where multiple users' assets are combined into a single account.

This approach is commonly used by cryptocurrency exchanges and service providers to streamline operations and reduce costs.

With omnibus accounts, all user assets, including Bitcoin, are pooled together without strict segregation.

Benefits of omnibus accounts

Operational efficiency

Combining multiple users' assets into a single account simplifies transaction processing and account reconciliation, saving time and operational resources.

Cost reduction

Maintaining a single account for multiple users minimizes administrative overhead and associated fees, potentially resulting in cost savings for enterprises managing large volumes of Bitcoin and other cryptocurrencies.

Enhanced liquidity

Consolidating funds and assets from multiple accounts into a single omnibus account improves liquidity. This pooled liquidity provides participants with greater flexibility and opportunities for trading and investment activities.

Challenges and risks of omnibus accounts

Lack of transparency

Commingling individual assets within the shared account makes it difficult to track specific assets allocated to each user, raising concerns regarding asset ownership and auditability.

Furthermore, omnibus accounts contradict the transparent nature of blockchain by requiring the custodian to record every transaction off-chain on their internal ledger.

Risk of illicit activities

The SEC (US Securities & Exchanges Commission) highlighted in a bulletin the link between omnibus accounts and illegal activities. Omnibus accounts, due to their shared structure and anonymity, can be used to obscure the identities of individuals involved in illicit activities and enable violations of federal securities laws.

Counterparty risk

Enterprises relying on custodians to safeguard their assets face potential risks if the custodian encounters financial or security challenges, which could put pooled assets at risk.

A prime example of this is what happened to FTX. Once the third-largest centralized cryptocurrency exchange, FTX is now bankrupt, with its founder facing criminal and civil charges.

FTX held assets in omnibus accounts and commingled them with the assets of other business entities. After the exchange collapsed, it left FTX clients struggling to recover their assets. Now, enterprises are more aware of the importance of institutional-grade custody and following security and compliance best practices.

What are segregated accounts?

A segregated account provides individual asset segregation and isolation within a custodial framework. Each user or enterprise has a dedicated account where their assets are kept separate from others.

Benefits of segregated accounts

Blockchain-based transparency

Segregated accounts leverage the transparent nature of blockchain technology. Blockchain records all transactions in a public ledger, allowing for easy verification and tracking of individual asset ownership. This transparency enhances trust and accountability.

Irrefutable proof of ownership

With segregated accounts, organizations have clear evidence and proof of their ownership of specific assets. This reduces disputes and ambiguity, as ownership can be easily verified on the blockchain.

More secure

Segregated accounts provide an additional layer of protection against unauthorized access, fraud, and internal malfeasance. Keeping assets separate minimizes the risk of theft or loss due to security breaches or vulnerabilities.

Minimize human error

Segregated accounts mitigate the potential for human mistakes. Assets are separated and clearly attributed to individual owners, reducing the risk of accidental transfers, mismanagement, or confusion.

Regulatory compliance

Segregated accounts align with regulatory requirements by enabling clear identification of assets owned by different entities. This makes it easier for enterprises to comply with anti-money laundering (AML) and know-your-customer (KYC) regulations.

Challenges and considerations of segregated accounts

Increased operational complexity

Maintaining separate accounts for each user or enterprise involves significant administrative effort, including account setup, management, and reconciliation processes. This complexity usually requires more time and resources.

Higher costs

Depending on the system used, segregated accounts may involve higher custodial fees compared to omnibus accounts. The additional complexity and administrative overhead associated with managing individual accounts contribute to the increased costs.

Segregated accounts: the clear choice for enterprise users

Enterprises are subject to stringent security standards and compliance regulations due to their scale of operations, potential financial exposure, and the duty to protect sensitive data. The stakes are high, and any mistakes in these areas can have severe consequences.

The implications of non-compliance or security breaches can be significant, including reputational damage, legal repercussions, and financial loss.

Therefore, segregated accounts stand out as the preferred choice for enterprise users.

The clear separation of funds and assets enhances security, minimizing the potential for unauthorized access or fraud. Additionally, segregated accounts facilitate auditability and accountability by maintaining a distinct and transparent record of financial activities.

The adoption of segregated accounts can be seen as a critical component of an enterprise’s financial infrastructure, equipping them with the necessary tools to meet their compliance responsibilities and mitigate security risks.