Digital Assets Custody
Digital Assets are a +$100 billion industry, and while substantial, the market is still in its infancy compared to broader financial markets. The lack of clear regulatory oversight and a reliable infrastructure for custody have been key factors causing many institutional investors to avoid the digital asset market.
Specifically, since inception, participation in custody services has been dominated by retail investors who have stored cryptoassets in exchange wallets, hardware wallets or outsourced custody to non-bank institutions (those without regulated licenses). And while, it would appear more convenient to outsource custody, doing so has been risky at times. Fraud and bad actor behavior has damaged the credibility of the exchanges (approximately 40 exchanges have been hacked resulting in more than $7B worth of cryptoassets being stolen, with some to the thieves being exchange operators themselves).
With the price of bitcoin rapidly rising over recent months (up 24% since the start of the year and over 90% since the beginning of December) more investors are seeking exposure to cryptocurrency, and sophisticated investors including large corporate institutions, endowments, and pension funds have started entering the market. However, governance concerns remain top of mind and regulators are being pressed for clarity.
The growing market demand has driven regulators to initiate the process of providing guidance and regulatory clarity. In 2020, the Office of the Comptroller of the Currency (OCC), part of the US Department of Treasury, issued an interpretive letter concluding that national banks and federal savings associations may hold “reserves” on behalf of customers who issue stablecoins, in situations where the coins are held in hosted wallets. In addition, the U.S. Securities and Exchange Commission (SEC) recently announced that it would let crypto-focused broker-dealers operate for five years without fear of an enforcement action provided they can verify they have possession and control of customers’ digital asset securities.
Following these positive regulatory signals, U.S. banks such as BNY Mellon (the world’s largest custodian bank), JP Morgan, Deutsche Bank and Goldman Sachs have begun actively announcing plans to enter the crypto custody market. Each of the banks entering the digital custody arena is expected to offer an institutional-grade hot/cold storage solution with insurance grade protection.
Today, custodianship for digital assets is most commonly referred to in terms of the basic core aspects, securely storing and providing access to assets. Given digital assets are programmable in nature, in the future, custodianship will expand beyond a cost center, and potentially become a means by which customers interact with the markets. Functions such as proxy voting, dividends, token splits, and tax reporting are not yet standardized functions for crypto-assets; however, they are expected to be offered in the future.