A handful of large financial firms are plunging into the world of cryptocurrency custody services.
While some government officials have given the OK, many companies have had concerns about regulatory scrutiny and legal liability. They also lacked the technology and expertise needed to do the job and feared the financial or reputational risks associated with such an unproven field.
Still, a few companies this month said they were getting into the business or dive deeper into it – including Northern Trust and Standard Chartered Bank, which announced a partnership, and Fidelity Digital Assets, and began providing crypto custody to clients borrowing from BlockFi against the bitcoin they have.
North Trust, worth $ 151.6 billion, says it has been receiving crypto custody inquiries from wealth management and institutional clients, and executives expect that to continue.
Hedge funds, traditional asset managers, retail and family organizations are all looking to either invest in cryptocurrency or create crypto products for their clients, according to Pete Cherecwich, Northern Trust-based president of asset servicing Chicago.
But these investors have concerns about the security of the assets and the reliability of cryptocurrency service providers, Cherecwich said.
The Northern Trust set up with Standard Chartered Bank London to form Zodia, an independent fintech that will be based in the UK and regulated by the Financial Conduct Authority. Both banks are investing an undisclosed amount in the venture and will advise and oversee it.
“We want to make sure we bring guidance to this entity, basically up the game in terms of what it means to be a cryptocurrency custodian,” said Cherecwich. “We believe that cryptocurrencies with the proper regulatory oversight are going to play a future role in our industry,” he said.
Initially, Zodia will have 25 employees with experience in banks and fintechs. They will abide by know-your-customer standards and company policies set by both banks.
The team has built a platform that will connect to multiple exchanges and blockchains, as well as bitcoin wallets.
Zodia should go live in early 2021. At launch, until the regulation is approved, Zodia will provide custody services for bitcoin and Ether. That digital currency is followed by XRP, Litecoin and Bitcoin Cash.
Meanwhile, Boston-based Fidelity Investments, which has $ 8.7 trillion in assets under management, formed a crypto services subsidiary, Fidelity Digital Assets, in October 2018 and went live in the first quarter of 2019. It has hundreds of customers for its bitcoin custody and operating services, letting bitcoin holders buy and sell the cryptocurrency.
Through the unit’s new partnership with BlockFi, a company based in Jersey City, NJ, that makes US dollar loans to borrowers based on their blockchain assets, Fidelity will hold bitcoin that BlockFi customers pledge against loans .
“This provides the lender with a more traditional structure that he might be used to in other asset classes,” said Terrence Dempsey, vice president of products for Fidelity Digital Assets. “And it also provides independence for who holds the collateral, so neither the lender nor the lender holds the collateral.”
Fidelity Digital Assets is also in talks with other lenders about serving as their collateral agents, Dempsey said.
Loyalty gets an asset under a custody fee, which in this case is paid by the lender.
The unit’s first custody customers were digital asset customers. Today, more traditional companies become clients, such as hedge funds, equity funds, and pensions and endowments, Dempsey said. And more public companies are interested in holding bitcoin on their balance sheets, he said.
Building the technology platform was difficult because the asset classes were so new, Dempsey said.
“The hardest part was the customer experience,” he said. “It marries a lot of that brand new technology you get from blockchains to provide a known and familiar experience they could be used to in the equity or the fixed income or foreign exchange. world. ”
For example, bitcoin goes out to eight decimal places. Many traditional customer books and records do not.
“You have conciliation or accounting issues right away,” said Dempsey. “Little details like that, you really need to look out for.”
Crypto custody has a host of challenges.
There are risk questions. “There’s an issue that they don’t want to put their assets and balances at risk or have a problem with reputational risk, so they keep things at arm’s length,” said Monica Summerville, Celent’s head of capital markets. “So you see things like Fidelity starting a different company and even JPMorgan has separated some of its blockchain activities now.”
Crypto custody also comes with technology challenges, Summerville said.
Secure storage of the private keys to digital assets is one technology issue. Another is to integrate digital wallets with banks’ systems. And there are logistical difficulties around distribution versus payment, because there is counterparty and credit risk.
“Large organizations are not going to be happy with the concept of it, I’ll send you the money and you’ll send me the crypto,” Summerville said. “The issue is, how do you build a system that can interact with the pay rails in a way that doesn’t leave you holding the bag if the trade goes wrong or the person disappears, and that’s happened in the crypto world. There is no clearing network at present. ”
A host of vendors have recently come out with different kinds of help. On Wednesday, FICO announced a partnership with Crystal Blockchain of Bitfury Group, a digital currency analytics company, to provide cryptocurrency risk management and monitoring services. Chainalysis and CipherTrace provide similar technology. NYDIG, Kraken, Avanti, Coinbase, BlockFi and Curv are among the companies that help banks create and offer bitcoin-related products. BNP Paribas works with Curv.
Another issue is that the bitcoin blockchain is a public ledger, where banks like the big transactions they place on behalf of clients to remain confidential.
“You don’t want the whole world to know about a trade happening until it’s completely settled because you don’t want it to affect the price,” Summerville said.
Some banks have been exploring the use of currency backed tokens that could be used to clear.
Rangers also have to prepare to act globally, Summerville noted.
“As an institutional custodian, you’re probably going to be dealing with customers with global interests,” he said. “You need to be very clear on which jurisdictions you can support and how you can comply with local regulations.” Countries have different licensing requirements, for example anti-money laundering.
Northern Trust, State Street and Fidelity all show leadership in this space, Summerville said.
“They are visionary,” said Summerville. “Companies like them are going to show the rest of the organizational community that this is a safe asset to engage with. And interest is growing. ”
The effort is vital for custody banks, he said, “because core custody services are a commodity and revenue is not increasing. They have to find some way to offer new services to clients, and this idea that they can attracting new assets to them is really exciting for them. ”