The bitcoin rally in recent months is attributed in part to institutional investors seeking exposure to digital assets. But as companies look to diversify their corporate treasury into cryptocurrency, they also want someone else to take custody of their holdings, to keep their digital assets safe.
Gone are the days when most cryptocurrency investors prefer to do it themselves in holding on to their digital assets — and risking their storage device getting hacked or their crypto accidentally getting lost or destroyed — without the involvement of other intermediaries.
Custody can take several forms, from self-custody where cryptocurrency owners retain complete control of their digital keys and assets, to third-party custody where customer assets are held by a service provider.
The latter is what is often top of mind for financial institutions and family offices when it comes to investing in cryptocurrency, said Eugene Ng, head of business development for Asia Pacific at cryptocurrency exchange Gemini, in a recent interview with Forkast.News.
“One of the things that they really want to figure out is the custody of the assets — who exactly hold [these] assets. If I’m going to be trading on Gemini, who is it that is exactly holding. So that’s the number one concern that most investors have,” Ng said. “It is a departure from our traditional securities where we buy a stock and it gets sent into one of our CDPs (central depository) in Singapore. But in crypto, it is slightly different. The exchange is also the carrier, it’s also the broker, it’s also the custody. So that’s a great departure and that requires a shift in thinking on this investment.”
See related article: 2021 will be the tipping point for institutional investors in digital assets
“Once the custody stack is tackled successfully though, we will see institutions allocating into this asset class confidently, and in greater numbers,” Ng told Forkast.News in a follow-up email.
Regulation is fueling the demand for crypto custodians as well. According to U.S. Securities and Exchange Commission regulation, institutional investors managing customer assets over US$150,000 are required to store the holdings with a “qualified custodian.” The SEC is currently seeking comments on the custody of digital assets and qualified custodian status.
Earlier this month, Gemini introduced “Gemini Fund Solutions,” a platform providing fund managers with custody, clearing, trade execution and other capital markets services specifically designed for cryptocurrency exchange-traded funds, closed-end funds and other fund vehicles.
Meanwhile, another regulated crypto-native player, Coinbase, has 7,000 institutional customers on its platform and US$44.8 billion in institutional assets under custody, according to its recent S-1 registration. The company became a leading custodian of crypto following its acquisition of cryptocurrency wallet Xapo’s institutional custody business for US$55.4 million in 2019.
According to the filing, Coinbase plans to expand its institutional customer coverage team in order to educate hedge funds, corporate treasurers, family offices and other institutions about the cryptocurrency economy and its platform, as well as increase its trading operations teams for large institutional customers.
Investing in digital asset custody companies
Non-crypto-native companies are also entering the custody market. PayPal, which now allows customers to buy, hold and sell cryptocurrencies from their PayPal account, announced this month that it was acquiring Curv, a Tel Aviv-based provider of cloud-based infrastructure for digital asset security.
“The acquisition of Curv is part of our effort to invest in the talent and technology to realize our vision for a more inclusive financial system,” said Jose Fernandez da Ponte, general manager of blockchain, crypto and digital currencies for PayPal.
Elsewhere, Komainu, a Jersey-based regulated digital asset custody services provider, also announced that it had closed a US$25 million series A round to expand its global presence and accelerate growth plans.
The fundraising was led by Alan Howard’s Elwood Asset Management with additional participation from Galaxy Digital, NOIA Capital and Nomura Research Institute. The funds will allow Komainu to expand its cryptocurrency custody services and “provide complementary services in the digital asset prime brokerage business,” according to a company statement.
The company is an example of how traditional finance is partnering with players in the digital asset class. Komainu was created in 2018 as a joint venture between Nomura, the global investment bank, Ledger, a digital asset security firm, and CoinShares, a digital asset investment house. Komainu currently holds over US$3 billion in crypto assets under custody from asset managers, institutions, corporations and government agencies.
“Komainu will continue to build the future of digital asset custody, extending beyond simply the storage of assets, to a core strategic pillar of any investment management strategy,” said Henson Orser, Komainu’s president, in a press release.
Will legacy finance be left behind?
Traditional banks are now also exploring ways to accommodate the growing institutional demand for cryptocurrency. Part of that includes providing cryptocurrency custody services, the lack of which has been a barrier to institutional investors looking to enter the market in greater numbers. But this is changing, industry insiders say, as traditional financial institutions that are often trusted household names get into the crypto custody business.
Custody is not new to traditional banks, but the custody of cryptocurrencies is, and banks such as Goldman Sachs are responding to a trend of evolving customer needs, from basic custody to brokerage services for digital assets.
“This is a fast-evolving landscape where the crypto incumbents have certainly made huge progress over the last couple of years, be it from an institution, a custody, a risk management perspective.” said Mathew McDermott, Head of Digital Assets for Goldman Sachs’ Global Markets Division, in a recent Goldman Sachs Markets Update podcast. “But as institutional demands, there is an expectation from clients now that the incumbent banks will develop their offerings to satisfy that demand.”
A key factor for the U.S. banks is the inability to “trade the physical,” McDermott said. A lot of demand, particularly from hedge funds and asset managers in the macro funds, shows a desire to spot trade. Physical trading is actually trading the spot instrument on a blockchain.
“We’ve had to think cleverly how we can facilitate that demand in a different way,” McDermott added. “When we talk about top products that clients are interested in, specifically in this marketplace, it is the ability to access spot through their prime brokers.”
The investment bank announced this month that it has restarted its cryptocurrency trading desk and will begin dealing bitcoin futures and non-deliverable forwards for clients, according to Reuters.
“A lot of these banks are starting at ground zero — understanding custody and potentially building their own custodial solutions in-house or working with some of the third-party providers to develop a white-label solution,” said Justin Chow, global head of business development and relationship management at Cumberland DRW, a crypto-asset trading company, in an interview with Forkast.News.” They are understanding that, for their clients, they need to have that solution in place for them.”
In Asia, Singapore-based DBS bank — the largest bank in Southeast Asia — has become one of the first traditional banks in the region to launch its own digital exchange that is integrated with a custody service for its institutional investors.
“The exponential pace of asset digitalization provides immense opportunities to reshape capital markets,” said Piyush Gupta, DBS’ chief executive officer, in a statement. “For Singapore to become even more competitive as a global financial hub, we have to prepare ourselves to welcome the mainstream adoption of digital assets and currency trading.”
See related article: Singapore’s DBS bank becomes first in Asia to offer crypto exchange
Meanwhile, last month, BNY Mellon — the world’s biggest custodian bank with US$41.1 trillion in assets — announced the formation of a new digital assets unit to help corporate clients address growing and evolving needs related to the growth of digital assets, including cryptocurrencies. This includes providing custodian services.
Linda Lacewell, Superintendent of the New York State Department of Financial Services, took to Twitter to comment, “@BNYMellon a NYS-chartered banking institution is authorized to custody digital assets without the need to obtain a #NYDFS Bitlicense with the approval of the Superintendent.”
.@BNYMellon a NYS-chartered banking institution is authorized to custody digital assets without the need to obtain a #NYDFS Bitlicense with the approval of the Superintendent. (1/2) https://t.co/B0lcGUMORL— Linda Lacewell (@LindaLacewell) February 11, 2021
The market for custodianship has been dominated by cryptocurrency asset specialists and fintech companies, which enjoyed a first mover advantage. But that’s changing. The bigger traditional players are moving in.