As the demand for cryptocurrencies increases so does the demand for organisations that can store them. In this article we chart the rise of the Crypto Custodian and ask what future role we expect them to play in the cryptocurrency market.
In short, a Crypto Custodian is an organisation that securely stores cryptocurrency assets. Cryptocurrency Custodians can store cryptocurrency for both institutions and individuals who want to protect their crypto assets. They do this by charging a small fee in exchange for a secure storage facility for cryptocurrency. Examples of Crypto Custodians are Coinbase Custody, BitGo, Gemini, itBit and Kingdom Trust.
There are two main benefits for using a Crypto Custodian. Firstly, it allows potential investors to invest in cryptocurrency without the hassle of having to organise the storage and safekeeping of these assets. Secondly, it allows investors, who are legally obligated to store their assets with a regulated custodian, to enter the digital asset market. This allows investors who were not previously allowed to enter the digital asset market, to invest in cryptocurrency.
The process for onboarding a Crypto Custodian is largely similar to that of a regular custodian. Potential investors would initially register themselves at a Crypto Custodian, and upon successful completion of Anti-Money-Laundering (AML) and Know-Your-Customer (KYC) checks, the investor would transfer their cryptocurrency holdings to a digital wallet managed by the custodian.
More recently, market leading custodians have shown an interest in entering into the cryptocurrency space. This has been mainly driven by client desire to hold digital assets. Bank of New York (BNY) Mellon were one of the first when they offered their enterprise digital assets unit in February 2021. Their aim was to build a single multi-asset digital custody and administration platform for both digital and real assets.
State Street has followed BNY Mellon by launching their digital finance division to enable them to provide custodial services for cryptocurrency, blockchain, tokenisation and central bank digital currencies. Following on from this, other mainstreams custodians have also expressed an interest in entering the digital asset space, namely BNP Paribas Security Services, Citi and HSBC Security Services.
While client demand is currently the key driver for mainstream custodians to enter the digital asset market, it is not the only factor. Decentralised finance (DeFi) is becoming more prevalent. DeFi essentially changes the way the financial markets can offer conventional financial products and services by offering them through Smart Contracts. A Smart Contract is a self-executing automation that runs on blockchain. Smart Contracts essentially transfer the ownership of the asset.
The uptake of DeFi is increasing rapidly. According to DeFi Pulse in April 2020, the amount of value in DeFi was between $700m and $800m (USD). As at June 2021 that figure was more than $62bn (USD).
With the desire to invest in cryptocurrencies ever more prevalent, regulators are having to take action. In September 2020 the EU drafted its Markets in Crypto Assets (MiCA) regulation as part of its wider European Digital Finance Strategy. This is to address the issue that existing European financial services regulations do not encompass cryptocurrencies. For firms offering crypto services in Europe, they will need to apply for a pan-European passport in order to continue offering their services in what is being coined a ‘mini-MiFID’.
The willingness for both mainstream custodians and regulators to look at the cryptocurrency markets suggests how prominent they believe they have become. EU regulation is still going through the legislative process (which could take 18-24 months) and much could change in this time. Certainly, this is a very exciting market to watch.
James Girling
Managing Consultant