Wall Street activity in the battle to provide custody services for the more than trillion-dollar digital-asset market is heating up rapidly, and in surprising ways, turning what would typically be considered a sleepy area of finance into one of the most lively sectors.
Nasdaq Inc. said last week it’s halting plans to launch its own crypto-asset custodian, citing a lack of business opportunities and an uncertain regulatory backdrop. Citigroup Inc. is reviewing its partnership with Swiss digital-asset custodial software provider Metaco Inc., which had been acquired by another crypto firm, while State Street axed a deal with London’s Copper Technologies. Elsewhere, Societe Generale was granted a license by France’s market regulator, allowing it to provide services for storing and safeguarding digital assets, while UK asset manager Schroders is on the hunt for a crypto custodian.
A growing number of banks and institutions see profit potential arising from the surge in investor demand for third-party custody following the high-profile collapse of FTX and other crypto platforms last year, which left traders who had stored their coins on those venues nursing millions of dollars in losses.
“Getting custody right has always been the most important thing for digital-asset investors from Day One, but risk tolerance has changed after last year’s multiple failures,” said Anatoly Crachilov, chief executive of Nickel Digital Asset Management, a London-based crypto fund. “Unfortunately, it took FTX for many investors to realize that the segregation of core functions, such as custody and matching engines, would offer critical protection to investors and help grow the space,” Crachilov added.
While this realization opened up opportunities for traditional financial firms to gain a toehold in the custody business, regulatory differences across the globe and varying cost dynamics are enabling some players to move faster while causing others to reassess. In the case of Nasdaq, regulatory uncertainty in the US played a role in its decision to retreat.
“That just made us decide that it’s not the right time for us to enter that business,” Nasdaq’s chair and chief executive Adena Friedman said on an earnings call Wednesday. The exchange group still sees promise in other areas like supporting a potential Bitcoin exchange-traded fund, Friedman said.
Rules laid out by the Securities and Exchange Commission in March last year, as well as others expected to come soon from the Basel Committee, trigger higher capital requirements for some regulated institutions custodying crypto-assets. This has made it more costly for some major financial players to do business in the area, said Michael Shaulov, chief executive of digital-asset tech provider Fireblocks Inc..
The situation was made worse when crypto-exposed banks like Silicon Valley Bank and Signature Bank collapsed earlier this year, Shaulov added. Regulators in the U.S. have cracked down on a number of major crypto companies — including exchanges Binance and Coinbase — with their enforcement actions acting as de-facto guidance in absence of new rules, leaving many wary of operating in the space until clearer regulations come through.
“The complicated nature of regulation surrounding custodianship has made it difficult for new players to enter the space and existing players to successfully navigate the regulatory landscape,” said Clarisse Hagège, founder and chief executive at custody technology firm Dfns. “This is not to say that compliance is not possible,” she added, but confusion around certain rules has “hindered the U.S. market.” Dfns is backed by ABN Amro’s venture arm and market maker Susquehanna.
One way that some banks have navigated the regulatory challenges in other jurisdictions is by spinning out a fully or majority-owned subsidiary, like Standard Chartered’s Zodia Custody Ltd. Those units often aren’t subject to the same capital requirements as their bank owners, Zodia Custody Chief Executive Julian Sawyer said, making it easier for them to operate in the space.
Standards-setters like the Financial Stability Board and the International Organization of Securities Commissions have stressed that firms seeking to engage with crypto-assets should ensure that activities like trading, custody and clearing are segregated to avoid undue risk.
But with the regulatory environment up the air and institutional demand not yet very high, banks considering developing their own custodians may be finding that “there are better ways to use their investment capital, said Larry Tabb, head of market structure research at Bloomberg Intelligence.
State Street, after ending its deal with Copper, is pushing ahead with developing its own digital-assets custody offering pending regulatory approval, according to a spokesperson. And even Nasdaq said it plans to keep developing technology for the custody business.
“What you are seeing is folks quietly continuing to build behind the scene and engaging in R&D activities,” said Matthew Homer, board member of Standard Custody & Trust Co. and managing member of VC firm The Department of XYZ. Standard Custody had a partnership with Cowen Inc.’s crypto unit until the boutique investment bank shut down the division in May.
“The challenge for these companies is really the timing — many of them probably believe crypto is here to stay,” Homer said. “There will be enduring demand for digital assets like bitcoin. The real question is the timing and when will the regulatory environment allows for that.”