“I think every major bank, every major investment bank, every major high net worth firm, is going to eventually have some exposure to bitcoin,” Bill Miller said of bitcoin a month ago.
What a few months it has been. Covid-19 brought about digital acceleration for most businesses around the globe. It also brought about the acceleration and adoption of cryptocurrencies. Arguably, the catalyst for the recent bull run was triggered by PayPal’s announcement (offering services to help their customers buy, sell and hold and even pay for goods with crypto) to enter the crypto space. Combine this news with increasing investor/client demand for access and exposure to crypto and digital assets (e.g. tokens) and what do you get? Client driven market solutions. The adage ‘the customer is always right‘ springs to mind.
In recent weeks we have seen Banca Generali, BBVA, DBS, ING, Northern Trust
What Are Custodians? What Do They Do?
Custodians are regulated financial institutions that look after their client’s funds. They charge a fee for providing this service, typically based on a percentage of assets under custody (AUC). The “hockey stick” moment for crypto and digital assets, is believed to be when institutional money (pension funds, large funds) begins to flow into the likes of Bitcoin, Ether, Polkadot, ChainLink amongst many others. So we are all on the same page, the numbers here are not millions or even billions, custody is a multi-trillion-dollar game.
Let’s look at “Why Now?” from three different lenses:, regulation, demand and time.
Regulation in this space is a good thing. Regulation brings clarity, standards, investor confidence and in time, adoption. From a European perspective, one of the primary reasons to enter the crypto-custody market or to prepare to do so, is the MiCA or Markets in Crypto Assets proposal. This legislative package has been designed to create:
- A pan-European regulatory regime for crypto-assets and related services, and;
- A pilot regime for market infrastructures based on distributed-ledger technologies, which creates a safe space for testing innovative DLT-based financial market infrastructures in the European Union
In the U.S., a federal approach is unclear at present with State laws leading the way. For example, Gemini is a New York-based trust company and Coinbase is licensed to engage in money transmissions. Are banking licenses on the way?
In Hong Kong, the Securities and Futures Commission (SFC) have proposed a new licensing regime under its anti-money laundering legislation, requiring all cryptocurrency trading platforms that operate there, or target investors in the city, to apply for an SFC license.
The price of bitcoin and other crypto-assets has again reached dinner table conversations in many homes. As Stan Druckenmiller said, “(bitcoin) has a lot of attraction as a store of value to both millennials and the new West Coast money and, as you know, they have a lot of it.” In May of this year, we saw the bitcoin ‘halvening’ event, where the supply of bitcoin reduce by approximately 50%. As demand increases, the supply cannot meet demand (2.5% increase on supply per year). Therefore the price should go up. A real tipping point for many was when a conservative and risk averse insurer, Mass Mutual purchased $100m of Bitcoin. You read that correctly, an insurance company bought Bitcoin, and lots of it!
At a B2C level, Coinbase arguably has the largest piece of the pie and their recent IPO filing is timely with BTC at or near all time highs. Robinhood, Gemini, Kraken, Binance, PayPal
At a B2B level, hedge funds, family offices and private funds are under never-ending pressure to produce returns. Some have allocated a percentage of their portfolios to crypto to help them make returns. Clients of the large global custodians too want in on the action and are requesting their service providers for a means to access the crypto wave.
In terms of institutional solutions, some organisations use hot wallets (online exchanges) to buy, sell and hold crypto. In contrast, other companies prefer taking their Ledger Nano-X out of the designated drawer every time they want to make a trade. They then make the trade, and the device is then put back in the drawer. I think I hear risk professionals gasping in horror from here! For institutions to buy, sell and hold crypto and digital assets, they need robust multi-authentication institutional crypto-asset custody solutions. These need to be fit for purpose and meet their organisation’s strict risk and compliance requirements.
Many have publicly deemed bitcoin and other cryptocurrencies to be a fad. As John LaForge, head of retail asset strategy at Wells Fargo
Old v. New – What Are the Views of the Crypto Native Companies?
Coinbase now has $20 billion in assets under custody.
Andrew Robinson, Head of EMEA institutional coverage for Coinbase, shared that “2020 has already been a strong year for institutional adoption of digital assets. At Coinbase, we have seen our assets under custody hit a new milestone of $20bn. We saw three key trends in recent months; well-regarded macro investors advocating for the asset class, publicly listed corporates like Microstrategy shifting a portion of their treasury from fiat to bitcoin and institutional investors publicly disclosing their investments in the space.”
Earlier in 2020, Ledger launched an institutional asset custody offering called Komainu. This is a joint venture between Nomura, Ledger and CoinShares.
Alexandre Lemarchand, VP of global sales for Ledger, commented that “the challenge for incumbents in this space, is that instead of competing with digital native companies (like most industries), in our crypto and blockchain world, medium to large financial institutions are competing with crypto-native companies who are at the forefront of innovation, such as security, staking and lending through digital assets. Due to the various priorities of large financial institutions (regulatory, digital transformation), many of them are still working out what their move is in relation to crypto and digital assets and are still assessing the possibility of building their own solution instead of trusting crypto-native companies.”
Cameron & Tyler Winklevoss see Bitcoin hitting $500k and have recently hired industry veteran, David Abner, as global head of business development.
Blair Halliday, head of Gemini U.K. and also Gemini’s Chief Compliance Officer for Europe, commented, “There is ongoing discussion about how the buoyant crypto market in 2020 is attributable not only to retail customers, but also to increased institutional volumes and other corporate players buying in. Many institutions and companies have made public statements about their confidence in digital assets and their investment intentions, driving further confidence in the market. In 2021, especially following the devaluation of fiat currencies, as more people look for diverse ‘safe-haven’ assets, or the potential to earn significant returns on investment, more institutions will allocate funds to crypto as a viable part of a diversified portfolio on behalf of their clients.”
What Are the Big Players Doing?
Bar Northern Trust’s recent launch of their cryptocurrency custodian solution for institutional investors, Zodia (in partnership with Standard Chartered), the primary global custodians are yet to appear to provide clear market offerings. Established banks with regulatory moates, proven business models and extensive client lists appear to be conscious of Jim Collins’ stage 2 reason why companies fail, the undisciplined pursuit of more. Notwithstanding this, it begs the question, why does it appear (appearances can indeed be deceiving) that the custody powerhouses (on the outside at least) are slow to move? Is it due to lack of client demand? Conflicting priorities due to Covid-19? No need to rush into anything? Or are they merely yet to show their hands.
BNY Mellon, State Street, JP Morgan, Citi and BNP Paribas make up the top five global custodians and combined have a mouth-watering $135.3 trillion (yes trillion) assets under custody, with BNY Mellon holding $37.1 trillion, State Street $36.6 trillion, JP Morgan $27 trillion, Citi $22.8 trillion and BNP Paribas $11.8 trillion. If the hockey stick moment for crypto-assets is to come about, one or more of these banks will have to make a move. Despite their measured moves on crypto-custody, these companies are no slouches when it comes to blockchain technology. Each of these global banks are actively working on various blockchain-based initiatives. JP Morgan’s repo trade with Goldman Sachs and BNY Mellon, Citi’s equity swap work, BNP Paribas’s tokenisation work, State Street and S&P’s investment into cryptocurrency data provider, Lukka. To dig a little deeper on BNY Mellon, in 2019, they launched a digital asset fund (domiciled in Ireland), whose objective is “to achieve long-term capital growth by primarily investing in digital assets companies.”
What Lies Ahead?
The level of activity in the custody arena is likely to increase over 2021. With more big banks and crypto native players entering the market (like BitGo in May), expect to see eight things:
(i) Regulation – Just because we are seeing increased customer demand does not mean there will be a reduction in regulation. I would argue that the opposite is true. The riskier an asset, the more regulatory scrutiny there is (the primary reason regulations exist are to protect investors). Regardless of the jurisdiction, it takes considerable time and money to be authorised as an approved custodian. Entities that have appropriate banking licenses are approved trust companies and have strong track records in following regulations with their respective regulatory authorities, will continue to be in a strong position to continue offering crypto and digital asset custody services or pivot to offer them in the near future.
(ii) Investment – Larger players making investments in laser-focused crypto and digital asset security companies.
(iii) Partnerships – Strategic partnerships between established custodians and crypto native companies.
(iv) Consolidation – In the second half of the year as boutique players are bought by larger players.
(v) White-Labelling – Look out for larger institutions white-labelling custody solutions from niche entities to reduce their time to market with in-house built solutions.
(vi) DeFi (Decentralised Finance) – Increasing number of DeFi players, platforms and corresponding digital assets.
(viii) Talent – The war for talent in the crypto, digital asset and crypto space will also move up another notch. Expect to see more exciting signings like Ian Rogers’ move from Head of digital in LVMH to Chief Experience Officer at Ledger.
In short, is the question when, not if, for crypto and digital asset custody solutions to be provided by all significant custody banks? The next questions and perhaps the more interesting ones quickly become, who will win and why?