The collapse of crypto firm FTX will lead to the definition of institutional-grade custody for digital assets and best practices will move up the priority list.
David Easthope, senior analyst who heads up fintech research on the market structure and technology team at consultancy Coalition Greenwich, said in a blog that FTX operated a vertically integrated model allowing it to trade, settle, custody, and lend/borrow digital assets.
However, customer assets were allegedly not in verifiable, segregated accounts and FTX’s bankruptcy filing means clients may not be able to recover their assets.
Recent research from Coalition Greenwich found that institutional-grade cold storage and exchange wallets were equally popular among institutional investors – but this will change due to the FTX collapse.
“As firms consider the available range of hardware and software-based storage options, such as cold storage and multi-party computation (MPC), institutional-grade solutions are likely to become far more popular and crowd out the exchange-provided wallets (by demand and later by regulatory edict)” said Easthope.
He also expects that U.S. regulators will seek to separate proprietary trading activities from any U.S. crypto platform that seeks to define itself as a regulated exchange or alternative trading system, and to separate custody from other exchange activities.
“The SEC will move to further define a “qualified custodian” or QC for digital assets,” Easthope added. “According to our research, almost two-thirds of buy-side firms report they do not fully understand rules defining what it means for their custodian to be a qualified custodian for digital assets.”
As a result, Easthope expects that institutional-grade custodians, particularly those with well-established brands, secure technology and healthy balance sheets, will see their solutions more heavily sought after.
Bank of New York Mellon
In October BNY Mellon, which is 238-years old, announced that its Digital Asset Custody platform was live in the U.S with select clients able to hold and transfer bitcoin and ether. At the end of June this year, BNY Mellon had $43 trillion in assets under custody and/or administration, and $1.9 trillion in assets under management.
Robin Vince, chief executive and president at BNY Mellon, said in a statement: “Touching more than 20% of the world’s investable assets, BNY Mellon has the scale to reimagine financial markets through blockchain technology and digital assets.”
BNY Mellon is integrating technology from digital asset custodian Fireblocks and data provider Chainalysis to meet the security and compliance needs of clients across digital assets.
Katey Neate, chief risk officer, securities servicing and digital at BNY Mellon, spoke about the new digital asset service at City & Financial Global’s conference on digital assets and crypto on 18 November in London, and highlighted that it was developed in just two years.
Neate said a recent survey from BNY Mellon of about 300 clients found that nearly three quarters, 71%, said they could only expand their use of digital assets if they could utilise a qualified or reputable, regulated custodian. She highlighted that BNY Mellon provides large-scale regulated security for its traditional asset base and clients, and that interoperability with digital assets is critical.
“Why self-custody your digital assets when you hold your traditional assets with a custodian,” she said. “Investors want to be able to see all their assets in one place, have assets serviced in one place, and report on assets in one place.”
She explained that custody has not been outsourced to Fireblocks but the firm is using their technology in a software-as-a-service (SaaS) model.
“We have had to augment our risk framework,” said Neate. “We have retooled around financial crimes, compliance data and the provision of market data in the digital asset space.”
Neate believes the institutional appetite for digital assets has not diminished, despite the collapse of FTX.
“If anything, FTX highlights the value of having good risk management and well-regulated, well-capitalised institutions entering this space and providing the stability, strength and security that it needs,” she added.
Another traditional institution, Fidelity Investments, has been active in digital assets. Chris Tyrer, head of Fidelity Digital Asset Management and head of Europe, Fidelity Digital Assets, said at the conference that digital assets are a unique asset class.
“Digital assets have unique security characteristics which need to be taken into account,” he added. “We need more traditional players in the space because you need their risk management framework and operational controls.”
Tyrer explained that the digital asset business has been building out capabilities that can be incorporated into other Fidelity businesses over the last 18 months.
In April this year the firm announced the launch of Fidelity’s workplace Digital Assets Account (DAA), the first to allow individuals to have a portion of their retirement savings allocated to bitcoin through the core 401(k) plan investment lineup. Fidelity manages 23,000 pension plans in the US that cover more than 20 million individuals according to Tyrer.
In November this year the firm launched Fidelity Crypto, a commission-free crypto trading product for retail investors using custodial and trading services provided by Fidelity Digital Assets.
Tyrer said the vast majority of the businesses’ trading volume is transacted with over-the-counter market makers, not with crypto exchanges.
“The one thing we are looking at, and I think that this is very pertinent given the events of the last couple of weeks, is the ability for clients to be able to access exchange volume, but from cold storage,” he added.
He continued that Fidelity takes a long-term view. The Digital Asset business has doubled in size this year and expects to add another 100 people. Tyrer said: “I don’t see FTX as an existential event.”