What inspired State Street's digital asset investing venture
While most banks are steering clear of cryptocurrency over regulatory uncertainty, State Street is taking small steps toward helping clients invest in related assets through a partnership with Gemini.
The bank is allowing its institutional investor clients to work with Gemini, the firm founded in 2014 by Cameron and Tyler Winklevoss. State Street is providing statements that report on those crypto investments alongside all of the clients' traditional investments.
“Our vision is that the digital asset space is something that will impact the market going forward and we want to be there when this happens,” said Ralph Achkar, managing director of digital product development and innovation at State Street.
It’s a pioneer stance.
“This is a very significant piece of news,” said John Dwyer, digital assets research lead at Celent. “State Street is one of the oldest and most venerable financial institutions in the U.S. Their entry into crypto via a new pilot that allows institutional investors to report their traditional assets alongside digital assets is a major sign of maturity for crypto.”
Why it’s unusual
Dwyer said there are three reasons why traditional institutional investors and financial institutions have been extremely cautious on crypto — concerns about asset class legitimacy, lack of regulatory clarity and the need for institutional-grade digital asset infrastructure.
“The first two have been addressed by a general recognition that crypto — bitcoin in particular — is not going away coupled with CFTC-approved on-ramps such as Bakkt, ErisX, CME and others,” Dwyer said, referring to the Commodity Futures Trading Commission. “However, concerns about institutional-grade infrastructure have persisted, especially in the area of custody.”
Though it had all the above reservations, State Street also felt strong demand from institutional investors, according to Achkar. In a survey of clients and nonclients, 94% said they plan to increase their exposure to digital assets in the next year.
“Institutional investors are looking to get in but don't have what they would consider to be the appropriate channels to do so, given the ambiguous regulatory environment,” said Josh Rawlins, managing director of financial operations at Gemini.
State Street decided a partnership approach would be the best course and spent a year trying to find the right partner. Other parts of State Street have an ongoing relationship with Gemini.
“They were established in that space,” Achkar said. “They offer services to an institutional segment, which is exactly what we do.”
The partnership “is a baby step in the right direction,” Achkar said. “We’ll learn about the space from the know-how and the experience of providers like Gemini, which has been providing services for a good part of two years right now in the markets.”
Gemini is looking to build an institutional grade infrastructure as a digital asset exchange and as a custodian, according to Rawlins.
“We are extremely focused on many of the things that institutional clients serviced by State Street care about, mainly security and regulation,” he said.
Gemini has a trust license from the New York State Department of Financial Services.
“As such, we are beholden to certain requirements such as capital reserves and New York banking law,” he said.
The company also undergoes annual SOC 2 and BSA audits and holds insurance. It’s also subject to strict anti-money-laundering rules.
“As the asset class matures and the solutions mature, we're getting much better at being able to identify the different veins within the spider web of where monies are coming from and where they are going,” Rawlins said. “What is interesting with these asset classes is that while people like to like to reference dark markets, basically everything is published to the blockchain. So the monitoring solutions that we use make it quite easy for us to identify certain forms of money laundering and where the money is derived from.”
One sticking point for institutional investors is the need for a qualified custodian.
The Securities and Exchange Commission hasn’t approved any qualified custodians in the cryptocurrency space, but it hasn’t said what a qualified custodian looks like or the criteria to achieve that designation.
“We believe that we are a qualified custodian in this space” in part because of the New York license, Rawlins said. “State Street of course is a qualified custodian in traditional asset classes. We think that the marriage of the two in this partnership provides a qualified custodian solution.”
The client needs to have a relationship with both organizations. Gemini holds liability for any losses. State Street will also closely monitor its clients’ crypto activity.
“Like any work with any external partner, you can outsource an activity but you can never outsource the responsibility behind it,” Achkar said.
The partnership is part of a broader shift to recognizing the validity of public blockchains and digital assets, Dwyer said.
“It means the ‘bitcoin bad, blockchain good’ mantra, which accompanied the growth in private blockchains or DLT, is becoming a distant memory,” he said.
2020 will likely bring developments in central bank digital currency, digital wallet adoption, tokenization and scalable implementations of public blockchains, Dwyer said.
“All of which will leverage infrastructure being explored by Gemini and State Street.”