Back in January, many of us celebrated the
With SAB 121 out of the way, banks can now
There the synergies end, however. Offering crypto custody involves a lot more than adding support for new assets — it requires an entirely new and complex technology build, with different risks but
A defining feature of traditional asset custody is the set of processes and rules that govern recordkeeping, reconciliation, corporate actions, compliance and more. The technology underpinning this activity is mature, centralized and standardized.
With crypto asset custody, the defining feature is the technology, which has little to do with that used for traditional assets. What's more, it involves many new technologies, adding to the complexity and risk.
If a bank can custody a corporate bond via electronic book entry, for instance, it can custody almost any type of bond — there will be differences in reporting, tax treatment and some integrations, but the technology is largely the same. Not so with crypto. Investing in the cost of setting up safekeeping systems for bitcoin does not enable a bank to custody ether. That would require a separate build on ethereum, just as offering custody for SOL tokens would require a separate build on Solana, and so on.
To complicate matters further, the term "custody" in the crypto ecosystem has a completely different connotation in that the custodian does not hold the assets as they live on the respective blockchain. What the custodian holds is the private key, usually a string of characters that gives access to a particular crypto balance.
Safeguarding this string is far from simple, as anyone who knows what it is can move the assets. And keeping anything secret online these days is an escalating challenge.
So, a range of institutional crypto custody technologies has emerged, with varying degrees of security and complexity. "Hot wallets" are software-based and connected to the internet, always ready to transact. "Cold wallets" store the private key offline, such as on a hardware device or air-gapped computer, more secure but less accessible. Multi-sig features require several private keys held by different entities or individuals to authorize a transaction. And some systems fragment the key and distribute its pieces amongst stakeholders.
In each, processes matter, but the technology is the core feature. And with different builds required for each blockchain and each type of security, it is far from standardized.
To sum up the key difference between the two types of custody: In traditional finance, ownership is process-driven. In the crypto world, it is technology-driven.
Federal Reserve Vice Chair for Supervision Michelle Bowman floated the idea of allowing employees to hold small amounts of digital currencies, arguing that it would help with retention and understanding of the product. But some questions whether the move will yield those results, or raise ethical problems instead.
This introduces new risks. In traditional book-entry assets, ownership issues can be centrally solved. Not so in crypto where, on public blockchains, an asset transfer is irrevocable, even when it is the result of an illegal action, such as theft. Would the custodian be responsible for replacing the stolen assets? Insurance is increasingly available, but it is not cheap.
Another new risk is that of a blockchain fork that leads to an asset split. In traditional finance, asset splits can be centrally managed and do not require a new technology build. Not so in crypto, where a blockchain fork as a result of a protocol change can lead to an entirely new blockchain and a new set of assets. An example is Bitcoin Cash, which in 2017 implemented a change to the original bitcoin protocol to enable a larger block size and greater transaction throughput. Bitcoin enthusiasts thought this would lead to bloat and were not interested in the new version, which split off into a separate chain. Since public blockchain history cannot be erased, the history and distribution of bitcoin became the history and distribution of Bitcoin Cash, and bitcoin holders at the time of the split found themselves also owners of Bitcoin Cash token BCH. This was only accessible, however, if custodians supported the new chain.
As well as new risks, however, crypto custody brings new opportunities in the form of new services.
One is staking certain crypto assets on behalf of clients. This is a feature of "proof of stake" blockchains such as ethereum that involves locking ether in a dedicated smart contract in order to become a network validator and earn a regular yield.
Another could be managing governance tokens that give owners the right to vote on protocol issues, similar to traditional proxy voting but with more technology expertise required.
And there's the relative ease with which crypto assets can be combined into new assets in an on-chain securitization that shrinks the volume of paperwork while enhancing the flexibility of the resulting token. This would reduce the lift for a high-margin investment banking service, while broadening its potential reach.
The above are just some of the new functionalities that crypto custody allows banks to offer clients. What they all have in common is that they leverage the investment in crypto custody services into new revenue streams, not just bringing in new clients but moving into new types of assets and services.
Beyond what blockchain technology can enable today, however, is the boost to innovation from a new way of thinking.
Changing something as systemically entrenched as finance involves more than introducing new technologies: It requires new ideas for new markets. Crypto assets and their ledgers are altering how we understand basic financial concepts, from what custody is to how it can power new types of client relationships. This is giving us a glimpse of just how far-reaching the transformation can be.
