We look into the recent developments traditional custodian banks are making to service institutional client demand for digital asset related services.
Financial institutions across the world are expanding their digital asset offerings. In August, Coinbase announced a partnership with BlackRock that would enable Coinbase Prime to service the asset manager’s institutional clients looking to buy bitcoin.
Retail and institutional investors’ growing interest in digital assets has led to an increase in the number of crypto custody providers.
While there are many crypto-native custody providers (see above), this report examines how traditional custodians plan to service this demand, as well as the steps they’ve taken to build their own crypto custody services or partner with tech providers so they’re not missing out on this opportunity.
What are custody services, and what role do custodians play?
Traditional custodians, at their core, serve a key function in supporting the safekeeping of investor assets and securities, typically in physical or electronic form. Custodians have physical control over financial accounts and use a depositary service for storage.
Crypto custody, also referred to as digital asset custody, serves a similar function as the safekeeping and protection of a customer’s crypto or digital assets. They are similar to custodians in the traditional financial markets, but the main difference is the type of “asset in storage” done via secure key management, which enables cryptographic asset protection. These assets are protected in a controlled manner – usually by a professional service managing a client’s private keys, or a technology provider who provides custom custody solutions that keep the client in control of their private keys. For more about crypto custody, download our 41 page report.
Opportunity for Traditional Custodians
It would make sense for traditional bank custodians to offer a wide range of financial services for cryptocurrency-based assets because they already have built-in systems and established client networks. Introducing such services will help them gain a competitive edge over other retail banks and technology service providers that do not provide crypto custody services.
Digital asset custody services
While there’s currently less standardization among crypto-native custodians compared to traditional custodians, custodians in the digital asset space operate in the same way as those in the traditional finance market. Their primary role is to safeguard customers’ assets (digital) through safe key management.
In crypto custody, all data and transactions exist on the blockchain. For this, a private key is used to sign transactions and establish ownership of the blockchain. This private key can be defined as a randomly generated binary number that helps to encrypt and decrypt information available to the creator of the content.
There are a few custody options unique to digital assets that are available to both retail and institutional investors, each with their pros and cons:
- Self-custody: Includes hardware, software, and/or paper wallets to store private keys. This type of custody is vulnerable to loss.
- Exchange wallets: Solutions where the investor gives control and management of public and private keys to the exchange but maintains access via an online wallet, however there is a counterparty risk involved.
- Third-party custodians: Solutions designed for institutional investors to send digital assets to a third party custodian to store on their behalf using their own vaults, manage them, and provide access to services such as staking or DeFi.
Many retail investors use centralized exchange wallet services to store their private keys. Security can be a concern here, especially for institutional investors, given the lack of clear regulation and standardization around these providers’ risk management services.
According to a PwC Global Crypto Hedge Fund report, half of crypto fund managers surveyed said they use multi-signature wallets, hot/cold wallet set-ups, or other ways to store the private keys of the fund’s crypto assets. This has led to a rise in crypto funds using a third party for self-custody or exchange custodianship.
How traditional custodians can derive value from digital asset custody
Custodian banks can leverage their existing solutions and deliver immense value to cater to the investor demand for single consolidated portfolios. An increasing number of banks are including the option of crypto custody in their service offering.
This is a huge opportunity for traditional custodian banks to service their asset management clients looking to offer institutional investors exposure to crypto trading services. Case in point: While BlackRock uses BNY Mellon, Citigroup, and JP Morgan as custodians for traditional finance, it chose to partner with Coinbase Prime to provide crypto trading, custody, prime brokerage, and reporting services to Aladdin’s client base (BlackRock’s portfolio management software).
Despite the volatile nature of cryptocurrencies, traditional bank custodians must see adding crypto custody services as an expansion of their value proposition, as well as a method for rationalizing involvement with a wider portfolio of digital assets.
Below, we’ll look at the moves traditional custodian banks have made with respect to providing custody services for digital assets.
Traditional custodian banks offering digital asset custody services
According to research from NYDIG, more than 80% of customers and clients that hold bitcoin would consider moving it to their existing bank if that bank offered secure bitcoin storage. NYDIG also found that 71% of bitcoin holders would switch their primary bank to one that offered Bitcoin-related products and services in addition to regular bank products.
This reinforces why traditional custodian banks would consider offering custody services that cover both traditional finance and digital assets. The space has already started to become competitive as major banks expand their offerings.
To offer custody solutions to investors, banks are either building their own crypto custody capabilities, acquiring crypto custody technologies and services, or outsourcing to sub-custody service partners.
Below we’ve outlined the top 9 custodian banks by assets under custody (AUC) and examined how they’re adapting their business to service their clients with crypto custody.