A framework for the custody of digital assets is needed for funds development in the crypto universe. Funds Europe speaks to some of the largest custodians to find out what the future holds.
In the us earlier this year, New York-based fund manager VanEck was denied authorisation for a cryptocurrency exchange-traded fund (ETF). The firm indicated that custody was the “final outstanding problem” not just for its ETF, but for the digital asset fund universe.
Speaking at this summer’s CryptoCompare Digital Asset Summit in London, Gabor Gurbacs, VanEck’s director of digital assets strategy, said the application for approval of its bitcoin ETF had been ongoing for about four years, but that the fund management industry and regulators faced issues with digital assets, including “proper pricing” and custody.
In May, the Securities and Exchange Commission, America’s main financial regulator, said it had delayed VanEck’s bitcoin ETF application. The announcement was widely expected, but bitcoin reportedly increased in value after the announcement. Some interpreted this as anticipation of future approval and increased demand for bitcoin as regulated funds gain access to it.
“Regulators are very up to speed on crypto. I believe we are going to see bitcoin ETFs down the line, but the custody market has to firm up first,” Gurbacs said. Crypto is seen as “digital gold” in some quarters, he added.
The latest developments
For a clearer picture of what’s happening now, Funds Europe asked leading custody banks in Europe about problems with custody for digital assets and if they are looking for solutions.
Arnaud Claudon, head of asset managers, BNP Paribas Securities Services, says: “Crypto assets are still at a relatively early stage of development. The industry is just starting to understand how crypto assets could complement central securities depositaries as an alternative approach to dematerialising financial instruments.
“Our foremost concern is the safety aspect of crypto assets: how to keep these assets – which are vulnerable to hacking – safe. We are, however, exploring services that may develop around digital assets linked to the tokenised economy, focusing on regulated or soon-to-be regulated assets.”
Tom Casteleyn, global head of custody at BNY Mellon asset servicing, says: “Ensuring the safekeeping of private keys and crypto assets is essential to institutional investors, though uncertainty surrounding the regulatory framework and the lack of safe, qualified custody are significant barriers preventing them from joining the crypto market in greater numbers.
“The challenges in the custody of digital assets are not only the concerns around the security of the private key and transaction addresses, but also how to allow third parties, such as regulators and fund administrators, to receive the pertinent information without compromising the safety of assets. We are evaluating potential solutions based on our clients’ needs, but there are many questions yet to be answered regarding the regulatory and legal environment.”
Pervaiz Panjwani, Citi’s regional head of custody and fund services, says: “First, we must define digital assets and where they are issued – public or private blockchains. The two ecosystems are both evolving but are different from each other in some ways, such as market structure, participants and risk.”
Public blockchains, which are decentralised and permissionless, and ‘permissioned’ private blockchains exist.
“Public blockchains carry more risk for institutions due to their decentralised nature, such as risk of asset loss – cyber-security breaches and no recourse – and currently a lack of regulatory certainty,” Panjwani adds.
On private permissioned blockchains, a central authority controls the nodes and participation in the network, he says, and a number of financial market infrastructure providers are either replatforming on permissioned blockchains (such as the Australian Stock Exchange) or establishing digital asset exchanges (such as the Swiss Digital Exchange operated by stock market operator SIX). More permissioned ecosystems are likely to develop, he says.
“The custodian role for digital assets residing on blockchains (both public and private) will be control and security of the private keys for those assets and the connectivity with the blockchains themselves.
“Although key technology is in use in production today, crypto assets on public blockchains will necessitate much more sophisticated and secure application of these tools.”
Panjwani says Citi, as a custodian, is working with a number of infrastructures to develop digital asset marketplaces on permissioned blockchain, as with clients on asset tokenisation and issuance use cases on permissioned blockchains.
“The roles of a custodian will not fundamentally change – asset safekeeping and asset servicing – but the technology in order to do so will. Custodians will take a node in the blockchain and manage the private keys for the wallets on the blockchain as well as manage asset servicing. This requires new technology and connectivity.
“We see fragmentation in the market, with varying blockchain ecosystems developing. Investors will want to invest across numerous markets and asset types. Custodians will provide single points of access for investors as they do today and the associated record-keeping and reporting.”
Clive Bellows, regional head of global fund services at Northern Trust, says there is insufficient asset class definition by regulators and government.
“Although there are many concerns associated with cryptocurrencies, Northern Trust thinks digital currencies, with appropriate regulatory oversight, are likely to play a role in shaping future developments in our industry, and we are actively working with industry associations to advocate and contribute to the development of policy and regulatory frameworks,” he adds.
Paul Stillabower, global head of product management at RBC Investor & Treasury Services, says anti-money laundering processes are also a key short-term challenge, along with regulatory, legal and fiscal.
“In addition, the evolution of the crypto space to date has focused on the provision of trading capabilities – and post-trade functionality has not been front of mind. As a result, we have vertically integrated infrastructures where exchanges also provide custody but, to achieve far greater liquidity with the participation of institutional investors, this environment needs to evolve with the implementation of separate, institutional-quality custody functions,” Stillabower says.
Like others, he cites the secure custody of crypto keys. “There have been many well-publicised cases where the keys, and thus the crypto assets, have been stolen and never recovered. This is a new type of risk which custodians must address.”
Niklas Nyberg, head of products, global custody at SEB Bank, says: “There are a lot of risks involved and one of the largest risks is that there are no standards or technology to safely store digital assets. Storage and exchanges are the most vulnerable points of the digital asset economy. At the moment, we have no intention to invest in this area. But, SEB is actively participating in several forums and think tanks to enable continuous assessment of when and how to potentially invest.”
At France’s Societe Generale Securities Services, Etienne Deniau, head of strategy, says: “Our clients, both asset owners and asset managers, operate in a regulated environment. It is only when laws and regulations have been adapted to handle crypto assets that our clients can invest in them.
“The biggest challenge is to make sure that our clients understand laws and regulations, and the level of responsibility of the provider for the safekeeping of digital assets or digital asset keys.”
Jörg Ambrosius, regional head of business at State Street, says: “For anyone working in the digital assets space – be it cryptocurrencies or asset tokenisation – the question of how the custody industry can evolve to support digital assets is still unresolved. The starting point perhaps should be, what do we actually mean by digital custody?
“In its advice on crypto assets published in January, ESMA, the European securities regulator, stated that ‘having control of private keys on behalf of clients could be the equivalent to custody/safekeeping services, and the existing regulatory requirements should apply to the providers of those services’.
“More recently, the draft German law to implement the fourth EU Money Laundering Directive would define custody of crypto assets as ‘the safekeeping, administration and safeguarding of crypto assets or private cryptographic keys used to hold, store or transfer crypto assets for others’.
“What is common to these definitions is that when it comes to digital assets, custody services no longer concern the simple safekeeping of ‘assets’ but rather the storage of cryptographic keys that control those assets. Clearly, a digital custody solution necessitates private key storage capability, whether that’s for bitcoin, blockchain or DLT [distributed ledger technology]. As a result, the question around how those private keys are controlled is a critical one for defining the role of custody of digital assets. This is a given.
“However, differences in technology between crypto and institutional platforms, as well as the applicable and still evolving regulatory framework, requires a more holistic view of custody that goes beyond the storage of keys. Put simply, the emerging definition of what is digital custody will be more than a question of who holds the private key.”
©2019 funds europe
