Redefining Finance: Traditional Banks Embrace Crypto Custody

Banking Approaches: Building vs Outsourcing Digital Asset Custody

While facing challenges like technical complexities, regulatory variations, and the need for partnerships, banks are striving to integrate digital asset solutions. Options include building in-house solutions or partnering with established custodians, which helps them swiftly enter the market while meeting regulatory standards. However, regulations remain fragmented globally, impacting the banking sector's approach to digital asset custody.

In a recent webinar organized by HAYVN, Darren Jordan, Head of Sales at Komainu, underscores the challenges of fragmented regulations and highlights the impact of upcoming regulatory developments like MICA in Europe, aiming to streamline the landscape. Varying regulatory statuses for digital assets pose hurdles for banks seeking to integrate certain services, making compliance and cold storage requirements different across regions. Richard Swainston, Market Director of APAC at Metaco, highlighted the value of partnerships between banks and digital asset-focused organizations in the webinar. Leveraging digital asset-native firms' expertise becomes crucial in overcoming integration challenges and streamlining the process through iterative learning from past experiences. Choosing a sub-custodial route allows banks to swiftly enter the market, meeting regulatory requirements and benefiting from established operational processes. This choice minimizes risk by relying on custodians with strong audit and regulatory compliance, added Darren.

The Emergence of Crypto Custody by Giant Banks

Banks have quietly been involved in the digital asset space for several years. Initiatives like Nomura's Komainu in 2018 show this, but stigma around crypto made banks hesitant. However, behind the scenes, they've been exploring proof of concepts. Now, banks are more open about their involvement, signaling confidence in digital assets and crypto.

The trend of traditional banks offering crypto custody services gained traction in 2021. It marked a watershed moment when Bank of New York Mellon (BNY Mellon), a stalwart institution that had assets under custody amounting to almost $47 trillion, announced that it was developing a multi-asset digital custody platform in February 2021. This pivotal move signaled a shift in the traditional banking landscape's attitude toward digital assets.

Other banking giants like Banco Bilbao Vizcaya Argentaria (BBVA) and U.S. Bank swiftly followed suit, underlining the growing interest among banks in providing crypto trading and custody services. BBVA's move into Switzerland emphasized the expansion of services to include Bitcoin trading and custody for its clientele. Deutsche Bank, on the other hand, partnered with Swiss firm Taurus to offer custody services for institutional clients, marking its entry into the crypto custody space.

More recently, the third-largest bank in Germany, DZ Bank, has launched its blockchain-based digital asset custody platform. This platform, introduced on November 2, 2023, caters to institutional clients by offering access to crypto securities.

Shortly after, on November 15, Commerzbank secured a crypto custody license from German regulators, becoming the nation's inaugural "full-service" bank to enter the realm of crypto custody. This license empowers the bank to develop an extensive array of digital asset services, focusing notably on crypto assets.

Moreover, HSBC announced its intentions to introduce a custody service in 2024 for storing blockchain-based tokens, excluding cryptocurrency, through a partnership with Swiss digital asset firm Metaco. The platform, set for launch in 2024, supplements HSBC's recent ventures into tokenized gold and the issuance of digital assets.

Bank Crypto Custody in the UAE: A Gateway to Financial Innovation

A traditional bank in the UAE has obtained a No Objection Certificate (NOC) from the UAE central bank to operate as a custodian, a source speaking to Unlock. However, despite this clearance, the bank is yet to receive the necessary license from the regulators.

The global shift towards embracing cryptocurrencies is evident, with leading jurisdictions like Switzerland, Singapore, and the European Union making substantial strides in accommodating crypto custody services. However, Standard Chartered's choice of the UAE as its crypto custody service hub is purposeful, driven by the UAE's favorable regulatory landscape compared to increasingly tense scrutiny in the US.

Additionally, Nomura-backed crypto custody firm Komainu obtained its operational license from VARA on August 18, 2023. This achievement follows its successful acquisition of an MVP license to offer crypto custody services in November of the previous year. Having completed the entire licensing process with VARA, Komainu is now poised to deliver its range of custody services to clients in the Emirate. This includes offering institutional staking and collateral management through its Komainu Connect platform. This step signifies the growing momentum of the UAE as a burgeoning hub for crypto custody services, indicating a transformative era in the region's financial landscape.

Sebastian Widmann, Head of Strategy at Komainu, conveyed his optimism regarding the entrance of traditional banks into the custody space during an interview with Unlock. He viewed this development as a sign of heightened institutional adoption and a positive trajectory for market growth.

Deciphering the Drivers: Why Traditional Banks Embrace Crypto Custody

The entry of traditional banking giants into crypto custody is propelled by several key drivers. Firstly, the increasing institutional inflow into digital assets demands robust custody services. Wealthy investors, seeking established and trusted partners, are nudging banks into this space, driving them to cater to the evolving needs of the market. "We’re seeing increasing demand for custody and fund administration of digital assets from asset managers and asset owners, as this market continues to evolve," Zhu Kuang Lee, chief digital, data and innovation officer at HSBC, told Reuters.

Regulatory milestones, such as the US Office of the Comptroller's (OCC) approval for banks to offer crypto custody, have acted as catalysts, providing a green light for banks to explore this domain. Additionally, global regulations aiming to safeguard banks against potential risks associated with crypto assets are encouraging their involvement while ensuring a level playing field in banking. The classification of crypto assets into different risk categories by authorities like the Basel Committee on Banking Supervision (BCBS) helps establish clearer guidelines and rules for banks holding these assets, ensuring a more secure environment for investors.

Furthermore, the integration of distributed ledger technology (DLT) and blockchain in the financial sector is reshaping banking practices. Banks are recognizing the potential advantages of using digital currencies, not just as investment vehicles but also as mediums of exchange, prompting them to explore custodial accounts for digital assets.

Digital Asset Investment Products Witness Substantial Inflows

In a rapid surge within two months, institutional investments in Bitcoin have surged, shaping a pivotal shift in the crypto landscape. Assets under management for crypto Exchange-Traded Products (ETPs) linked to Bitcoin nearly doubled since 2023 began, illustrating a swift adoption acceleration.

Accompanying this surge is a fascinating trend: the amount of stored Bitcoin now exceeds newly mined amounts by 2.4 times, according to Glassnode’s latest weekly newsletter, “The Week On-Chain”. This underscores growing institutional confidence in Bitcoin as a robust asset class with significant long-term growth potential.

The injection of over $1 billion into Bitcoin within two months underscores the crypto sphere's resurgence. The excitement around the potential approval of the U.S.' inaugural Bitcoin and Ether ETFs has spurred significant price surges in major altcoins. While the total market capitalization of crypto increased by $600 billion within a year, the standout revelation lies in the recent surge of funds directed towards crypto investment products mainly in the last two months as shown in the below TradingView chart.

Total Cryptocurrency Market Capitalization: Nov. 22, 2022 – Nov. 22, 2023. Source: TradingView

CoinShares' November 20 report reaffirms this narrative, highlighting the renewed capital influx into Bitcoin and alternative coins, shaping a promising market trajectory in 2023. The report highlights consistent upward trends, with digital asset products witnessing substantial inflows of $176 million in the last week alone. This marks eight consecutive weeks of inflows, accumulating year-to-date inflows of $1.32 billion. Trading volumes in ETPs doubled this year's average to reach $3 billion per week, accounting for an average of 11% of total crypto volumes, surpassing the long-term historical average of 3.4% and averages observed in the 2020/2021 bull market.

Bitcoin saw inflows of $155 million in the past eight weeks, representing 3.4% of total assets under management. However, short-bitcoin products experienced $8.5 million outflows last week. This positive sentiment aligns with the impending approval of a spot-based Bitcoin ETF in the U.S., affirming Bitcoin's significant position among institutional investments.

Source: Bloomberg, CoinShares, data available as of close 17 November 2023

Source: Bloomberg, CoinShares, data available as of 17 Nov. 2023.

Balancing Decentralization: Banks and Crypto Custody

As traditional banks enter the realm of crypto custody, concerns regarding the potential impact on decentralization arise. The essence of cryptocurrencies lies in their decentralized nature, offering individuals autonomy over their assets without relying on intermediaries like banks.

While the involvement of banks in custody services may introduce centralized custodians, it is important to note that many institutional and retail holders of crypto assets prefer to store assets with custodians, regardless of whether they are crypto-native or established banks. Nevertheless, this notion doesn't impede millions of other crypto holders from being their own bank and storing coins in personal wallets, preserving decentralization at an individual level.

Conclusion: A Transformative Future

The entry of traditional banks into crypto custody marks a profound shift in finance, reflecting the merging realms of traditional finance and digital assets. Custody services, while less glamorous, are vital for instilling trust and driving broader adoption of cryptocurrencies. Integrating digital assets into banking systems proves intricate due to technical, operational, and regulatory complexities, exacerbated by diverse global regulations.

Collaborating with specialized digital asset firms becomes crucial for streamlined integration and iterative learning. As banks navigate regulatory landscapes and customer needs, the future holds a promise of seamlessly integrating crypto into traditional banking, fostering a comprehensive, regulated, and secure digital asset management ecosystem for a transformative financial future.