Crypto Custody Has a Problem and Only Banks Have a Solution

TradFi types might find this pretty cool — DeFi types might not be up for it yet

OPINION
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Paul Fleet/Shutterstock modified by Blockworks

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There’s nothing more some in the crypto industry would like than to seize upon the failures of Silicon Valley Bank, Signature Bank and Silvergate to sow distrust of traditional financial institutions. And while it doesn’t seem these banks did anything illegal at this juncture, the events may indicate a broader, perhaps industry-wide, failure. In fact, a recent report suggests that at least 190 additional banks in the US are currently in danger of uninsured market runs (similar to that of SVB and Signature). 

Despite the crisis, traditional banks are in many ways still far better equipped to provide crypto services than their crypto counterparts are. First, banks are skilled at taking custody of assets in a manner that is secure and compliant with regulation. Second, banks, in many cases, are still considered to be more trustworthy and transparent than their crypto-native counterparts. And third (most importantly), traditional banks can offer more diversified portfolio management, straddling both the crypto and fiat domains. All three points here give banks a definite leg-up in providing digital asset services to retail and institutional investors alike.

A deep, dark void of trust 

The hacks, insolvencies and crashing crypto valuations that characterized 2022 have eroded consumer trust and confidence in crypto to its lowest levels in years. Believers and skeptics alike have had their faith severely tested. Increasingly, both critics and crypto natives are calling for more regulation and oversight. Industry thought leaders and exchange CEOs are all urging for self-custody. With a general lack of trust for all things crypto native — and in particular centralized exchanges (CEX) — a major void has formed within the industry.

Up until now, the market has virtually been monopolized by crypto-native companies. Financial institutions have been slow to keep pace with their crypto-native counterparts. In fact, a recent survey by Celent found that 65 percent of institutions go through crypto-native platforms for digital asset services, such as trading, lending and borrowing.

However, over the last couple of years, traditional financial institutions have gradually warmed up to digital assets, realizing that they have been missing out on viable revenue-generating opportunities. With 35 percent of the market share at the end of 2022, traditional finance has been steadily gaining traction for crypto custody, even prior to the collapse of FTX.

Regulation is around the corner

Given the events of the past year, regulators around the world have upped their game. MiCA (Markets in Crypto Asset) regulations are expected to be passed in the EU during the first half of 2023. Earlier this year, the UK announced plans to strengthen regulation in the crypto industry, with stricter rules for financial intermediaries, custodians and crypto trading platforms. The US is also slowly making progress with a framework published in late 2022, albeit with less certainty. 

Straddling the divide

Banks offering digital asset services could easily straddle the divide between traditional finance and the ‘future economy’ by offering customers access to diversified portfolio management. No longer would investors need to manage their crypto with A and their fiat with B.

Case in point, the aforementioned Celent survey suggests that 70 percent of institutional investors would increase their digital asset activity if services like custody and management were available from recognized, trusted institutions. 

Moreover, 72 percent of institutional investors prefer to work through financial institutions providing hybrid portfolios consisting of both digital and fiat-backed assets. This indicates that the prevailing separation of asset classes doesn’t provide the optimal strategy for most investors.

Not as easy as it seems

Traditional financial institutions are well-positioned to fill the void of ‘trust,’ have more experience in asset custody, and know how to work with regulatory bodies — all of which positions them to take advantage of new revenue-generating opportunities in the custody and management of digital assets.

But there’s certainly a learning curve for financial institutions entering the digital asset custody space. While banks are well versed in safeguarding fiat assets, the custody of digital assets often requires a different mindset. The very nature of these digital assets exposes them to unique challenges which require additional safeguards. 

Banks need to look to technology solutions that will enable them to effectively custody digital assets in a way that fits their operational needs while providing the highest degree of security. Luckily, digital asset custody solutions have come a long way and are empowering financial institutions to play a larger role than many would have imagined a year ago. 

Regulators, investors and responsible industry players are all looking to minimize uncertainty and guarantee basic investor protections. The crises experienced across both markets make the need for a safer, more stable, financial ecosystem for all more clear than ever before. An ecosystem in which traditional financial institutions have an opportunity to take the lead.



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