Tuesday 1 September 2020 12:23 pm

The Race for Digital Asset Supremacy

The financial services industry is in the midst of a generational transition. 

Where once cryptocurrencies and digital assets represented a counterculture movement, developed as a direct response to the failings of the financial system in the 2008/9 financial crash, today they have become a central part of the financial services industry. 

The adoption of digital assets and distributed ledger technology (DLT) use-cases by governments, financial institutions, and global corporations has reached a peak that we have not seen before. PayPal recently announced that it will bring crypto trading to its 325M+ users, a number of governments are accelerating their plans for Central Bank Digital Currencies (CBDCs) and Visa has filed a patent for its own blockchain based digital dollar

Secure custody infrastructure is the cornerstone upon which the success of many of these digital asset use-cases will lie. There are far too many reports of crypto use-cases compromised by hacks and stolen funds due to ineffective infrastructure, and financial institutions, in particular, require institutional grade solutions. 

Considering the rapidly evolving lifecycle of digital assets, the significance of the Office of the Comptroller of the Currency’s (OCC) announcement that all nationally chartered banks can provide custody services for cryptocurrencies cannot be overstated. It is the biggest news of the year in digital asset adoption and a complete game changer. 

With the stroke of a pen, the OCC has transformed the landscape for crypto custody in the US and globally, as it is likely that a trickle down effect will occur as other jurisdictions follow suit. This development did not occur in a vacuum, and has undoubtedly been influenced by the regulatory warmth towards digital assets by many jurisdictions in Europe and Asia.

Fidelity recently reported on the considerable disparity in the adoption of digital assets by institutional investors in the US versus those in Europe. In the US only 27 per cent of institutional investors are invested in digital assets, a figure rising to 45 per cent in Europe. It is in jurisdictions where regulators have a clear taxonomy for crypto and a licensing regime such as Germany, Switzerland, Japan, and Singapore, that we have already seen legacy banks develop crypto custody capabilities. 

These developments had not gone unnoticed by the US financial giants, many of whom have been quietly experimenting with cryptocurrencies and digital assets without a clear roadmap of the business case or timing for productive deployment–hamstrung by a lack of regulatory clarity. 

That murkiness has now decisively cleared and looks likely to set off a race among banks to develop secure custody infrastructure solutions. Already the signals of such competition are emerging, with Standard Chartered Bank publicly declaring its intent to build a Digital Asset Custodian for the launch of crypto custody offerings. 

Enabling banks to offer crypto custody is a huge step towards mainstream institutionalization and retail access to cryptocurrencies. Once the incumbent players in financial markets offer access, adoption of digital assets will significantly increase. If you can trade Bitcoin futures through the same broker and exchange that you trade Eurodollar futures, the ease of access and seamless integration with your existing rails removes the barriers to entry to crypto futures markets. 

As the race for development heats up among financial institutions, the question of speed to market and “build or buy” will no doubt be a focal point. One can expect a significant increase in M&A, with a focus on the larger incumbent digital native custodians by banks that want to jump start their business, market share, and also acquire the technical know-how required to manage a digital custodian. 

For those crypto custodians that are not acquired and don’t have significant balance sheets, this is an existential change and will drive further vertical consolidation, as we have seen with trading firms acquiring custodians in an effort to survive and compete with the new challengers.

While some industry experts heed caution in the pace of change that we can expect famously guarded banks to move at, the reality is that many institutions have had plans primed for some time now, and this regulatory greenlight will see many move quickly. 

We are moving to an exciting phase for the markets as custody, the foundation for digital asset markets, migrates from the fringes to a core offering of financial markets. 

A fundamental restructuring of the financial services industry is underway, now is the time for stakeholders to innovate, or be left behind. 

Seamus Donoghue VP Sales and Business Development at METACO

Seamus has extensive domain expertise in investment banking, wealth management, commodities and crypto markets that spans market structure, regulation and technology. He spent 20 years building and managing trading operations across all the global financial centres with JP Morgan, Deutsche Bank, Barclays and Bank of America Merrill Lynch. Since 2011 he has been active as a founder, leader, and investor in fintech and crypto projects including founding Allocated Bullion Solutions, an award winning open architecture technology platform for wholesale precious metals risk management and distribution automation, and as the Asia managing director of the Swiss digital asset exchange Lykke.