Legacy financial institutions continue to develop digital- asset custody solutions to meet institutional demand, despite this year's declines in the crypto markets, regulatory uncertainty and the cost of adding these services.
Bank of New York Mellon and Nasdaq are developing crypto custody platforms for institutional investors, with plans to offer other crypto services. BNY Mellon went live with its custody service for some investors this week, and Nasdaq plans to come to market in the first half of next year, primarily developing the technology internally.
Traditional financial institutions, crypto-native custodian companies and consulting firms believe custody services are the basis of digital-asset management and the gateway for legacy companies to play their hand in the evolving crypto landscape. The revenue custody provides alone isn't enough to support the business case for adding the service, said John Oliver, co-leader of PricewaterhouseCoopers FinTech Trust Services. But some banks and institutions may forgo return on investment in the short term for a longer-term vision in light of growing investor interest, he said.
"Institutional money is used to a certain set of wide- ranging services, they are used to having access to capital at a certain cost, they are used to having access to ancillary services on top of their custody, and many crypto natives may not be there yet," Oliver said.
Leaders in the digital-asset sector told American Banker that traditional financial services companies need to consider whether developing the technology in-house or partnering with third parties is the best course of action.
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BNY Mellon this week launched its digital-asset custody platform to hold and transfer bitcoin and ether for select U.S.-based institutional investors. Caroline Butler, CEO of the firm's custody services, said BNY Mellon's differentiating capability is connecting digital-asset management to the traditional asset space. She said this is important for institutional clients who invest in digital assets, but through portfolios that have a mix of digital assets and some traditional assets.
Butler added that the bank can bring digital and traditional assets together on its systems for clients to facilitate reporting for compliance or tax purposes.
Nasdaq announced last month that it was building a digital-assets business to serve institutions, with plans to launch custody and execution products next year. The second-largest stock exchange aims to increase institutional access to crypto assets, and tapped Ira Auerbach as head of digital assets to lead the strategy and development. Auerbach, who most recently was with the cryptocurrency exchange Gemini as global head of the platform's prime broker, said Nasdaq is developing a distinctive offering.
Custody platforms can use hot wallets, cold wallets or a combination of the two to store cryptocurrency private keys. Hot wallets are connected to the internet, which make them more accessible and scalable but potentially more prone to cyberattacks. Cold wallets are air-gapped from the internet — in other words completely offline, making them more secure but also less accessible.
Auerbach said Nasdaq's platform will combine hot and cold wallet systems in a way that provides scalability and accessibility, but declined to give specific details on the technology. Nasdaq is concurrently expanding its anti-financial-crime technology to tailor capabilities to digital assets.
"A lot of crypto-native exchanges have close to a decade head start on Nasdaq," Auerbach acknowledged. "What we have is a vantage point of working with institutions for over 50 years, intimately knowing the workflows and the requirements from both the custody and the liquidity standpoint. We believe we can combine that with the latest cryptographic tools and bring to market a product that is superior than what currently exists in the marketplace."
Diogo Mónica, co-founder and president of the crypto custody platform Anchorage Digital, said it's difficult for traditional financial institutions to develop crypto custody solutions given talent constraints, legacy technology bogging down systems and a rapidly changing digital asset environment. Anchorage, founded in 2017, was granted a national trust bank charter from the Office of the Comptroller of the Currency in 2021.
PWC's Oliver said banks and firms need to weigh their individual core competencies while deciding how to enter the crypto custody business. Legacy institutions may develop in-house, partner with third parties or even begin down a path and later pivot, but will find a way to offer the service if they so choose, he added.
"When we see these traditional firms get involved, they put significant capital and dedication in to test their hypothesis," Oliver said.
BNY Mellon began designing its digital-asset services last year, but also enlisted financial technology firms to help. The firm used Fireblocks for wallet infrastructure, but fully integrated the system to hold wallets behind its firewall, Butler said. The company also worked with the fintech Chainalysis for analytics to supplement anti-money-laundering compliance and know-your-customer compliance.
"We don't believe in building it all ourselves," Butler said. "We leverage the best-of in the industry, integrated into an open architecture as part of our innovation strategy. So this is just very much in line with what you'll see across a lot of our innovative journeys in the bank."
Butler said BNY Mellon is aiming to roll out more crypto capabilities after monitoring its custody platform for a while, depending on regulatory approval and demand. Auerbach said Nasdaq hopes to launch ancillary services concurrently with its custody platform in the first half of 2023.
Financial regulation has also affected companies' plans to get in the crypto custody game. In March, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 121,
Butler told Bloomberg this week that BNY Mellon
"I do think, given that we've got regulatory approval here in the U.S., that's testament to the institutional- grade standards that we've brought to this particular capability, this particular part of the digital-asset landscape," Butler said. "And we look forward to the continued engagement with our regulators, because they've trusted us to provide custody in the markets."
