Traditional financial institutions are inching ahead on cryptocurrency custody and other services as exchange-traded funds that track the price of bitcoin take a step closer to hitting Wall Street.
A recent court decision may push the Securities and Exchange Commission to reevaluate its previous rejection of a spot bitcoin ETF, and banks should be ready to meet the market, experts said.
Wall Street has dragged its feet on touching volatile digital currencies, but last week, the U.S. Court of Appeals for the D.C. Circuit ruled that the SEC's rejection of the crypto-asset manager Grayscale's application to list a spot bitcoin ETF was "arbitrary and capricious."
Spot bitcoin ETFs would give investors exposure to bitcoin on an exchange without having to own the underlying asset since the manager of the fund would hold the bitcoin. The SEC has already approved bitcoin futures ETFs, which track contracts to buy and sell bitcoin at a predetermined price on a later date. The appeals court ruled that the federal regulator couldn't provide a "coherent explanation" as to why it approved futures bitcoin ETFs, but not the proposed spot bitcoin ETF.
The court's decision has stirred optimism that a spot bitcoin ETF will be approved, said Carl Fornaris, co-chair of the digital assets and blockchain technology group at the law firm Winston & Strawn. He added that financial institutions are monitoring developments so they can keep up with regulation.
"I think this is something that is very much on [banks'] radar, and they will want to be poised and ready to go if and when the SEC does issue an approval so that they have a product with the right team ready to launch," Fornaris said."
Fornaris said it's also important that financial institutions discuss digital-asset plans with federal regulators, which he said have been "skittish" about banks offering crypto products and services.
State Street, one of the largest custodian banks in the world, is ramping up crypto services to take advantage of the potential opportunities presented by the court ruling, like custody and administration for ETFs. The Boston-based bank sees a spot bitcoin ETF in the U.S. as a way to increase accessibility to the currency for institutional investors, without them having to own it, said Frank Koudelka, global head of ETF solutions at State Street.
The court decision could also open the door for other spot bitcoin ETF applications, including from major players like BlackRock, Invesco and Fidelity, Fornaris said. Banks like State Street then act as the fund administrator of the ETF, providing custody of ETF shares, fund accounting and transfer agency.
State Street is slated to be the fund administrator for a spot bitcoin ETF listed by the investment manager VanEck, if approval goes through. Head of Digital Assets Jay Biancamano said the institution is working to start offering custody of bitcoin and ethereum by the end of the year, pending regulatory approval.
"For most clients, building to have custody and administration under the same umbrella is preferable," Biancamano said. "So that's what we're looking to do. Offer not only our fund administrator services and ETF services, but also custody — all to the same clients."
The bank had previously been working with the crypto custody firm Copper on the service, but pivoted away in March and is working with a different undisclosed partner, Biancamano said. Bank of New York Mellon also announced last fall
Bank of New York Mellon didn't think it would need to record on its balance sheet digital assets held in custody when it asked the New York State Department of Financial Services for permission to offer the service, according to a filing obtained by American Banker. The SEC has since said otherwise.
Biancamano said providing administrative services for spot bitcoin ETFs is similar to other ETFs, but that State Street has more stringent rules and requirements around crypto because it's unregulated and volatile. Koudelka said a spot bitcoin ETF provides end investors with the same benefits of other ETFs, like intraday liquidity and access on an exchange.
"We continue to see more innovation, bringing in innovative asset classes, to allow for better diversification and asset allocation for end investors," Koudelka said. "So when I look at spot bitcoin … it's really what the ETF issuers are trying to bring. 'How do we get investors married up with products that they're interested in and put it in a very liquid wrapper?'"
Koudelka and Biancamano said that spot bitcoin ETFs are just the tip of the iceberg, and that State Street is hearing from clients that plan to eventually operate crypto ETF strategies that offer more than just bitcoin, such as an index or a multi-asset basket.
"I think what you'll see in the market is hopefully we'll have a crypto ETF approved within the next year," Biancamano said. "That will result in a stampede of others looking to get into the space. … Then you'll start to see clients or asset managers look to diversify and offer more sophisticated products with exposure to the space."
The appeals court ruling, which came out Aug. 29, isn't an automatic win for spot bitcoin ETFs. Now, the SEC could appeal the decision, which would send the case either to the Supreme Court or an "en banc" appellate-panel review. If the regulator doesn't appeal, the court could mandate that the SEC approves Grayscale's application, or it could direct the SEC to reassess, in which case it could either approve or reject the application on different grounds.
But sentiment among the traditional financial market around crypto is shifting, experts said.
Caitlin Long, CEO of the crypto-focused institution Custodia Bank, said that BlackRock's application for a spot bitcoin ETF similar to Grayscale's in June was a watershed moment for banks. She added that she isn't optimistic about SEC approval of the ETF in the near future but thinks that the $9-trillion-asset-under-management firm's filing, since it came from a traditional financial firm, was a signal to Wall Street that "bitcoin is not going away."
"I am not expecting a positive decision on the ETF," Long said. "But I think the punchline is everyone sees what's going on. Bitcoin did not go away. Now the regulators in Washington, D.C., are coming to the realization that they need to do something to create a regulated pathway for the industry. And if they don't do it, the courts are going to do it for them."
Custodia is currently awaiting federal approval to custody bitcoin.
