(Bloomberg) -- In the traditional investment world, providing custody of assets is a pretty boring, albeit crucial, business: Keeping clients’ holdings of stocks and bonds safe is a fairly straightforward job.
Yet in the roughly $2 trillion cryptocurrency market, a favorite playground for hackers and fraudsters, custody is anything but boring. As a result, the service costs up to 10 times more than safeguarding traditional assets like securities and cash, according to Hadley Stern, chief commercial officer for Solana custody tool Marinade, who previously headed digital asset custody at Bank of New York Mellon Corp. That makes it a potentially attractive growth area for startups as well as Wall Street banks and other firms looking for ways to expand into digital assets.
Crypto-native firms such as Coinbase Global Inc. and BitGo Inc. have been among the dominant service providers so far, with traditional financial companies mostly in a holding pattern because of the regulatory uncertainty that surrounds digital assets. While only about a $300 million market now, the business remains alluring with participants such as Fireblocks Inc. estimating the sector is growing at about 30% annually.
“New entrants are betting that this market becomes substantially larger,” said Campbell Harvey, a finance professor at Duke University.
BNY Mellon, State Street Corp. and Citigroup Inc., some of the largest custodial banks in the world, have made initial forays into crypto custody or have expressed interest.
Custody has been controversial since the earliest days of crypto, when many participants adhered to the expression “not your keys, not your coins.” The term sprung from the fact the only those who possessed the encrypted keys to open digital wallets truly controlled the assets.
While custody firms have helped to lower the risk of theft and hacks, missteps continued. Just this month, both the retail brokerage Robinhood Markets Inc. and investment firm Galois Capital reached settlements with US regulators, at least partially over crypto custody-related failings. Robinhood said it’s since corrected the problems.
“Both cases emphasize how important qualified custody is to institutional investors,” said Tim Ogilvie, global head of institutional at the exchange Kraken, which also provides custody.
So far, Wall Street efforts have been full of fits and starts. BNY Mellon announced its digital-asset custody infrastructure in 2022, but is yet to expand the endeavor. In 2023, Nasdaq Inc. halted its crypto custody undertakings.
Still, companies are moving ahead with trials, with many plans revolving around safeguarding tokenized assets. JPMorgan Chase & Co. runs a project called Onyx, which allows for blockchain payments between the bank’s clients, for example. In December, Depository Trust & Clearing Corp. acquired Securrency to provide products for tokenized traditional financial assets. In August, State Street selected provider Taurus for tokenization and custody for digital-asset services.
“This partnership would provide us with the technological foundation to offer, subject to regulatory approval, digital asset custody services once the regulatory climate, particularly in the US, becomes more favorable,” said Donna Milrod, head of digital asset solutions at State Street.
One major issue that’s hindering established financial entrants is a US Securities and Exchange Commission rule, known as SAB 121, that makes it impractical for highly regulated financial firms to provide crypto custody. President Joe Biden vetoed Congress’s effort to overturn it. A few banks have received exemptions from the rule.
In a Sept. 9 speech, an SEC official highlighted specific examples when the agency’s staff has allowed entities not to adhere to SAB 121 and explained why. Still, others that are struggling to get exemptions are awaiting the results of the US presidential election to see if Donald Trump returns to the White House and fulfills his vow to replace SEC Chair Gary Gensler with a regulator who will fully open the door to crypto.
“Although the SEC has begun to provide relief under SAB 121 for banks, it has not done so in a transparent manner that applies across the board,” said David Portilla, a partner at Davis Polk & Wardwell LLP who represents banking and crypto clients. “The technological, legal and regulatory risks cited by SAB 121 are substantially mitigated by the existing and extensive legal and supervisory framework that applies to banking organizations, yet the SEC’s policy does not reflect that.”
Even overseas providers are making plans for a possible regulatory change. After a retrenchment last year, London-based Copper is considering a fresh focus on the US market if Trump wins.
“It’s just, depending on the election outcome, it might happen faster or slower,” said Bobby Zagotta, chief executive officer of crypto exchange Bitstamp USA, which uses BitGo for custody. “The main Wall Street players are not going to miss an opportunity, particularly if it signals an evolution of the traditional services marketplace.”
--With assistance from Muyao Shen and Emily Nicolle.
©2024 Bloomberg L.P.