Hackers and fraudsters are attracted to crypto like flies to honey. This makes crypto custody a high-stakes business, as opposed to custodying traditional assets like stocks and bonds, which is considered to be a crucial but fairly straightforward job.
The high stakes come with the high risk of safeguarding crypto, which in turn makes crypto custody an expensive business. According to Hadley Stern, chief commercial officer for Solana custody tool Marinade, it costs up to 10 times more to custody crypto compared to traditional assets, Bloomberg reported.
According to Stern, who previously headed digital asset custody at Bank of New York Mellon Corp, the higher costs make crypto custody a prime growth area for traditional Wall Street banks and startups alike.
Currently a $300 million market, crypto custody business is growing at a fast pace—at a rate of around 30% annually, according to estimates by Fireblocks.
Campbell Harvey, a finance professor at Duke University, told Bloomberg that new entrants in the business are “betting that this market becomes substantially larger.”
Traditional banks have been foraying into crypto
Currently, crypto custody is dominated by Coinbase and BitGo. This is because traditional firms have been dithering about foraying into crypto given the regulatory uncertainty.
However, banks like BNY Mellon, State Street Corp., and Citigroup have either entered the business of crypto custody or announced plans to do so. But players have mainly been taking baby steps.
For instance, BNY Mellon launched a digital assets custody platform in October 2022, but it only supports Bitcoin and Ethereum custody and is yet to expand to other cryptocurrencies. Nasdaq, on the other hand, paused its plan of launching a crypto custody business in July 2023 citing “shifting business and regulatory environment,” after announcing it in September 2022.
Crypto custody is controversial
Third-party custody services have long been frowned upon by the crypto community. The longstanding crypto mantra of “not your keys, not your coins” continues to cast a shadow on custody services. This phrase emphasizes the importance of holding one’s own encryption keys to maintain control over assets.
Crypto custody firms have strived to lower the risks of hacks and thefts, but their records are far from being squeaky clean. Earlier this month, Robinhood, a popular retail brokerage firm, and investment firm Galois Capital settled with the U.S. Securities and Exchange Commission (SEC) for lapses in custody protocols, at least partially.
The U.S. SEC remains the main hurdle
One of the significant regulatory hurdles has been the SEC’s rule, SAB 121, which imposes restrictions on financial firms offering crypto custody services. While President Joe Biden vetoed a congressional effort to overturn the rule, a few banks have received exemptions.
In a Sept. 9 speech, an SEC official explained with examples the specific cases when banks have received an exemption from the SAB121 rule and why. Still, uncertainty persists, with many in the industry awaiting potential changes depending on the outcome of the U.S. presidential election.
The crypto community is waiting with bated breath for former president Donald Trump to win the November elections. Trump has vowed to replace SEC chair Gary Gensler with someone who would embrace crypto rather than stifle it.
David Portilla, a partner at Davis Polk & Wardwell LLP who represents banking and crypto clients, told Bloomberg:
“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…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.”
Some overseas players, like London-based Copper, are waiting for Trump to win to refocus on the U.S. market.
“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. He added:
“The main Wall Street players are not going to miss an opportunity, particularly if it signals an evolution of the traditional services marketplace.”