Will users of digital assets need traditional custody providers?

There are only a handful of banks that currently dominate global custody markets, and as we see an increase in the use of digital stocks and bonds, there is a real possibility that being able to keep up with and real-time asset tracking and / or having the use of multi-signature portfolios could remove the need for custodial services as we know them.

Banks are under increasing pressure to adopt new business practices and offer alternative products and services as financial markets evolve and adopt more technology, both at the institutional and retail level.

As our lives become more and more digitized, there is an increasing dependence on computing and automated processing, as opposed to many analog paper-based systems that have historically been the backbone of systems and procedures. banking.

For example, there is a growing question about the current need for custodial services which have historically been provided by banks offering to hold assets (such as stocks, bonds and commodities) on behalf of their clients. safe and secure way.

Custodians by assets under custody …

Source: The Asian Banker

Custodian bankers generally do not offer what might be termed traditional banking services – mortgages, checking accounts or loan services, but have focused on offering institutional services, especially for fund managers.

At some level, it’s quite odd that an investor in a fund managed by Blackrock – the world’s largest fund manager with over $ 7.1 trillion in under-managed assets – has to rely on a third party. such as a custodian and not Blackrock for the safety of its funds. .

Financial services regulators, such as the SEC in the US or the FCA in the UK, insist that Blackrock must use an external, independent custodian to actually own the assets – the stocks or bonds of a fund. , for example. This adds to the costs of the fund to the investor as well as an additional level of complexity and the requirement for more records to be verified and monitored, as well as the inevitable queries and delays in processing. data reconciliation.

At the time, the requirement for such a system was developed when asset managers were required to physically process paper assets and it was extremely difficult to know for sure who actually had physical possession of them. a share or bond certificate.

Unsurprisingly today, there is a threat of redundancy for this rather archaic mode of money management, with the existence of the digitization of information.

The ability to keep data in a very structured way means that machines can easily track and trace who owns what and where assets are held, in “real time”.

The application of blockchain technology and the use of smart contracts ensure that most of the current manual checks and monitoring can be done automatically. Therefore, it’s no surprise that organizations such as the Depositary Trust and Clearing Corporation (DTCC) have worked with IBM to create a Blockchain-powered platform to manage the current $ 10 trillion in derivatives that the DTCC manages per year.

Recently, Singapore’s financial regulator allowed Asian bank, DBS, and cryptocurrency exchange, Independent Reserve (based in Australia), to offer digital asset services to retail clients as well as clients. institutions in Singapore. Independent Reserve CEO Adrian Prelozny urged Australians to follow Singaporean “in-depth approach to crypto industry licensing», Reminding them that “there are no depositary requirements for trade in Australia”.

Are multi-signature parties necessary?

Meanwhile, there is an argument that by using a multi-signature wallet, it is not necessary to have a separate business to provide custodial services since the only way assets can be transferred from a multi-signature wallet is if a number of multi-signature parties are involved.

While this sounds appealing as no party is solely responsible for the security of the digital asset, so custody fees may be lower. However, multi-signature wallets present challenges:

  • if something goes wrong, finding a legal address can be a challenge, as multi-signature wallets are relatively new concepts.
  • transaction speed can be slow because multi-signature wallets need multiple parties to complete a transaction.
  • The process of recovering a multi-signature wallet requires importing each of the recovery phrases to a different device, which is not a quick process.

For now, institutions that trade and hold cryptocurrencies are required to continue using custodial services, which is why some of the larger traditional providers, such as Bank of New York, State Street and more recently US Bank, now offer digital asset custody. services.

Although the cryptocurrency market is still relatively small (around $ 2.5 trillion), as we start to see more and more organizations issuing digitized equity and debt securities, the bond using traditional banks to provide custodial services may well be increasingly challenged.

The potential ability to remove the need for a custodian is an example of “disintermediation” – a term often used as a primary reason financial markets are disrupted by blockchain-based platforms. In addition, such use of blockchain-powered platforms offers greater transparency, and therefore greater confidence, which should lead to lower professional liability insurance premiums and lower costs for the end customer. .

A smaller “total expense ratio” for a fund should lead to better performance of funds held in your retirement plans and savings. The use of blockchain technology also offers compliance departments and regulators, as well as senior management, greater oversight (potentially in real time).

These are powerful drivers that help to encourage the enormous potential offered by blockchain technology and, in turn, this raises the question of what funds in the future will invest in the use of digital assets or even need the custodians. traditional which are so widely used today?