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In April 2022, the U.S. Securities and Exchange Commission (SEC) published guidance about how corporations should account for the custody of crypto-assets on behalf of clients. The SEC says these crypto-assets should appear as both an asset and a liability, whereas the custody of conventional assets does not touch a balance sheet. Although the Basel Framework considers custody outside its scope, if banking regulators concur with the SEC's position, crypto custody could become expensive for banks. In fact, Reuters is now reporting that some U.S. banks are rethinking plans to offer crypto custody services.

The Capital Markets and Technology Association published a common industry standard for the management and custody of crypto assets. Dubbed "Digital Assets Custody Standard," the document attempts to elucidate how the custody of digital assets differs from that of traditional assets. Having identified the differences, the CMTA then laid down foundational security and operational requirements for crypto custody providers. https://www.cmta.ch/news-articles/cmta-issues-open-industry-standards-for-custody-and-management-of-digital-assets

Boerse Stuttgart Digital, the digital asset brand of the Boerse Stuttgart exchange group has received final licensing from the German Federal Financial Supervisory Authority (BaFin) for its blocknox service to operate as a crypto custodian. Boerse Stuttgart Digital has been providing custody services through blocknox under a provisional license since crypto custody regulations were introduced in Germany on January 1, 2020. It had begun offering trading services to German residents in the prior month and introduced a trading app in 2021. Boerse Stuttgart Digital received its final custody licensing ahead of several other contenders, including Binance. https://www.boerse-stuttgart.de/-/media/files/gruppe-boerse-stuttgart/pressemitteilungen/en/2023/230330-mr-boerse-stuttgart-digital-crypto-custody-licence.ashx

Bakkt has acquired crypto custodian, Digital Asset Custody Company, and partnered with custodial bank, BNY Mellon. These developments are part of its strategy to provide a fully regulated, end-to-end crypto asset custody and trading ecosystem for institutional investors.

Custodial solutions are important for financial markets, whether traditional or innovative, and have been historically limited for Bitcoin. But why do institutional investors need custodial services, and what are the unique challenges of Bitcoin custody?

The venture investments unit of Standard Chartered, will begin offing crypt-asset custody services to institutional clients. It has partnered with Northern Trust to launch Zodia Custody, an institutional-grade crypto custodian targeting institutional and wealthy clients. Zodia's launch is expected next year, pending approval of the UK Financial Conduct Authority. In July, U.S. Comptroller of the Currency Brian Brooks announced that American banks are allowed to offer custody services for digital assets.

"Even with the blessing of regulators, crypto custody on its own doesn't make economic sense for banks that are subject to strict capital rules. In March, the US Securities and Exchange Commission published an accounting guideline that said public companies holding crypto assets on behalf of clients should treat them as liabilities on their balance sheets. That means banks would need to hold capital to offset liabilities created by crypto in custody. It's "something we see as restricting our ability to scale our offering fully," Caroline Butler, BNY Mellon's CEO of custody services, told me in an interview. State Street, among others, is trying to persuade the SEC to change the guideline."

Thailand's Securities and Exchange Commission (SEC) issued new regulations on custodied crypto-assets. Companies offering crypto custody services are now required to "establish a digital wallet management system to accommodate efficient custody of digital assets and keys and ensure safety of clients' assets." https://www.sec.or.th/EN/Pages/News_Detail.aspx?SECID=9827

Adam Levitin considers what would happen to customers' custodial holdings if a crypto-asset exchange in the United States were to fail. U.S. law gives substantial protection to the custodial holdings of securities, commodities, or cash deposits by securities or commodities brokers or banks, but no such regime exist for custodial holdings of crypto-assets. Instead, bankruptcy courts are likely to deem the custodial holdings to be property of the bankrupt exchange, rather than of its customers. The customers would merely be general unsecured creditors of the exchange, entitled only to a pro rata distribution of the exchange's residual assets after any secured or priority creditors had been repaid.

Fidelity may not be offering ethereum custody support at first, due to uncertainty over hard forks. This caution highlights some of the intrinsic risks of crypto assets and goes a long way toward explaining why institutions are taking a cautious approach. Crypto asset custody is riskier and more complicated than most realize

Despite all of the advances in digital custody, the industry will need to wait for the appropriate legislation to define what digital custody is and what it entails.

For anyone working in the digital assets space - be it cryptocurrencies or asset tokenization - the question of how the custody industry can evolve to support digital assets is still unresolved. The starting point perhaps should be: What do we actually mean by digital custody?

Avanti, a new crypto-asset bank to be based in US frontier state Wyoming, will take advantage of the state's potentially revolutionary new legal framework for the custody of clients' crypto assets. In contrast to hundreds of years of established practice in the global markets for banking and securities custody, Wyoming's laws emphasise that clients' assets cannot be reused without their consent.

In a move to lure more institutional money into the space, U.S. crypto exchange Coinbase just completed two major security audits for its custody solution.  Coinbase Custody, the exchange's custody subsidiary, recently underwent its SOC1 Type 2 and SOC2 Type 2  compliance certifications for the second half of 2019.

"The business opportunities presented by cryptoasset custody models are significant. The wave of institutions entering and participating in the market need a trusted partner to hold their cryptoassets for safekeeping, minimizing the risk of theft or loss while ensuring they are available and accessible for speedy transactions on blockchain networks. However, the technical and operational requirements of cryptoasset custody, security and exchange create unique challenges for enterprises and financial services institutions, including both traditional institutions and crypto-native startups."

SEC staff issued a public statement asking questions about the definition of "qualified custodian." That term is traditionally applied to banks, brokerages, and futures commission merchants. The statement, from the SEC's Division of Investment Management, follows a no-action letter from the Wyoming Division of Banking to a state-chartered public trust company, Two Ocean Trust. In it, the division judges Two Ocean to be a "qualified custodian" and therefore eligible to "provide custodial services for digital assets under Wyoming law, including virtual currency and digital (tokenized) securities." https://www.sec.gov/news/public-statement/statement-im-finhub-wyoming-nal-custody-digital-assets

The US Securities and Exchange Commission has proposed the expansion of custody rules to include crypto-assets. In order to become a "qualified custodian" U.S. and offshore firms would additionally need to ensure that all custodied assets are properly segregated, while these custodians will be required to jump through additional hoops such as annual audits from public accountants, among other transparency measures.

"Banks in Virginia will soon have the option to provide cryptocurrency custody services, after the state's Senate unanimously voted last week to approve a bill amendment focused on the custody of digital assets."

Lawmakers in both the U.S. House and the Senate have taken formal steps to reverse the Securities and Exchange Commission's (SEC's) Staff Accounting Bulletin (SAB) 121, which makes providing crypto-asset custody services prohibitively expensive for banks. SAB 121 rule forces all listed companies, including banks, to disclose crypto-assets under custody as both an asset and a liability on the balance sheet, which is not the standard accounting treatment, because the assets don't belong to the company. Even the Federal Reserve Chair, Jerome Powell, has acknowledged the SAB 121 treatment is "unconventional". This rule is especially problematic for U.S. banks because they are subject to capital requirements based on their balance sheet.

The developers at ZenGo, an Israeli startup that recently released a keyless, non-custodial retail wallet, just published open source code for Libra's first non-custodial wallet, just two weeks after Facebook's announcement.