Inside State Street’s Digital Unit, which is seeing triple-digit growth

State Street is the second-oldest bank in the U.S. with more than $42 trillion in assets under custody. Now it’s embracing the digital money age.

For some time, the bank has provided access to cryptocurrency services for its clients, typically through exposure to regulated services, such as bitcoin futures. It wasn’t until the start of this year that demand really picked up, however, convincing the company that it needed to set up a dedicated crypto unit —which it did in June.

The Block sat down with Swen Werner, State Street Digital’s managing director, at Token 2049 to learn more about the thinking behind the new unit.

Werner says the bank set up its digital unit due to the “transformational potential” of digital assets and “the observation that the client interest in those assets has been growing phenomenally.”

Early in the year, client exposure to digital assets increased by 300% over a two-month period, he says. And in the months since the unit has been set up, its total assets under management  has doubled on a monthly basis.

State Street’s clients are becoming even more crypto curious too. “We’re equally getting interest from clients right now, saying, ‘What can you do about NFTs?’ ‘What can you do about security tokens?’ And so, we’re having some exploration on that side,” says Werner.

What State Street Digital currently offers

Part of the idea behind State Street’s fledgling digital unit is to bring all crypto related activities — which had been spread across the business — under one roof. 

“We will have better control of our service, product roadmap, our pricing structures and really treat this as a business as opposed to experimentation and proofs of concepts,” Werner explains.

While State Street Digital isn’t providing full crypto services, such as custody, it’s supporting investment products that give exposure to crypto without directly holding it. “We are open for business in terms of helping asset managers to launch funds that invest in digital assets,” says Werner.

The digital unit is also the fund administrator for the VanEck Bitcoin Trust, a bitcoin ETF that’s awaiting approval by the U.S. SEC, and for a fund in Germany. Ithas even more products in the pipeline in the APAC and other regions, Werner says, and could also expand beyond bitcoin in the future.

“At the moment it's bitcoin. But we also have clients who are looking at other currencies, and we're seeing these kinds of products being launched, at least for ether. But nowadays you can also have polkadot and cardano and these kinds of things. So we are, at the moment, doing it for bitcoin, but we're looking to extend it into other assets.”

Right now the firm is only providing administration and accounting services for digital assets due to regulatory uncertainty, while providing access to other companies that provide custody and trading services. But it would like to be more comprehensive.

What the digital unit is planning to offer

The two main things State Street Digital would like to provide to its clients in the near future are custody and trading services for digital assets.

Werner says that the bank will aim to layer features on top of its accounting services for digital assets. “We are a large significant fund accounting organization overall. But then you can add on this. You could add in future custody. You could add trading — if and when the regulatory landscape allows for that.”

He says that the bank is working on a roadmap for the custody of digital assets and is testing potential platforms. But he notes again that this is all pending and subject to regulatory approvals.

And indeed, there are quite a few regulatory hurdles. For example, Werner points to the recent consultation from the Basel Committee on Banking Supervision that discussed a capital charge for holding crypto on a balance sheet, describing it as restrictive and costly. On the basis that crypto would fall into the highest risk category, this would require banks to hold significant dollar reserves to back up their crypto holdings.

He also highlights that there is a lack of alignment between asset management regulation and crypto regulation. One such issue is the lack of “finality” — the point after which the funds legally belong to the recipient of a payment — for a proof-of-work blockchain transaction. Bitcoin transactions become probabilistically more final over time, but there’s no specific time when they are set in stone.

For example, if a European fund invests in an asset they also must employ a depository to look after the asset and provide so-called control functions. One such function is to inform the investor when they have received ownership of the asset, for their own records. But with probabilistic finality, it’s unclear when this occurs. And it’s a lack of guidance for issues like these, says Werner, that leads to uncertainty for providing such services.

For this reason, State Street is an investor — along with 14 other financial institutions — in Fnality, a digital coin that settles with deterministic finality rather than probabilistic finality.

According to Werner, Fnality has applied to set up an Omnibus account with the Bank of England, a new service that will allow it to create pre-funded wholesale tokens that have instant settlement. This is still under development, though.

The promise of security tokens

Werner is particularly interested in the concept of representing securities as digital assets.

While he acknowledges the market for security tokens is still quite small — some $1 billion or so — he says there is growing interest from asset managers. But it’s not just about investing in these tokens; they are more interested in tokenizing their own funds. 

“In the future, you could buy all your pension investments through your phone and everything in a token form, and that should speed up the process and give the asset managers an ability to make investments into their product more attractive,” says Werner.

He says that security tokens would also streamline the situation for businesses like State Street. For example, when an investment manager makes a purchase, the firm has to make sure it is within the guidelines of the fund and that it was made at the going rate in the market. With security tokens, he explains, this is all done in one go and automated. “And that should offer significant efficiencies over time,” he notes.

Werner acknowledges, however, that the complexity of implementing security tokens is causing the market to develop slowly. He says, “I don't know if it's five years, 10 years — whatever it will take — but you can see the potential. You just have to have a little bit of patience.”