The exponential growth of virtual assets offers tremendous opportunities on reshaping the capital market. In order to strengthen the competitiveness of global financial market, a growing number of countries are gearing up for the trend of virtual assets. Custodial business, which can provide institutional and professional investors with enterprise-grade safekeeping solution for virtual asset, is becoming a key strategic partner in the virtual asset sector.
States and Regions’ Openness towards Custodial Business
Although the global regulation and practice for the virtual asset sector are still undefined, there are more countries or regions that have adopted an open and positive attitude towards virtual asset-related custodial services, such as the United States, South Korea and Germany, in contrast to strictness of virtual asset trading.
The attitude towards virtual assets varies across states in the U.S., whereas Texas approves state-chartered banks to provide virtual assets custodial service in June 2021. Although South Korean regulators banned police from purchasing virtual assets in May 2021 this year, they allow traditional banks to conduct the virtual asset custodial business. On the other hand, the German government supports qualified virtual asset custodians to conduct business in the country.
Fierce Competition among the Custodial Industry
In the traditional financial sector, funds need to be deposited with third-party custodians for financial activities involving large amount of money. In the U.S., e.g. the SEC requires financial institutions holding more than USD 150,000 for investors to entrust their funds to a custodian.
Thus, in the traditional financial system, the maturity and good reputation of custodian is a necessity for large-scale investment entry, and the same applies to the virtual asset industry. As of July 2021, there were 28 companies providing virtual asset custodial services to institutional clients. Of these 28 virtual asset custodians, 22 (approximately 79%) were founded in 2017 or later. There have been 46 investments in institutional client-focused custodian companies, amounting to USD 1.6 billion. (Source: The Block, data since 2012)
Compliant custody for virtual assets is the core system for the entire industry. Not only is it valued by institutions in the virtual asset sector, but it also attracts the participation of traditional financial institutions. Currently, several traditional banks have started their virtual asset custody businesses, including Bank of America, Woori Financial Group of Korea, DBS Bank of Singapore, Commonwealth Bank of Australia, Deutsche Bank, etc.
The blockchain industry implies for technology-driven sector and uses a completely new set of rules in terms of technology. Most traditional financial institutions lack the basic knowledge of virtual asset investment and custody, and runs with low capabilities on wallet technology, in comparing to professional institutions currently in the field who understands the market with higher technical edge. Therefore, few traditional banks are able to carry out virtual asset custody business directly. Most of them either in partner with professional custodial service providers in the sector or invest in related startups, hoping to layout the foundation on their roadmap for virtual asset custody business.
Why Is the Custody Business the Core of the Virtual Asset Ecosystem?
Traditional custody business has developed diversified business models such as custody, settlement & clearance, asset servicing, banking services, agency payments, etc., the virtual asset custody business is expected as an essential part to "entrance to the virtual asset ecosystem". "Custody business is the core of the virtual asset ecosystem." Jenny Lau, Head of Hong Kong office, Huobi Trust, agrees with the positive prospect of custody business and emphasizes the importance of virtual asset custody.
Trend of Compliance in Custody Industry, Conducive to Its Development
For practitioners in the blockchain industry, in addition to technical risks, they are still facing significant policy and regulatory risks, which is undoubtedly a huge challenge for virtual asset custodians. Institutions are also aware of the importance of conducting business in compliance and have started to actively apply for compliance licenses in relevant regions. For example, Huobi Trust not only has a registered Trust Company incorporated in Hong Kong holding a Hong Kong Trust or Company Service Provider (TCSP) license, but also holds a US Nevada Retail Trust Company license through a US entity.
More Institutions Entering the Market, Increasing Demand for Custody
An important reason for custodianship attracts institutional funds to the market is simply its ability to secure virtual assets. According to the Blockchain hacked archives of SlowMist Hacked, from 2012 to date, 98 blockchain security incidents of exchanges have been disclosed, with a total loss of approximately USD 6,892,365,669.39; since 2018, 25 blockchain security incidents of wallets have been disclosed, with a total loss of approximately USD 289,371,253.59. It could be seen that the security of virtual assets is extremely challenging for the capability of custodians. More virtual assets investors, especially high net worth individuals as well as institutional investors, are now choosing to have their assets safekept by professional virtual asset custodian. By leveraging their expertise and advantages in security technology, they can obtain vault-level security protection.
Scalability of Custody Is the Same as Banking Systems
In addition to asset custody business, as the underlying basic service, custodial service is naturally linked to other businesses, such as transactions, loans, and even DeFi. Users of virtual assets are not satisfied simply with the security of asset storage alone, the ability to add value to assets is becoming a new highlight of customer acquisition. More custodians are trying to add more quality service to their platforms. Other than safekeeping client's asset in a secured environment, offering value-added services becomes a key direction in the industry. For example, Huobi Trust has recently launched a trading asset custodial function that keeps assets in custody during users’ transactions.
The virtual asset custodial solution provides a new compliant and secure direction for the custody and use of virtual assets, which is the core foundation of the entire ecosystem. The maturity of the custody business development will certainly promote the development in compliance and the popularity of the entire virtual asset industry.
© 2023 The Block. All Rights Reserved. This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.