The popularity of digital assets will lead to significant changes for the financial industry, including within the area of asset custody. Today’s global custody industry goes back to regulatory changes in the 1970s. Digital assets, the most well-known being Bitcoin, differ in several ways from traditional assets, including the role of information technology, specifically of private key management, which will be accompanied by potential regulatory differences.
Sven Werner, head of digital custody and payments at State Street Digital, addressed the difference. “In the traditional assets space, typically you control the assets by having access and authority to send instructions over account.” For digital assets, “it comes down to the cryptographic key giving you control over the assets.” Werner was speaking at the recent European Asset Management Conference hosted by Association of the Luxembourg Fund Industry, or Alfi.
Referring to the European Union’s upcoming Markets in Crypto-Assets regulation, or Mica, he explained that the issue of custody is clearly set out. “A provider who maintains the control over the assets, i.e. the private keys is being the one who’s considered providing digital custody.”
Framework needs to support control
Beyond the technology and the key management, there is an important element of “really developing a framework for how these control functions can be performed, so that investors get comfortable, regulators get comfortable,” he explained.
The new regulation may be hotly awaited, but its absence hasn’t stopped market enthusiasm for crypto assets, explained Dimitrij Gede, Head of Compliance Relations at Iconic Holding. He pointed to figures made available on his firm’s website showing that “a lot of family offices - around 80 to 90 percent - are actually either already holding some blockchain assets or considered to hold.”
When it comes to institutional investors, he explained, there’s a very big risk appetite difference. “It’s not a thing that they can just say, hey, dear pensioners, we’re going to invest 20 percent of our total NAV (net asset value) into blockchain assets,” he said, adding that “in institutional trading, you have to justify your opinion.”
More crypto investments expected
“What we’re seeing a lot is that investment managers and asset managers are allocating, let’s say, one percent, three percent, five percent, of specific funds into blockchain and digital assets,” he explained, mostly in Bitcoin, and a lesser extent Ethereum, saying he expects this to increase in the next five to ten years.
Lawyer Steve Jacoby, a managing partner at Clifford Chance, said the new assets raise important questions of categorisation. “One of the examples,” he explained, “is the categorisation between financial instruments and other non-financial instruments,”, which he said had a huge impact on the custody business.
Jacoby emphasised the important questions raised by digital assets. “It’s important to understand obviously the legal implications, and particularly how the technology works. And then to make sure that everybody understands the risks and the liabilities and puts it into contracts.”
Digital needs to match framework
A representative of Luxembourg’s CSSF financial regulator, Patrick Hoffmann, explained the CSSF position. “We think of digital assets as being assets that shouldn’t be regulated just differently, because they have different technology.”
Hoffman picked on a theme raised by Jacoby and said he agreed that “we have to fit this new world into our existing relationship, because we have a framework in place,” he explained.
For those who see the coming of MiCA as being the final word, Hoffmann had some words of caution. “Even after MiCA, I think more questions will come up and it’s not going to be solving everything and bring clarity to everything,” he explained. However, he said the CSSF will continue to publish guidance documents.
Blockchain can support sustainable finance
One question for the panel raised a controversial cryptocurrency issue. The questioner asked how sustainable investing and digitalisation, especially power-intensive cryptocurrencies can coexist.
“Well, it’s a biggie of a question,” said Gede of Iconic Holding. Pointing out that Bitcoin mining operations have to be powered, he announced that his firm offsets emissions from Bitcoin when it is in their custody.
Ultimately, resolving the problem could involve working new features into the blockchain forensic system and the blockchain itself, he said. “It’s not about marketing. I mean, everyone knows that. Climate change is real. I hope everyone.”