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The changeable burden that regulation is about to lay on digital asset custodians: Article

Safe custody is the service that will unlock corporate issuance and institutional investing in the securities, asset-backed, non-fungible and fund token markets. While there is widespread recognition that regulation of digital asset custodians would accelerate progress, regulators around the world have so far reached consensus on combating financial crime only. Even that is proceeding slowly and patchily, but regulation of digital asset custodians and digital asset custody risks is proceeding more raggedly still as different jurisdictions jostle for advantage.

Secure custody emerged early in the history of cryptocurrency markets as the main barrier to the entry of institutional investors. It remains the major obstacle to the engagement of traditional, long-only institutional investors in tokenised assets such as Non-Fungible Tokens (NFTs) and security tokens.

Even the more adventurous institutions pioneering trading and investment of tokenised assets – namely, hedge funds, wealth managers, exchanges, corporate treasuries, sovereign wealth funds and family offices – are now demanding custody services that are not only high-quality but regulated.

It is not hard to see why. The task of safekeeping the cryptographic public/private key pairs associated with a digital wallet that confer ownership and control of a tokenised asset requires the mitigation and management of risks that are different from those of traditional cash and securities custody.

Because they are used to store, manage and transfer tokenised assets, private keys also represent a single point of failure. In a traditional custody chain, by contrast, various intermediaries (brokers, depositories, clearing houses, custodians) reconcile holdings and transactions repeatedly.

Indeed, the technologies and methodologies at work in the issuance (directly into investor wallets, which may be hosted or non-hosted), transfer (transactions are irreversible) and safekeeping (notably, the private keys) of digital assets are genuinely novel.

But there are familiar features as well as novelties. Just as investors in digital securities look to custodian banks to safekeep and service assets, so do investors in digital assets look to third parties (exchanges or service providers) to supply digital wallets and collect entitlements.

The difference is that custodian banks are regulated entities and securities are regulated instruments everywhere. There is as yet no equivalent, comprehensive regulatory regime in any jurisdiction that protects investors if a custodian loses the digital asset.

If the custodian fails altogether, investors may even find – unlike the position in traditional financial markets – that they are unable to access or liquidate their assets for months or years and may not have any recourse to law or regulation or insurance to remedy the failure.

Cryptocurrency markets are unregulated. Participants are at risk of inadvertent non-compliance with existing regulations that might apply. Investors cannot predict how they and their assets will be treated in cases of theft, fraud, loss or bankruptcy. Most digital asset custodians lack financial strength.

Until these shortcomings are rectified, tokenisation will never attain its full potential. Institutional investors need a regulated infrastructure of exchanges and custodial services. If they do not get it, tokenised assets will remain a minority interest, conducted largely offshore.

And it is the enormous potential of tokenisation that has encouraged regulators as well as digital asset custodians on both sides of the Atlantic, to begin work on the creation of legal and regulatory frameworks that will afford token market participants a greater degree of predictability.

But that work is uneven and uncoordinated. This event will focus on what that means for  one aspect of the emergent regulatory framework for cryptocurrencies and tokenised assets – namely, secure custody – in the major financial centres of Asia, Europe and North America.  

Registration for event is not open yet

What topics will be discussed?

  1. The unusual and the familiar custody risks that tokenised assets issued on to and traded across blockchain networks represent
  2. Whether existing technologies and methodologies can ever give a custodian exclusive control of customer assets
  3. What institutional investors want and need from a digital asset custodian
  4. The implications of institutional investment activity spreading beyond the top 20 tokens
  5. What acquisition activity in digital asset custody says about activity levels, growth prospects and business strategies
  6. Whether global custodian banks can make their partnerships with start-up digital asset custodians work
  7. The use of sub-custodians as a route around multiple laws and regulations
  8. Managing the different risks represented by digital assets issued on to different blockchain protocols
  9. The value of certifications (such as ISO 27001)
  10. How digital asset custodians can comply with Anti-Money Laundering (AML), Countering the Financing of Terrorism (CFT) and sanctions screening rules
  11. The approaches to digital asset custody taken by US regulators of banks, brokers and crypto-currency service providers
  12. The impact of the SAB 121 recommendation that customer assets be on the balance sheet of digital asset custodians and foreign custodian banks
  13. Why the NYDFS “BitLicense” is popular with digital asset custodians
  14. Other regulatory routes for digital asset custodians active in the US
  15. The impact on digital asset custodians of the EU Regulation on Markets in Crypto-assets (MiCAR)
  16. The impact of the MiCAR stipulation that digital asset custodians accept liability for loss of digital assets belonging to customers
  17. Whether digital asset custodians should act now or wait for MiCAR to come into effect in 2024
  18. What obligations regulated digital asset custodians face in the United Kingdom and Singapore
  19. Whether, in the absence so far of a successful custody hack, regulation of digital asset custodians is a sensible priority