State Street Digital, the digital-assets arm of global custodian bank and investment manager State Street, will have a custody product ready to show regulators by the end of this year, says Irfan Ahmad, Singapore-based product lead for Asia Pacific, the Middle East and Africa.
“We want to launch quality products for safekeeping keys and taking custody of digital assets,” he told DigFin.
The firm’s custody service will be able to service Bitcoin, Ethereum, and ERC-20 tokens (a standard API format for Ethereum-based coins).
Third-party custodians in crypto are evolving to serve different user segments. In State Street Digital’s case, it will cater to its traditional clientele: asset owners (such as sovereign wealth funds) and global asset managers.
Ready for crypto ETFs
Ahmad says the timing may prove fortuitous if the US Securities and Exchange Commission approves crypto-focused exchange-traded funds. Recently, Grayscale Bitcoin Trust won a court case against the SEC’s decision to deny it an ETF license.
ETFs or exchange-traded products that invest directly in crypto tokens or futures, or indirectly in shares of companies investing into the Web3 ecosystem, are traditional structures that will require the services of a fund administration. Fund admin is a typical product within a custody offering.
The SEC has yet to green-light a crypto ETF, but the Grayscale court ruling means it is going to be under pressure to do so, be it for Grayscale or for ETFs tabled by traditional asset managers such as BlackRock, Fidelity and Invesco.
And if that happens, other markets such as Hong Kong may well follow. So far in Asia Pacific, Australia has been the only jurisdiction to license a crypto ETF; there are now eight such products listed on the Australia Stock Exchange. But ASX is small: its total market cap is only about $1.5 trillion, versus $4.6 trillion for Hong Kong.
Regulator review
Ahmad would not go into specifics about what State Street’s digital-asset service will look like. It won’t be launching its product at year end, but rather showing it to regulators in the US and elsewhere.
“Regulators need to be sure this will be safe and sound,” he said. “We’ll be operationally ready to put our product in front of them for feedback. They’ll be able to spot any shortfalls.”
Some of the challenges the bank has worked on include data, fund administration, and tokenizing funds. But the biggest focus has been on maintaining a secure process, while giving clients flexibility on how they want to use their assets. Some may be passive investors but others may want to use their crypto to stake, to wrap it onto other products, or to lend.
Ahmad said the bank is relying on some longstanding methodologies such as multi-party computation, in which several players can validate a single transaction without revealing their private information. Another is sharding, which enables scaling by dividing the network into smaller units, so that validation doesn’t require the full network to weigh in on every transaction.
State Street Digital has built proprietary cryptographic software using such elements that adapt to different types of underlying tokens and strategies.
This is the element that regulators will want to poke and prod. Ahmad says getting this right for a third-party custodian has been complicated by other regulation. For example, at the beginning of the year, US regulators determined that US banks can’t hold crypto as principal, which makes it impossible for them to use Ether to pay gas fees. A workaround is required that is fast and secure.
Related services
Along with core custody, the bank has been working to offer ancillary services including digital-asset reference information.
“Data is the lifeblood of any financial market, whether it’s crypto or TradFi,” Ahmad said. In the traditional world, custodians vouchsafe client assets and add on many ancillary services that are based on data, such as fund valuations.
The idea will be similar for crypto but the structure of the market and the services is different. Two years ago, State Street Digital partnered with Lukka, a crypto data management business, to provide reference data sourced from multiple crypto exchanges. This in turn is used to create pricing and valuation data on client holdings – which makes it possible to provide fund admin for crypto ETFs, as well as post-trade services such as transaction-cost analysis.
Ahmad expects State Street Digital to focus on building-block products that investors can easily access, such as ETFs. Down the road, it will expand to tokenization, be it in the form of central-bank digital currencies, deposit tokens, or securities.
One aspect of third-party custody in this regard is transfer agency, which is the entity that maintains registers of funds (be it ETFs or tokenized funds). In traditional finance, custodians or TA specialists do this to help asset managers and distributors keep track of who owns what fund units. In crypto it could be applied to primary issuance of tokenized funds, giving them the power to mint and burn tokens on behalf of asset-owning clients.
Whether it’s fund admin, transfer agency, or core custody, Ahmad says the main business consideration is scalability. State Street’s traditional custody business has $37 trillion of assets under custody, so it will be looking to have a capability with comparable scope to grow for digital assets.
It’s volume that makes custody profitable, although specialist services can be lucrative. The onchain world may have a different market structure, but for institutions looking to offer third-party custodian to investors, scale is still the name of the game.
