Understanding the Role of Digital Asset Custody in Finance

By Sudhir Pai, Chief Technology & Innovation Officer at Capgemini Financial Services

Digital assets are all hot in the financial world today. It started with being used synonymously with cryptocurrencies and later expanding the potential of underlying technology to include crypto assets (funds, derivatives) and tokenized assets (security tokens, utility tokens). The hype seems justified if we try to understand some of the benefits of digital assets – reduced time and cost of transactions through tokenization and smart contracts, increased security and privacy through cryptography, and improved liquidity of illiquid assets (such as real estate) through fractionalization.

As digital assets gather mainstream adoption, there is an increased demand for a robust and resilient infrastructure that can provide a safe and secure storage and exchange of digital assets. With the growth of crypto and its derivatives, there has also been a significant rise in theft as well as illicit usage of digital assets. This is exactly where digital asset custody becomes an area of prime importance. It provides the professional management as well as safekeeping of investors’ assets in addition to providing other services such as asset exchange, settlement, clearing & analytical insights.

If we look at the digital asset custody landscape, the custody services are mainly provided by crypto exchange platforms themselves, fintech firms as well as the traditional financial institutions (FIs). Many new age firms started pitching in to grab the opportunity by providing crypto exchange, wallet, and other services.

Digital Asset Custody: An Opportunity for Traditional Financial Institutions?

The digital asset market is estimated to grow exponentially, estimated between 2-4 trillion. With a significant rise in institutional investment, Gen Z and millennial age group demanding new age products and services, stronger push to create liquidity, this space is definitely going to evolve further.

As the market continues to grow, traditional FIs need to up their game to provide new products and services around management and safekeeping of these assets so as not to become obsolete. Incumbents have a significant advantage of being perceived as trustworthy and reliable by both retail and institutional investors, which they should leverage to stay relevant in the market.

In the last couple of years, we have seen several FIs foraying into the digital assets space, primarily via 3 routes:

1. Invest: Investments to create a dedicated unit focused on digital assets (recent announcement from Google is an example of how Big Techs are also eyeing this space). In addition, venture investments are also being made in niche custody platforms like HQLAx  ,Paxos, etc.
2. Build: FIs are strengthening their own capabilities to act as a custodian for digital assets, as an extension to the current services. Some FIs have also started working with exchange platforms playing the role of a custodian.
3. Partner: FIs are partnering with third-party custodians to leverage their expertise & resources to add digital asset custody to their existing line of services. Third-party players benefit from the large customer base, while FIs benefit from niche expertise.

Digital Asset Storage

Implications for Financial Services

Digital asset custody is an evolving space that traditional FIs cannot afford to take lightly. We anticipate an unprecedented demand for custody services triggered by the rapid surge in interest in digital assets. The push for digital assets will be further accelerated as regulators are preparing frameworks for governance and compliance for digital assets.

However, retail and institutional investors are faced with the complexity of new technology infrastructure, interoperability with legacy systems, regulatory and compliance requirements. FIs need to be cognizant of the high demand and tailor new products and services for digital asset management. A hybrid approach combining both traditional and digital assets would be the need of the hour. One of the ways in which incumbents can capture the market could be via collaboration with FinTechs to accelerate adoption of state-of-the-art custody solutions. A few have made substantial investments through acquisitions to add niche custody solutions to their existing portfolio.

Furthermore, the traditional financial market is also at the cusp of rapid transformation. Blockchain and smart contracts are influencing digitization and automation of traditional markets. As the technology adoption occurs at scale, institutional digital asset custody will become the key for incumbents to unlock both traditional and digital asset classes.

From a business standpoint, FI’s need to investigate their wealth & retail portfolios, start offering crypto services (like exchanges, payments) and build a marketplace around issuance of new asset classes/tokens to their customers. These propositions along with digital custody will provide complete package of offers helping FI’s to retain & grow their client base.