Crypto custody white paper
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The need for secure private key storage is not limited to individual consumers; large cryptocurrency investment advisors may also want a safe place to securely store the cryptocurrency funds they manage. Traditionally banks provided safe deposit boxes for physical object storage, including valuables such as bullion.
Safekeeping As the world moved from physical to electronic goods and services, so did banks. In OCC Conditional Approval and OCC Conditional Approval , the OCC found that the escrow of electronic encryption keys and secure-web based document storage were both permissible safekeeping activities for national banks, incidental to the business of banking. Neither of these guidance decisions granted the subsidiaries fiduciary powers over the stored data. In essence, these decisions directly expanded safekeeping i.
Custodial Services Custodial services developed from other recognized safekeeping and settlement services, and are viewed, often in conjunction with the delivery of fiduciary services, as permissible under 12 U. According to the Clearing House , custodial services can be separated into multiple buckets—safekeeping, asset servicing, transaction processing and settlement, and banking services. There are generally two types of client accounts: 1 cash deposits held by institutional investor clients and 2 securities accounts.
Custodians also provide transaction processing and settlement, and finally banking services. Bank custodians act as the intermediary between a client that invests traditionally in securities , and the financial market utilities that provide the financial market infrastructure to settle and clear transactions. Like with custodial services for securities investors, potential cryptocurrency custody clients are varied including crypto-investment advisors like Grayscale or wealthy individuals and families.
Regardless, the custodial client makes all investment decisions regarding the assets. Custodians therefore act as just one tier in the securities system, which helps to facilitate efficient and diversified access to financial market utilities. Current Risks to Bank Custodians The arms-length nature of custodial services diminishes the risks to banks, but the Clearing House details how custodial services are not a completely risk-free enterprise.
The custodial balance sheet is generally liability driven by cash deposits. Though custody services do not require the same maturity transformation that banks do, custodians will still engage in short-term lending activities, generally to facilitate trade settlement, which may expose the custodian to limited operational, liquidity, credit, and market risk.
The limited credit risk exposure occurs when overnight and intraday credit is extended to facilitate settlement of transactions and when there is an agreement to indemnify clients on the securities lending programs offered through the custodians against certain losses. The market risk that custodians are exposed to is generally limited because it is not related to the assets in custody — which goes to the owner of those assets — but rather to the nearly immaterial risk associated with trading assets and liabilities.
Lastly, custodians are exposed to liquidity risk due to intraday maturity mismatches, which is generally managed by the custodian retaining highly liquid assets. These risks may be amplified by the volatile and highly technical nature of cryptocurrency. The OCC Slides Into Fintech Territory The guidance in Interpretive Letter the Letter provides that national banks and federal savings associations may provide custody services for cryptocurrencies and digital assets.
The OCC posits that these cryptocurrency custody services are in demand because private cryptographic keys are irreplaceable if lost, banks are more secure than existing wallet options, and crypto-investment advisors may want to access banks as custodians. The guidance asserts, via footnote, that under 12 CFR 7. In its discussion, the OCC lays out how 1 banks may hold cryptographic keys in safekeeping as an electronic safekeeping activity, and that 2 banks may provide custodial services for cryptocurrency in either a fiduciary, or non-fiduciary capacity.
Yet there are differences between the previous grants of authority and cryptocurrency custody that the OCC fails to highlight. First, Conditional Approval was granted only for key recovery safekeeping. The private key s held in bank safekeeping may have multiple copies elsewhere that are in active use, and the OCC made no distinction nor provided any guidance on what measures banks must take to ensure that these keys or any potential copies are safe. However, a future Comptroller can rescind or amend the guidance within Interpretive Letter The Custody of Cryptocurrency Interpretive Letter provides that: Providing such [custodial] services is permissible in both non-fiduciary and fiduciary capacities.
In most, if not all, circumstances, providing custody for cryptocurrency will not entail any physical possession of the cryptocurrency. Holding the cryptographic access key to a unit of cryptocurrency is an electronic corollary of these traditional safekeeping activities. Banks that engage in custodial cryptocurrency services may provide a wide range of services for their customers. The OCC was established under the National Currency Act of later known as the NBA , and is responsible for the creation, organization, and administration of a system of nationally chartered banks to promote a uniform national currency fiat currency.
In the time since its inception, the OCC has been the line-drawing authority on permissible and impermissible banking activities. Therefore, it is paradoxical that the OCC has recently been such a proponent of merging the banking and cryptocurrency industries. In Interpretive Letter , the OCC determined that safekeeping and custody of cryptocurrency assets is similar to safekeeping and custody of other electronic assets—particularly assets like securities, which evolved into an electronic form.
On that basis, the OCC concluded that banks may provide custody services to electronic assets i. This is based on a flawed premise. The OCC then concludes that because custodial services evolved from traditional safekeeping, custody of electronic assets is likewise permitted. For example, securities, which constitute much of the custody industry, started as a physical asset and evolved into a wholly electronic industry.
Cryptocurrency exists exclusively online. In custody, the stakes for creating institutional-grade solutions are high. The maturation of crypto as an asset class depends on the long-term safety of both personal and institutional funds.
Our learnings gained over releasing multiple versions of our custody solution since are encapsulated in our white paper. Our aim is to help educate retail investors, professional crypto traders, and financial institutions on what a world-class custody infrastructure looks like. With that understanding, they can decide for themselves what kind of industry solution meets their unique needs and standards.
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