Cryptos’ Path Forward Seen Filled With Custody and Trust Challenges

The crisis engulfing cryptocurrencies can be traced, in part, to custody.

FTX has imploded, the crypto world continues to shudder, and the trust factor looms large. After all, putting custody of consumers and institutions’ digital holdings on exchanges — lightly-regulated entities at best — has proven to be a stumbling block to cryptos’ mainstream embrace.

FTX is only the latest example of the issues at hand, where following the money is no easy task, and where consumers have found out just how vulnerable they’ve been to losses only after the fact. When crypto exchanges go bust, users can lose some or all of the money that’s been held on that exchange. While conventional wisdom holds that self-custody is a safer way to store crypto, it demands that one not lose private keys, else they risk losing access to their cryptos (and the money tied to them) forever.

Work in Progress

The exchanges? Well, they’re a work in progress. One of the key issues being untangled in the FTX morass is how customer assets were (or were not) held in segregated accounts — thus making it hard to recover those holdings. Crypto wallets offered over exchanges have been an onramp to the exchanges and to crypto trading, but they’ve also been onramps to bad (or inefficient) corporate actions. In the case of FTX, customer funds were reportedly used to “prop up” the trading firm Alameda. The exchanges, too, have been hacked (i.e., Binance earlier this year, and FTX reportedly was hacked just hours after its bankruptcy filing).

The issues surrounding custody on the crypto exchanges stand in marked contrast to custodial practices seen in traditional financial services. Money in the bank, of course, is insured by the FDIC for up to $250,000.  Elsewhere, and in the stock and investment markers, the SIPC protects accounts at member brokerage firms for up to $500,000. Further, tracking of ownership of various investment holdings is done by the Depository Trust Company.

Since the regulatory environment for cryptos is still in in its nascent stages, there are no such guarantees in place. It might seem a natural fit for the banks, with, well, centuries of fiduciary experience in place, to take on those responsibilities, and perhaps put some guardrails on the crypto space itself.

Though the Office of the Comptroller of the Currency said back in 2020 that banks and thrifts can provide custody services for crypto assets, the uptake has been fairly limited. As relayed in PYMNTS research this past summer — and well before the FTX debacle — most banks do not regard crypto services a top-of-mind endeavor. Nearly two-thirds of banks do not consider crypto-related products and services to be a priority in their growth strategies over the next two years, according to data from the Federal Reserve. BNY is among the more high-profile banks offering crypto custody services for clients.

But the interest and intent on the part of traditional FIs is hardly uniform. As noted in this space in recent weeks, in an interview published on the European Central Bank website, Mark Branson, member of the supervisory board of the ECB and president of the German Federal Financial Supervisory Authority (BaFin) said that banks’ interest in offering crypto-asset trading to their customers is “limited.”

For all PYMNTS crypto coverage, subscribe to the daily Crypto Newsletter.