SINCE the beginning, banks have been cryptocurrencies' number one critic. With the support of their big brothers, the central banks, they have launched copious warnings to the investing public about concerns and risks associated with these types of digital assets. Concerns about cryptocurrency range from money laundering, terrorism financing, and fraud to privacy of user information. Furthermore, banks have pointed out that cryptocurrencies have no intrinsic value; hence, cryptocurrency investors should be prepared to lose their investments anytime.
However, it is ironic that these banks are now heavily investing in crypto and other blockchain-related companies. This information is based on the July 2021 report released by Blockdata, an Amsterdam-based blockchain research firm. The said report disclosed that 55 of the top 100 banks in the world by asset under management (AUM) have such investments either directly or through subsidiaries. Based on ranking, the report enumerated Barclays, Citigroup, Goldman Sachs, J.P. Morgan Chase & Co., and BNP Paribas as the top five most active investors based on number of investments in blockchain companies. It is also worth mentioning that 23 of the top 100 banks in the world by AUM are building custody solutions or investing in the companies that provide them. Banks earn fees as custodians of these digital assets. Though basis varies, custodianship fees are primarily based on the value and vulnerability of the asset. There, again, banks have found an oasis in the middle of a pandemic that otherwise would have dried the tanks.
Based on the May 2021 Global Digital Asset Management Industry Report, the global market for digital asset management is estimated at $3.8 billion in the year 2020 and is projected to reach a revised size of $15.5 billion by 2027, growing at a compound annual growth rate of 22.2 percent over the period of 2020 to 2027. It's a flourishing market that banks cannot forego to have a foothold over. Banks, as traditional asset custodians of capital markets, have recognized the growing global demand for digital asset custodianship to help manage the use of digital assets, and noted that digital assets carry additional risks as compared to traditional assets.
A digital asset custodian operates in a similar fashion to a traditional asset custodian, wherein the primary role is to safekeep an investor's assets and usually safeguard it with a private key. However, unlike traditional asset custodianship whereby the client is the one holding the private key and the asset is kept in the vault of the custodian, the digital asset custodian already has custody by holding the private key on behalf of the investor and thus ensuring that no unauthorized party can access it. Restricting access to a private key is the most important role of the digital asset custodian since most transactions, depending on the type of distributed ledger technology used, are irretrievable once executed. Likewise, if the private key is lost or stolen, recovery of a digital asset by its rightful owner may be tough unless the digital asset is a representation of an actual asset. For example, a security token, where an actual asset may remain secure, and a new token or digital asset can be issued. This is similar to a traditional instrument such as shares of stock, bonds, and units in an investment fund.
At the core of this business process, the safety of the assets is the primary consideration in entrusting the asset to a custodian. Coincidentally, digital assets have the following built-in security features: (a) these are usually reflected on distributed ledgers in the form of random binary digits, which provide security for a transaction because the record of transfers are secured on an independent ledger that is not easy to modify; and (b) these can only be accessed through public and private keys. These keys enable the investor to use the digital asset. Like traditional assets bearing built-in security features, these are still susceptible to loss.
What are the benefits of having a digital asset custodian as compared to self-custody and exchange wallets?
Like traditional asset custodians, digital asset custodians have institutional-grade security controls to provide certainty over safekeeping, which facilitates cryptographically secured trade settlements, exchange, and clearing. Assets under custodianship are insured as well, giving recourse for investors. This lifts the burden of self-carrying digital assets that are susceptible to hacking and mitigates the counterparty and commingling risks from exchange wallets on possessing the private key and the digital asset itself, by extension. However, the disadvantages are the high cost of custodianship for retail investors and regulatory uncertainty.
A bank's investments on blockchain companies will enable its traditional custodianship to be modernized to serve for the peculiarities and risks associated with digital assets. Setting foothold in this market has not been without tackling a multitude of challenges, ranging from cybersecurity and storage solutions to operational efficiencies, because digital asset transactions involve a multi-stage process.
In the Philippines, in collaboration with Hex Trust, a Hong Kong-based digital assets custodian, the UnionBank of the Philippines will be the first local bank to pilot digital asset custody for its own employees with the oversight of the Bangko Sentral ng Pilipinas (BSP) as it prepares the groundwork for a secured system for digital asset investors. As of July 31, 2021, the BSP has approved 15 virtual asset service providers (VASPs). These VASPs are guided by the BSP's Circular 1108, issued last January 2021, which covers capital requirement, scope, operations, and reporting obligations of VASPs in the country. In July 2021, the local bourse, the Philippine Stock Exchange, has expressed its intention to host the trading of digital assets to protect investors. However, until now, the local bourse is still waiting for the rules and regulations from the Securities and Exchange Commission on how digital assets will be governed.
So, if banks cannot change the investing public's craze over cryptocurrencies and other digital assets, they offer trust solutions for investors' safety and comfort. Ultimately, the success of a custodian comes down to investors' trust. Therefore, it is imperative for custodians to establish safe, efficient, and stable operations amidst the current regulatory uncertainties.
Seb Serrano is a senior audit manager at P&A Grant Thornton. P&A Grant Thornton is one of the leading audit, tax, advisory, and outsourcing firms in the Philippines, with 24 partners and more than 900 staff members. We'd like to hear from you! Tweet us: @GrantThorntonPH, like us on Facebook: P&A Grant Thornton, and email your comments to [email protected] For more information, visit our website: www.grantthornton.com.ph.