In a public letter dated July 22, Senior Deputy Comptroller and Senior Counsel Jonathan Gould wrote that any national bank can hold the cryptographic keys for a digital asset wallet or account, opening the way for national banks to enter the digital asset custody space.
The custody market for digital assets
The letter acknowledges a growing market for digital asset custody services:
“We understand that there is a growing demand for safe places, such as banks, to hold unique cryptographic keys associated with cryptocurrencies on behalf of customers and to provide related custody services. These services are in demand for several reasons.
First, because the underlying keys to a unit of cryptocurrency are essentially irreplaceable if lost, owners may lose access to their cryptocurrencies as a result of misplacing their keys, resulting in significant losses of value.
Second, banks may offer more secure storage services compared to existing options.
Third, some investment advisers may wish to manage cryptocurrencies on behalf of customers and may wish to utilize national banks as custodians for the managed assets”.
In other words, the OCC letter takes in the full scope of digital asset custody types. The danger of losing account keys is recognized, but so is the expanding demand for asset management and custody, rather than simply holding account keys.
What services can banks offer?
Banks can offer both fiduciary and non-fiduciary custody: “U.S.C. 92a expressly authorizes the OCC to grant fiduciary powers to national banks. National banks may also provide nonfiduciary custody services to their customers. The OCC has determined national banks may act as non-fiduciary custodians pursuant to the business of banking and their incidental powers”.
And the letter goes on to recognize the differences between traditional and digital assets custody:
“Providing custody for cryptocurrencies would differ in several respects from other custody activities”, the letter reads, observing that digital assets don’t exist anywhere but their respective blockchains and that there is no question of physically possessing something that doesn’t physically exist; to custody digital assets, banks will have to rethink custody.
“In most, if not all, circumstances, providing custody for cryptocurrency will not entail any physical possession of the cryptocurrency”, Gould explains. “Rather, a bank ‘holding’ digital currencies on behalf of a customer is actually taking possession of the cryptographic access keys to that unit of cryptocurrency”.
Banks can custody digital assets for individuals, businesses and institutional investors
The OCC letter also draws a line from the earliest days of the safe-deposit box, “for the storage and safekeeping of a variety of physical objects, such as valuable papers, rare coins, and jewelry”, to later forms of asset custody. In doing so it foregrounds banks’ role as safe keepers of value for individuals.
Later into the letter, though, it becomes clear that Gould is concerned with investor banking too. “Traditional bank custodians frequently offer a range of services in addition to simple safekeeping of assets”, Gould writes, explaining that a custodian will often offer “core domestic custody services for securities typically settles trades, invests cash balances as directed, collects income, processes corporate actions, prices securities positions, and provides recordkeeping and reporting services”.
A negative rationale: custody of other intangible assets is permitted
Ultimately, the OCC’s decision rests on precedent; the letter explains that there’s long been recognition that “banks may hold a wide variety of assets as custodians, including assets that are unique and hard to value”, and that “[t]hese custody activities often include assets that transfer electronically”.
Since the OCC has generally not prohibited these activities, the letter explains, there would be no reason to prohibit digital assets custody, so long as the bank has “the capability to hold the asset and the assets are not illegal in the jurisdiction where they will be held”.
Digital assets are legal in the USA, though they are regarded as various classes of asset or contract and none is legal tender, so there’s no obstacle to banks custodying digital assets on that basis.
What effect will this have on the digital assets custody space?
Banks wishing to do this will need to develop skills specific to the digital assets space, as Gould observes, writing that they should “develop and implement those activities consistent with sound risk management practices and align them with the bank’s overall business plans and strategies”.
This will involve significant infusion of technical skill from the extant digital asset custody space into the banking sector, as banks seek to recruit skilled staff and work with consultants to enter a new, technically-demanding market.
Banks that haven’t worked with digital assets in the past often have excellent traditional financial skills but lack both industry-specific skills, and the technology to put those skills into practice. We will probably see a sharp uptick in interest in technological solutions for digital asset custody, such as the Ledger Vault.
The view ahead for digital assets custody
Prior to this development, there was rapid growth in the digital assets custody space, with the traditional financial world supplying essential professional skills and structures to augment the specialist knowledge required to operate in the new industry.
Institutional money had already begun to flow into the digital assets space in response to these changes, and regulators worldwide have responded to the growth of the digital assets space with various attitudes. We can expect that process to accelerate.
While some regulators viewed the emerging industry as primarily a technological one, others sought to integrate it with their financial systems. In the US, though, regulators held back, waiting to see how other countries handled creating rules for the new industry. Congress seemed to move slowly, while existing regulators established jurisdiction over specific areas of the digital assets industry — as with the SEC and security tokens, for instance.
Banks have also held back, regarding digital asset exchanges, wallets and associated startups as compliance risks. As the regulatory environment firms up, we can expect to see more banks stepping in to offer banking services to digital asset companies, as JPMorgan Chase has to Coinbase and Gemini, as well as banks directly offering asset management and custody. Another grey area in the regulatory regime has been clarified and the result will probably be an accelerated development of this already-active market.
The OCC letter can be read in full here.