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Outsourcing, Asset management, Asset, Service Industry Insights (CAC21A) – Stephen Richardson of Fireblocks

With his keynote on choosing a custody model, direct custody versus sub custody, great um, thank you very much for the introduction and and hopefully uh. Please correct me if that folks cannot see the screen, but hopefully uh everyone can see the screen. So my name is steven. Richardson i’m: the vp head of product uh strategy and business solutions, uh for fire blocks, uh based out of singapore, um it’s a pleasure to join the cac conference uh this year. Um. I think, from my perspective, what i’ll spend the next uh 15 or 20 minutes is really exploring the models that we’re, seeing in the space today in terms of engagement with digital assets, uh and those models really resolve revolve around two specific areas. The first is the idea of direct custody um and in utilizing uh infrastructure to be able to on your own hold digital assets uh and then really build products uh on top of that, and the second being that of sub custody, which again, is, is a fully Relevant model that we think makes a lot of sense, uh for for certain players in the space and really to evaluate what are the different opportunities that arise with utilizing, direct custody versus sub custody, um and even thinking through you know, future models in terms of opportunities Where there might be opportunities for a hybrid based, uh approach to digital asset custody uh for for institutions, so you know we’re going to look at a number of different headlines that have really come into the space uh over the last few over the last year or So and when you really look at those headlines, they really resolve around.

You know a number of institutions, both the large natively digital, like bny, melon, jp, morgan, dbs and those that are in the fintech space and payment space like paypal, revolut, gemini and square all really announcing uh or you know, making a foray into the digital asset space Or announcing given their existing products in the digital asset space um, you know the relevant growth that they’re, seeing in terms of market adoption by retail, but i think one thing to really you know make folks aware of is that there is a commonality in all of These different approaches and all of these different uh providers that have made the announcement – i think the one big commonality is that all of them utilize some method of direct custody, uh or in self custody. They, the in essence, have built products uh leveraging infrastructure that they’ve ever either brought in house or bought to bring in house or leveraging a hybrid model by which they’re leveraging some custodial or sub custodial infrastructure based off of regulatory uh implications and geographies. That they’re operating against and then for others leveraging uh self custody as a basis of building a set net set of new products to go to market, and i think that is really important to to pay attention to, because you know this. This is a path that we’re seeing many large institutions take now you know when you think about the digital asset market and – and you know most folks in this conference – uh conference are fully aware.

Uh. There are some significant differences in the way that digital asset markets operate compared to traditional. You know fiat markets, uh or broader uh securities, and the first is really that it is a 24 7 functioning global market right. The the idea is that the market moves at all times. Liquidity is moving through the system at all hours of the all hours of the day and the night and it’s a market that really has multiple venues that are operating in a fully distributed and global way. I think the second thing is to really map out that distributed. Liquidity is that you have exchanges from asia to europe, to the us that all have significant liquidity. You have global market makers from the likes of the flow traders of the worlds. The jumps, the jane streets of the world uh to you know smaller bespoke uh market makers in different geographies uh, like the amber ais here in asia and the enigmas in in the uk that are all participating in a globally distributed liquidity model right. And so the idea of really having a centralized basis by which to participate in this marketplace is something that is fundamentally different. I think the last thing the third thing is that there are ever evolving set of new use cases. So if you look at the space, you know maybe four or five months ago, uh, you know or probably six months ago, uh we were seeing kind of the the beginnings of d5 right people were dabbling in the space.

There was a lot going on in terms of potential interest, but we’ve actually seen an explosion uh by both traditional firms. Uh, you know digital asset focused investment firms to really engage in in new and unique products like defy and what that means – and we anticipate that if you kind of look at the growth and the trajectory of this space, there’ll be more ever evolving use cases that Come into market that banks and institutions will need to evaluate as areas uh to engage in and then the last thing is the regulation right. You know compared to you know, markets that have been in place for for quite a bit of time. The regulatory landscape for digital assets is constantly changing. You look at what happened in china recently in terms of digital assets. Uh. You look at what’s happening in the united states, with the occ guidance, along the lines of banks being able to engage in digital assets, you’re. Seeing what’s happening in germany with with baffin regulations, there is a constantly changing set of of regulatory clarity right and it’s, going to take a period of time for that to solidify and and so really having flexible and adaptable infrastructure that allows you to respond to that. In kind is something that we think is important. Now, when you look at the potential you know, evolution of the digital asset offering for financial institutions we’re, really seeing a number of different and unique products that are coming into into the market and areas of exploration for financial institutions.

I think you start to see some things and – and this has actually been quite an interesting – take that we’ve seen in the market is this idea of crypto awards right this idea of crypto as a form of rewards program to supplement existing. You know native products, whether it be credit cards or loyalty, pro programs and – and this actually has been an interesting one – to look at because it’s allowed fintechs to allow banks to really be able to dabble in the digital asset market without necessarily having to build the Full blown infrastructure to be able to support that. The second thing is: custody right, so we’re, seeing large banks and fintechs again take a look at custody of digital assets, both for retail high net worth and their other fintech customers that they’re servicing and building an infrastructure that enables kind of a growing and scalable service. Uh, you know banking as a service uh from from a custody perspective. If you look at the third model, you’re really seeing things around trading and brokerage, so you have the likes of revolut. You have you know a number of different institutions, robin hood square. A number of institutions looking at this trading and brokerage model you’re seeing banks really start to engage in this trading and brokerage model. You have dbs here in asia, that’s built in exchange, uh you’re, seeing you know, banks in europe look at basically providing this to their customers, both on the retail side and direct to uh b2b, and this becomes another interesting area that, as you think, about the combinations Of different services becomes important in evaluating whether or not you choose a sub custody or a direct custom model, and then you’re looking at the last piece is really direct lending right.

So the ability to establish bilateral relationships to rehypothecate digital assets that have been held on behalf of your customers and then provide customers. Things like crypto savings accounts and yield generating uh basis again. Another area of interesting opportunity for folks from a product perspective, but requires a pretty flexible and adaptable infrastructure that generally is controlled uh by the product owner and then, if you think about it, you have tokenization of cbdc’s payments, uh, slash receipts and then staking and defy, As other ancillary areas of exploration that we’re seeing in the market in terms of uh the broader engagement and adoption of digital assets, now, when you kind of start to look at that at a real revenue opportunity basis right, you know you can look at these different Opportunities and say there is opportunity once you build the custodial infrastructure to really engage and then generate ancillary revenue. Um, you know by having the ability to control your product and the product market fit right, and what we’ve done is really give you some examples and a code of reference. So i mean, if you look at someone like coinbase at 223 billion in assets under uh. Under custody, look at someone like gemini, with 30 billion dollars of assets under custody; it’s, not unreasonable, for you know a new institution to enter the space and as they enter the space uh you know you know, have something between 500 million to a billion dollars worth Of crypto assets under custody and what we’ve done is really outlined.

The opportunity and the use cases that exist across these different modes and these different products and as you can think about them, each of these different products, depending on your ability to create a unique market, fit to understand. You know the competitor, the competitive landscape and then to build a unique product that services, your customers, you know, has real revenue generating opportunity right, and the idea really is that you now need to make sure you have the infrastructure that allows you to take advantage of Those revenue generating opportunities now, when you think about traditional sub custody in the digital asset context, i think there’s, you know really some interesting things that become you know that are are unique to what a self custodian has to do in this space uh. The first is, if you think about it, in the traditional financial world right, the sub provides the subcustodian provides custody services for the securities or other assets um. You know, given the infrastructure that has been built around those different securities and other assets, you know the ability and the thought around control is somewhat limited right, because in essence, you know, if you have a security uh, you move it out of the system. You generally still need to bring it back into the system uh in order for it to be useful and have somewhat of some some utility um in general, they are outsourcing security of the asset and related operational components, you’re, seeing vendors like checkpoint, vaspersky and others that Are tightly integrated into the operational security of the bank and the custodian as they provide these general services? What becomes really interesting, as you think, about the subcustodian, the context of digital asset market is that it it’s actually slightly different it’s, not even slightly it’s, significantly different.

In the case of the subcustodian you’re, looking at someone that’s really securing the concept of the private key right, they’re required to hold uh, you know those private keys and then they’re also required as a basis of holding those private keys to store and to transfer those Digital assets, on behalf of the customer right really at the end of the day, like the security model, entirely changes with the basis of of the digital asset space and leveraging a sub custodian. It makes sense and again we’ll go into that for a number of different providers or for a number of different users, but in this case this is something that we think is very interesting, uh to call out. Uh generally, those keys are being held in in cold storage and as a basis of one being able to acquire insurance. Um, given limited capacity of insurance in in you, know hot and warm wall markets, but generally they’re being held in cold storage, which affects the time to basically deployment of the asset when you think about the movement of the asset on chain. Now, unlike the traditional sub custody model like the safe keeping of private assets, of of private keys, really does introduce a lot of new complexities into this outsourcing model right uh. Generally speaking, there is a you know, a lack of operational flexibility when leveraging a sub custodian. As they are the guardians of that private key um, you know really they are being diligent and and some custodians are being diligent in how they approach the security of that private key, but that diligence may not necessarily reflect the priorities or the business needs of the Organization that is leveraging uh the sub custodian.

I think the second thing is for a lot of the sub custodians that we see today and a lot of the institutions that we’re working with the balance there’s a balance sheet in balance um. In essence, a lot of the customers – you know the large banks, the fintechs, actually have a much larger balance sheet than some of the substitutions we’re. Seeing in the today space, which really begs the question as to whether or not leveraging of your own balance sheet and then acquiring the right technology apparatus to execute direct custody makes more sense for these players and then the last thing is a jurisdictional risk right. So most of the sub custodians store, their private keys in their home jurisdictions, thus exposing the financial institutions to geopolitical and regulatory risk. Now, obviously, in places like germany, it has become very apparent that you know as you’re utilizing a custodian. The keys need to be held. Uh, you know in the jurisdiction, in germany, for example, but in a lot of other countries and a lot of other jurisdictions that we’re seeing there is no such requirement, which actually leaves people exposed and vulnerable to any implications or any changes in the regulatory nature. Of the self custodian now when we think about the benefits of direct custody, i think there’s, you know five really key ones that that we have noticed and seen customers take. If you look at someone like paypal, they were leveraging a subcustodian they out acquired.

You know curve as a digital asset infrastructure to be able to launch products. You look at someone like revolut, again, i’d leverage, a sub custodian and then brought a lot of the technology in house to be able to do that and execute on their own dbs. As an example utilizing, i believe, taco as a basis of being able to drive their own digital asset custody. There is a significant you know benefit to the idea of direct custody. I think when you think about that there’s you know the core and most important is the ability to maintain the full asset control and offer a top tier user experience right. If you look at paypal, you know indicating that 50 of its users that engage in bitcoin look at the app every day the ability to think about what that means in terms of user experience in terms of not only a retail product but as you’re serving on A b2b basis to be able to provide a comprehensive tool for providers to be able to use is really interesting. The idea that you can open, withdraw and deposit windows and be able to move assets, 24 7 you’ll be able to access liquidity globally and then look at new models like defy is something that we think is a pretty interesting place to look. The second is you control your own risk and compliance right, a lot of the times when you engage with digital assets, there’s a real question by the compliance department of what does compliance in this space? Look like how do we create our own customer risk profiles? How do we drive automation in this process and we think that by leveraging direct custody and building infrastructure or leveraging, you know, infrastructure like fire blocks and others there’s an ability to really control this own? This this risk appetite and to be able to build the level of bespoke integrations to services like chain analysis and elliptic that allow you to do and drive automation in the compliance department.

The third thing is to really escape the closed loop right. The idea that basically connectivity for liquidity trading and lending venues are need to be kind of entrapped within the sub custodial environment or ecosystem is something that we think is is really interesting. Um the ability to really see right and access. You know the liquidity globally. I think has been a benefit for many of the firms that we’ve worked with here at fireblocks. The idea that you can kind of open that ecosystem up and move from a closed loop model to more of an open model in terms of how you engage with digital assets and counterparties in the ecosystem, i think, is something that is quite valuable. For a number of folks to think about, and then i think something that gets overlooked quite a bit is the idea of future proofing your business as we mentioned earlier, we anticipate there are going to be new models that come about because of the evolution and and And the continuing um development in the blockchain space, and so when you think about you, know the idea of having a direct custody model where you’re actually able to respond by you know leveraging you know best in class vendors uh either. You know partnering with those vendors to build solutions yourself. The idea is that you’re able to utilize future proof technologies like mpc, uh sgx, and you know the idea of you – know bespoke policy engines as a basis of really future proofing, that business and working with technology providers that are going to be looking out on the Leading edge and anticipating, where the changes in the markets will be, and then enabling you that to bring that back in house – and the last thing i think is important – is being able to leverage your own balance sheet right.

The idea that you can avoid some of the counterparty and geopolitical risks that are associated with sub custody and that you’ll be able to provide trust and safety to your customers as you’re able to articulate right the backstop of the engagement with digital assets. It’S really coming from the bank itself or from the fintech itself now. This is just a quick overview of kind of where we see the direct custody for sub custody play and kind of some of the benefits that we think and things to be. You know keenly aware of, as you engage you know in this market now we do think that sub custody right and the idea of hybrid sub custody in a lot of sense in a lot of places makes a lot of sense right, we’re, we’re, not anti self Custody, we think there are opportunities where it makes sense for certain players and we think, for you know, fintechs banks and and others. It makes sense to really explore the idea of self custody um. I think, as you think about you, know these different areas and criteria to evaluate on from balance sheet, generally of of the sub custodian against the self custody basis. If you think about the flexibility that’s required in terms of the integrations into third parties, uh the integrations into different market venues, the idea to kind of expand beyond the subcustodian ecosystem uh. That becomes very interesting. If you think about integrations and utilizations around things such as tokenization and compliance and automation, that also becomes important and, as you think, about trading strategies and engagement with regulators, uh that becomes important to look at in terms of the sub custody model.

So you know generally we’ve found that sub custody works well, for you know long only funds, family offices and asset managers, but as you look to build products and services on top of custody, we find the self custody model works. Well. So thank you for your time.

What do you think?

Written by freotech

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