On-Chain Custody Explained

Good morning. Today, we’re going to compare traditional custody and on-chain custody. With the recent repeal of SAB 121 in the USA, big banks are scrambling to ensure their digital asset custody businesses are ready.

There are big differences in how global custodians look after assets in the “traditional world” vs how they need to safekeep and service assets in the on-chain world. This article explores these differences and provides some insight into where industry structure might evolve over the next few years.

Every Wednesday, we’ll share an article exploring the rapidly evolving global custody sector. Every Friday, we’ll bring you a curated roundup of the most important news and insights affecting our industry.

Traditional Global Custody: The Legacy Approach

How It Works
Traditional global custody has historically focused on managing paper certificates, securities, and other conventional investments. When extending these services to digital assets, custodians store and manage private keys through secure infrastructures—ranging from physical vaults to encrypted digital storage solutions. They provide clients with periodic statements and handle most blockchain-related operations, mirroring how they would manage and safeguard traditional securities.

Security and Regulatory Benefits
Global custodians are often deeply embedded in regulatory systems, giving them a clear compliance framework for safeguarding client assets. These institutions typically maintain substantial insurance policies, making their services particularly attractive to large institutions that must meet strict fiduciary standards. In many jurisdictions, regulations require certain types of investors, such as pension funds or registered investment companies, to rely on qualified custodians—a designation that many large banks and trust companies already hold.

Advantages of Traditional Global Custody

1. Regulatory Clarity: Traditional custodians are well-versed in navigating legal requirements, ensuring investors’ assets are backed by recognized safeguards.

2. Familiar Operational Processes: Global custodians have established protocols for settlement, reporting, and compliance, reducing the learning curve for institutional clients.

3. Liability Protections: Extensive insurance policies and capital reserves help minimize client losses in case of cyberattacks or operational mishaps.

4. Integrated Services: Many global custodians also offer traditional asset management, fund administration, and lending solutions in one platform.

Drawbacks of Traditional Global Custody

1. Potential Lag in Innovation: Historically conservative approaches can lead to slower adoption of cutting-edge security or blockchain tools.

2. Limited Asset Support: Traditional custodians may initially offer services for only the most established cryptocurrencies or tokenized assets, leaving more niche or emerging projects unsupported.

3. Higher Costs: The robust organizational structure and regulatory compliance often lead to higher fees, which may be prohibitive for smaller investors or emerging funds.

4. Reduced Direct Control: Clients rely on the custodian’s timeline and processes to move or transact assets, which can delay high-speed trading or real-time transfers.

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Digital Asset Custody From Global Custodians or Specialists

Two Distinct Tracks
Digital asset custody solutions generally come from two sources:

1. Global Custodians Expanding into Crypto: Recognizing the demand for secure, regulated digital asset storage, many major banks and trust companies have ventured into cryptocurrency custody. These offerings often mirror traditional custody operations but incorporate specific blockchain technologies, cold storage mechanisms, or multi-party computing techniques to protect private keys.

2. Specialist Crypto Custodians: These are crypto-native firms whose core competency is digital asset security. They develop sophisticated technological infrastructures, including hardware security modules, advanced encryption, and custom blockchain integrations. Many also pursue regulatory licenses to become qualified custodians, especially to serve institutional clients with strict compliance needs.

Security and Technology
Specialist custodians are often at the forefront of crypto security innovation. They may use cutting-edge methods such as multi-signature wallets or threshold signatures, reducing single points of failure. Some offer automated compliance checks, real-time transaction monitoring, or built-in decentralized finance integrations. On the other hand, global custodians expanding into crypto often lean on their brand authority and compliance expertise, combining newer blockchain-focused security measures with established internal protocols.

Advantages of Digital Asset Custody (Global or Specialist)

1. Technical Expertise: Specialist custodians, in particular, invest heavily in blockchain research and development, offering advanced solutions for institutional-grade security.

2. Asset Diversity: Many specialized crypto custodians quickly add support for new coins or tokens, aligning with the fast-moving nature of the crypto ecosystem.

3. Regulatory Momentum: In response to institutional demand, both global and specialist custodians are rapidly pursuing higher levels of regulatory approval, such as trust charters or bank licenses, ensuring stronger legal protection.

4. Innovation and Flexibility: Customizable solutions are common; clients can opt for multi-signature wallets, staking services, yield-generating products, or near-instant settlement.

Drawbacks of Digital Asset Custody (Global or Specialist)

1. Regulatory Patchwork: While regulations are evolving, clear guidelines vary widely among jurisdictions, creating potential legal ambiguities.

2. Rapidly Evolving Technology: Cutting-edge solutions can expose assets to unforeseen smart contract bugs, protocol vulnerabilities, or integration issues.

3. Dependence on Emerging Firms: Some specialist custodians are startups that may not have the financial stability or broad insurance coverage of century-old banks.

4. Scalability Challenges: Handling multiple blockchain networks—each with distinct protocols and security models—can lead to operational complexity.

Key Takeaways

As cryptocurrencies continue to grow, the difference between traditional global custody and digital asset custody from either large banks or specialist providers is becoming less obvious. Big financial institutions are quickly upgrading their services to support crypto, while specialist firms are working to obtain full regulatory licenses and operate like established financial institutions. Many experts think a blended model will appear, combining the regulatory expertise of banks with the cutting-edge technology of crypto-native companies.

At the same time, “tokenization” is on the rise. More traditional assets—like stocks, bonds, and even property—are now being turned into digital tokens on blockchains. Because of this, custodians (whether large banks or specialized crypto firms) will likely manage both classic investments and digital tokens on the same platforms. This setup could give clients a single place to view all their holdings, plus extra opportunities to earn income through newer services such as decentralized finance.

What’s next?

For the next few Wednesday editions, we’ll keep exploring digital assets in more detail and how they are very different from other asset classes when it comes to global custody and what institutional clients will need from an asset servicing viewpoint. We’ll keep sending our industry news roundup every Friday.