Digital assets have rapidly evolved into a significant component of the financial landscape, particularly in the Asia Pacific region. Defined as assets that exist in digital form and hold identifiable value, ownership rights, or permissions for use, digital assets encompass a variety of forms including cryptocurrencies, non-fungible tokens (NFTs), digital bonds, and stablecoins.
The demand for digital assets in Asia Pacific is on an upward trajectory. The digital asset custody market alone is projected to soar to approximately US$4.7 billion by 2030, a remarkable increase from its valuation of approximately US$1.3 billion in 2023.[1] A study found that digital assets constitute about 7% of surveyed investors' portfolios, positioning them as the fifth-largest asset class in the region—surpassing allocations to foreign currencies, commodities, and collectibles.[2]
Opportunities for digital asset custodians
As the digital asset market expands, the volume of digital assets circulating within the financial system will rise steadily. Both individuals and institutions are starting to gather digital assets that hold considerable value, making the protection of these assets increasingly important.
Digital asset custodians play a vital role in fulfilling this growing requirement. By jumping on this trend, custodian banks stand a better chance of meeting evolving customer needs, increasing their revenues, and getting ahead of competitors that only focus on traditional assets.
Becoming a digital asset custodian bank means having the security and compliance capabilities to safeguard access to digital assets. The custodian bank holds the private keys to the asset on behalf of the customer, ensuring that it cannot be accessed by any other party.
Private keys can be stored in three wallets: hot, cold, and warm. Hot wallets are fully connected to the internet and store private keys online, making it easier for customers to send and receive digital assets. Some hot wallets allow transactions to be approved automatically, making them the fastest option for operations such as trading. In contrast, cold wallets provide offline storage for private keys, and transactions require human intervention for approval. These features reduce the risk of exposure to cybersecurity threats, like hacking, but at the cost of slower transaction speeds. Warm wallets are connected to the internet but are not constantly online. They still store private keys online but require human involvement in authorizing transactions, offering moderate levels of convenience and security.
Depending on customer needs, digital asset custodian banks are equipped to offer a range of wallet options to satisfy the customer’s requirements to balance security, compliance, and liquidity. By providing increased optionality, digital asset custodian banks can customize a digital asset custody solution based on factors such as the regulations in the customers’ jurisdiction, the frequency of transactions, and the level of cybersecurity risks.
In addition to safeguarding private keys, digital asset custodian banks can also offer value-added services, like trading, staking, and lending against digital assets. For instance, transaction fees from crypto trading can contribute to new streams of income.
Entering the digital asset custody space early enables custodian banks to position themselves as leaders in this rapidly evolving market. By being proactive in digital asset custody services, custodian banks can set themselves apart from competitors by winning the growing base of clients seeking protection for their digital assets.
Barriers to digital asset custodianship
Despite the promising opportunities, custodian banks must overcome several challenges when they embark on digital asset custodianship.
Concerns about digital asset loss or theft deter custodian banks from adopting digital custodial solutions. The susceptibility of the digital asset space to cyberattacks introduces high stakes. The safety of digital assets rests heavily on cryptographic keys; if these keys are stolen, the resulting loss is often irreversible. Integrating advanced security protocols with existing systems can also be complex, and custodian banks lack the necessary technological expertise to deploy secure, institutional-grade infrastructure.
The fragmented regulatory landscape across Asia Pacific also complicates compliance for custodian banks that wish to manage private keys. For instance, jurisdictions like Singapore and Hong Kong have established progressive frameworks, while others like China impose strict regulations on cryptocurrency activities. Meeting compliance requirements also introduces management complexity and additional costs, which could drive up the overheads for custodian banks’ services. In 2023, financial institutions, including custodian banks, in Asia Pacific collectively spent around US$45 billion on financial crime compliance.[3] In the region, 98% of these financial institutions reported increased compliance costs, with heightened financial crime regulations as a main driver.[4] These findings highlight that navigating the region’s complex regulatory environment poses significant challenges.
Selecting the right digital asset custody approach
When overcoming these roadblocks, custodian banks must carefully consider their approach to managing the private keys to these digital assets. Currently, there are two main options: self-custody and managed custody, each with unique features that suit different needs.
Self-custody: Control, transparency, and liquidity
In the self-custody model, custodian banks benefit from direct control over the clients’ private keys. This autonomy allows for immediate access to assets, enabling quick transfers and transactions without the potential delays associated with third-party custodians. Additionally, the absence of intermediaries improves transparency, allowing custodian banks to track their holdings directly and reducing the risk of mismanagement or fraud.
However, self-custody is typically not without some limitations. Custodian banks may not have the necessary expertise to securely store private keys in-house, exposing them to cybersecurity threats. Furthermore, the operational complexity of maintaining specialized technology and ongoing maintenance can strain resources, especially for custodian banks that are not well-versed in digital asset management. As demand for digital assets increases, scaling self-custody solutions may become challenging without substantial investment in infrastructure and technology, or the right partner in place to help alleviate some of these burdens.
Managed custody: Streamlined management and scalability
Managed custody allows custodian banks to outsource the storage and management of private keys to specialized third-party custodians. This model is generally less labor-intensive, as third-party custodians handle key management and security, reducing manpower demands on the custodian bank. Additionally, third-party providers can supply IT teams and infrastructure, enabling custodian banks to scale operations quickly and efficiently. With this support, custodian banks can deploy digital asset custody solutions with minimal technological expertise, lower infrastructure investments, and reduced maintenance costs.
Despite these benefits, managed custody has certain drawbacks. Relying on third parties introduces risks around their security measures and regulatory compliance. Any issues the third-party custodian faces can directly impact on the custodian bank's access to assets. Additionally, outsourcing private key control means custodian banks depend on the third party’s policies and procedures, potentially leading to transparency and liquidity challenges.
Why custodian banks should consider self-custody solutions
While both self-custody and managed custody models have their merits, the former might be more compelling for custodian banks, especially when considering the strategic implications of outsourcing digital asset custody to third parties. Safekeeping assets is a core service offering of custodian banks, and outsourcing this function effectively licenses out a fundamental aspect of their business model. This could raise questions about a custodian bank’s control, trust, and the overall integrity of its operations.
Once a custodian bank has decided on a self-custody model, selecting a suitable self-custody technology involves several key considerations. The solution must offer robust security features and flexible key management options, such as hardware security modules (HSM) and multi-party computation (MPC), to mitigate risks. MPC software, for example, divides the private key into multiple shards distributed across different parties or systems instead of storing it in one location, preventing a single point of failure. HSMs, on the other hand, securely store private keys in a physical device, designed specifically to protect cryptographic secrets. These technologies have been trusted in banking for decades and offer physical security, cryptographic isolation and secure communications – making them ideal for offline, long-term storage use cases. MPC and HSM technologies can be complementary, and many institutions often use both to enhance security.
The self-custody technology must also ensure compliance with relevant regulations to meet regulatory obligations. A user-friendly interface will help customers gain better visibility into their holdings and transactions, while seamless integration with existing banking systems is necessary for smooth operations. Cost-effectiveness is crucial too to reduce overheads, allowing custodian banks to offer competitive prices.
Seizing the future of digital asset custody services
Digital assets are poised to reshape the future of custody services in Asia Pacific’s financial sector. To capitalize on this opportunity, custodian banks must act decisively – committing to the space, carefully assessing their requirements, and developing a deep understanding of the rapidly evolving digital asset landscape.
By strategically choosing partners that can facilitate the implementation of self-custody solutions, custodian banks can position themselves as leaders in this transformative financial shift, ensuring they remain competitive and relevant in an increasingly digital world.
[1] Grand View Research, Asia Pacific Digital Asset Management Market Size & Outlook, accessed Nov 2024
[2] Accenture, Providing Advisory Services is Increasingly Critical for Wealth Management Firms Looking to Seize Growth Opportunities in Asia, Accenture Report Finds, 2022
[3] LexisNexis Risk Solutions, True Cost of Financial Crime Compliance Study – Asia Pacific, 2024
[4] Ibid.