RDC was recently featured in “Banking [on] Blockchain: A Legal and Regulatory Primer, ” a comprehensive guide to the legal and regulatory landscape surrounding the use of blockchain technology, decentralization and digital assets within the financial services industry. RDC is cited as an example of a product-based custodial solution, whereby qualifying investors can deposit digital assets with a custodian in exchange for DRs (depositary receipts), held as traditional securities at a registered securities clearing organization.
Please note: RDC is not the author of this guide and is not responsible for the content and accuracy of the information contained therein.
Read on for the full excerpt:
Custody, Redemption, and Ownership
“Three core risk management principles support these safekeeping practices. First, safekeeping operations must be functionally separated from trading and other similar activities. Second, client assets must be segregated at all times from the bank’s proprietary assets and from the assets of other clients. Third, proper control over client assets must be maintained at all times, including in the case of crypto assets, by control of the private keys in order to eliminate any single point of failure in the record of ownership.
Digital asset custody is a broad term that includes various methods of storing and protecting digital assets on behalf of their owners. ⁶ They are similar in a number of ways to those described above for traditional financial assets. A customer can decide to provide that custody for himself, or custody providers can take responsibility for securely storing those assets, including the ability to buy and sell them and keep appropriate records of (i) their ownership, (ii) corporate actions with respect to such assets (such as payment of dividends), (iii) valuation of the assets, and (iv) transfer of the assets. Other traditional considerations are how the assets are segregated (individual or omnibus), whether sub-custodians will be used, and any contractual limitations on liability.
Self-custody involves an investor holding its digital assets in its own wallet, which actually is a piece of software sitting on a computer. This wallet will hold both public keys and private keys. Public keys can be shared publicly, and are used to generate a deposit address for the owner’s receipt of crypto. Private keys are large sets of numbers which must remain absolutely private because they can be used to transfer digital assets to another person. Obviously, the primary risk involving self-custody is that the individual customer is relying on himself to ensure the private keys are not lost and can be accessed when needed. This includes protecting the wallet against hacking and other risks, which can be more challenging for an individual customer than an institutional customer.
Third-party custody has become the preference of owners who would rather involve experienced intermediaries to safeguard their keys and bear some of the burden if the keys are lost. Moreover, certain institutional investors are obliged to use accredited (or qualified) custodians to safeguard their assets. The digital asset custody industry includes direct custodians and hybrid service providers. Among the direct custodians are crypto exchanges, such as Coinbase, financial institutions, including banks, and other established financial services concerns. Hybrid service providers offer individuals and businesses digital custody solutions through software and other technological means. In some cases, financial institutions will contract with a sub-custodian to provide such services. However, that may limit the type and number of clients, which investors may not be able to accept based on the sub-custodian’s risk profile and the options it supports. Product-based custodial solutions are developing as well. For example, qualifying investors are now able to deposit digital assets with a custodian in exchange for depositary receipts, which are held as traditional securities in book-entry form at a registered securities clearing organization. ⁷”
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6. Digital Asset Custody 101: Guide to Self Custody Wallet Options and More, Fireblocks, https://www.fireblocks.com/digital-asset-custody.
7. See, e.g., Receipts Depositary Corporation, https://receiptsdepo.io/ (last visited Mar. 23, 2024).
More About Banking [on] Blockchain: A Legal and Regulatory Primer
Edited by Sumeet Chugani and Stephen T Gannon
Banking [on] Blockchain is a comprehensive guide to the legal and regulatory landscape surrounding the use of blockchain technology, decentralization, and digital assets within the financial services industry. The book explores the potential benefits and challenges of using these technologies and offers guidance on how financial institutions can navigate the complex regulatory environment.
Providing you with an understanding of blockchain technology, decentralizations, and digital assets within the financial services industry, this guide examines the various regulatory frameworks put in place to govern their use in the banking sector, including anti-money laundering regulations, consumer protection rules, custody issues, and cybersecurity standards.