Custody of Cryptoassets

15 June 2023

The provision of custody services for cryptoassets has recently been under heightened scrutiny following high-profile insolvencies of certain crypto service providers. These insolvency proceedings have demonstrated that determining what type of claim clients of custodian wallet providers have in respect of their cryptoassets is crucial.

In the absence of a clear regulatory framework for cryptoasset custody, the product offering of custodian wallet providers varies significantly with the effect that, in practice, services provided under the label of crypto custody services, may not involve true "custody" and instead fall under an alternative legal regime. This has important consequences for a customer's claim to the "custodied" assets, including on insolvency.

We are delighted to have collaborated with digital asset custodian Komainu on this report, in which we aim to improve clarity for market participants on best practice, as well as draw attention to areas of legal and regulatory uncertainty where it would be helpful for legislators and regulators to take action that enhances certainty. The report contains a detailed analysis of the legal position of custodial wallet services across Australia, Germany, Japan, Jersey, the Netherlands, Singapore, the UAE, the UK and the US. We are grateful to the team at Carey Olsen for their contributions in relation to Jersey law.

Laura Nixon, Knowledge Director - Fintech says…

"Our new report on cryptoasset custody in collaboration with Komainu has some positive findings for market participants who offer or use carefully-structured custodial wallet services. However, the lack of consistent regulatory frameworks for cryptoasset custody globally presents a significant challenge for firms offering these services internationally. We hope that our policy recommendations will contribute to enhanced international consistency and legal certainty."

Madeleine Yates, Special Regulatory Advisor adds…

"This analysis of custody of cryptoassets throws into sharp relief the importance of understanding what is meant by the term "custody" and "segregation" amidst the operational constraints of cryptoasset services offerings."

Please download the report to read our full executive summary and policy recommendations, as well as our detailed legal analysis and insights on the legal and regulatory frameworks for the custody of cryptoassets across 9 key jurisdictions.

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How can cryptoassets be held in custody? What legal frameworks exist?

There are legal frameworks in many jurisdictions that allow custodian wallet providers to effectively safeguard cryptoassets on behalf of clients, provided that certain structuring or legal requirements are met.

For example, in many common law jurisdictions, this includes trust structures where assets can be "held" on behalf of beneficial owners without flowing into the custodian's estate.

However, the lack of consistent regulatory frameworks for cryptoasset custody globally emphasises the challenge that custodian wallet providers face when offering their services internationally. There is a complex and diverging regulatory landscape which makes the delivery of effective custody arrangements for cryptoassets practically difficult.

There are also notable differences in the extent and maturity of regulatory and legal frameworks that apply to the custody of cryptoassets across jurisdictions.

fintech-custody-of-cryptoassets-report-komainu-Diego-Ballon-Ossio

Partner Diego Ballon Ossio says...

"In order to create efficient markets in cryptoassets it is imperative to have legal certainty in respect of custody and settlement arrangements. We hope that this report enhances the policy discussion and brings us closer to successful wholesale cryptoasset markets."

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Can cryptoassets be held in a "bankruptcy remote" manner?

Crucially, many jurisdictions have frameworks that facilitate custodian wallet providers holding cryptoassets in a bankruptcy remote manner where relevant requirements are met.

However, the challenge for custodian wallet providers offering services internationally is in understanding the varying complex legal and regulatory frameworks for this globally. For potential clients, the challenge remains understanding exactly what the service on offer is, i.e. whether it is a true "custody" arrangement or not, whether the requisite conditions to achieve adequate separation of the cryptoassets being custodied and the estate of the custodian wallet provider have been met, and accordingly how the custodied assets would be treated in insolvency proceedings of the custodian wallet provider in the relevant jurisdiction(s).

Client assets held by a custodian are "bankruptcy" or "insolvency remote" where, upon the custodian's entry into insolvency proceedings, they will continue to be treated as assets of the client, and not as assets of the custodian.

fintech-custody-of-cryptoassets-report-komainu-Christina-Irgel

Komainu's General Counsel Christina Irgel says...

"The recent wave of high-profile insolvencies has underscored the need for clear guidelines regarding clients' claims over their cryptoassets in a fragmented regulatory environment. At Komainu, we believe in fostering trust by championing best practices and advocating for clear legal and regulatory guidelines where possible."

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Our policy recommendations

Well-considered and internationally consistent regulation for the custody of cryptoassets is crucial to allow the market to continue to develop responsibly and to avoid any further high-profile insolvencies, the cost of which is ultimately borne by investors. Certainty regarding how cryptoassets can be held in custody so that they are not available to the custodian wallet provider's creditors on insolvency is paramount. It is also important to be clear what a custodian wallet provider is authorised to do, or not do, with the assets it holds for clients. Any regulatory framework should strive to afford client protections commensurate with the commercial realities of a high-volume low-margin business.

Our policy recommendations for the ideal regulatory framework for custodial wallet services include:

- clarity on the definition of (and requirements and standards for) custodial wallet services, the term custodian, segregation best practice and the underlying legal frameworks;

- mandatory arrangements to support the argument that cryptoassets are not available to creditors of the custodian wallet provider;

- recommended disclosure around business operations and how client assets are held and recorded; and

We are delighted to have worked in collaboration with Komainu on this report. Komainu is a regulated digital asset custodian built by institutions for institutions and created as a joint venture between Nomura, digital asset manager CoinShares, and digital asset security company Ledger. Offering multi-asset support with regulatory compliance, Komainu is merging traditional financial services with leading security standards for the next generation of institutional custody. Headquartered in Jersey and with offices in London, Dublin, Dubai, and Singapore, Komainu (Jersey) Limited is regulated by the Jersey Financial Services Commission (JFSC) and Komainu MEA FZE is regulated in Dubai by the Virtual Assets Regulatory Authority (VARA). For more information, visit Komainu.

We are grateful to Christopher Griffin and team at Carey Olsen for their contributions in relation to Jersey law. For more information, visit Carey Olsen.

Download the report