What Does the OCC's Interpretive Letter Mean for Custody of Crypto Assets?

The Office of the Comptroller of the Currency (OCC) released Interpretive Letter #1170 on July 22, 2020, authorizing “national banks” and federal savings associations under its supervision to provide crypto asset custody services to their customers. The letter also affirmed such banks to provide their services to lawful crypto asset businesses. These clarifications are crucial in providing US banks with the confidence to better integrate crypto assets into the US financial sector.

Private keys granting access to crypto asset portfolios are stored in a “wallet” that secures it from third party discovery. These wallets can be “hot” (connected to the internet thus more liquid but susceptible to hacking) or “cold” (liquidation takes more time but completely offline - most secure method).

Need for national bank custody service:

• If a private key is lost, it is essentially irreplaceable. Owners can lose access to crypto assets, thereby resulting in significant losses. 
• Banks are more secure than other options currently available 
• Some investment managers might want to manage cryptocurrencies within a customer’s portfolio and may want to use a national bank
• UK/EC equivalents  

• The OCC now recognizes cryptocurrency custody solutions as a modern form of traditional custody services offered by banks. They have broadened the definition of such services beyond the virtual holding of private “keys” which give the holder access to a cryptocurrency portfolio, allowing the provision of banking services for crypto-oriented businesses.
• The OCC also recognizes the need for banks to develop novel technologies in order to protect cryptocurrencies, as technology permeates the financial markets, thereby finding key escrow service a physical equivalent to the safeguarding of physical assets. The OCC has now allowed national banks to provide:
• Secure web-based document storage 
• Retrieval and collaboration of documents and files containing personal information or valuable confidential trade or business information
• The above are recognized as the “electronic expression” of traditional safekeeping services.

Cryptocurrency Custody Services by National Banks and FSAs

Fiduciary Capacity

• Must comply with 12 CFR Part 9 for banks and Part 150 for FSAs, applicable state law, and any other applicable law such as the instrument that created the fiduciary relationship
   
• The fiduciary can take form of a trustee, executor of a will, administrator of an estate, a receiver or an investment advisor -- OCC gives them authority to manage these assets in the same way they would manage other assets as fiduciaries

Non-Fiduciary Capacity

• Solely provide safekeeping of the key, in most cases this does not entail physical possession of the cryptocurrency

• The acceptance procedure for custodians should provide sufficient review of the customer’s needs and wants while considering the operational needs of the account

• Assessment of the custodian’s expected duties to check they are within its capabilities and are compliant with all applicable laws and regulations

• Understanding of risks of crypto assets and that different crypto currencies might require different risk management procedures as they are subject to different OCC and non-OCC regulations

• Due diligence process including comprehensive review of compliance with AML rules 

Regulatory stamp of approval: The publishing of this letter by the OCC is evidence of their detailed understanding of how cryptocurrencies and crypto custody work, as well as the challenges faced by crypto companies in obtaining traditional banking services. This sets an important precedent for more cautious regulators to follow suit, while paving the way for a positive and progressive embrace of the crypto industry.

Heralding new investment into crypto market: As banks begin to enter the crypto custody market, such custodian services will become more common, thereby leading to cost reduction (due to increased competition) and increased investment into this space, while proliferating trust. This gives banks the unique opportunity to build technology pipelines for more customers to be able to access their crypto assets more expediently. Moreover, companies previously structured as trust companies, can now be structured as banks, thereby enjoying advantages such as a direct connection to USD payment systems. 

Fraud reduction by allowing big banks to service crypto companies: Formerly, Silvergate Bank was the only player in the crypto industry and was very selective in their choice of clients. A few months ago, J.P. Morgan became the only bank to provide services to crypto exchanges – Coinbase and Gemini Trust. As a result of the slow growth seen in the crypto custody industry, many companies have turned to unregulated offshore payment processors for their cash management needs. This was well evidenced in the issues surrounding the under collateralization of the stablecoin Tether (USDT) which began mainly because the issuing company could not secure a traditional banking relationship.

In the constantly changing landscape of crypto-currency regulatory guidance, Sia Partners is ready to assist our clients with their crypto-currency regulation and implementation needs with innovative and comprehensive solutions. Our crypto-currency regulatory capabilities include:

• Crypto-Currency AML/BSA/KYC Policies

• Relevant trainings

• AML Risk Assessment for cryptocurrency firms

• Implementing new procedures related to new crypto-currency usage, systems, and regulations

• Cryptocurrency regulatory guidance

• Assistance with Crypto-Currency related licenses and regulatory approvals

This letter provides regulatory clarity and approval around the fast-growing crypto industry, while opening the doors for expansion into a new client base, offering crypto asset banking services to their existing customers who want to get involved in crypto assets, creating new revenue streams and develop cutting edge innovative technology to service crypto asset offerings.

Daniel Connor

CEO US
+ 1 862-596-0649
Daniel.Connor@sia-partners.com
 

Jonathan Gold

Manager
+ 1 914-320-4039
Jonathan.Gold@sia-partners.com
 

Gayatri Choudhury

Junior Consultant
+ 1 929 217 2167
Gayatri.Choudhury@sia-partners.com