Should you custody digital assets?

As discussed in the first two blogs in this series examining Australian digital asset regulation, anyone who has factual control of digital assets will, under changes proposed by Treasury in the Regulating Digital Asset Platforms Consultation Paper, be providing a financial service and will be subject to requirements for a digital asset facility (DAF), including financial requirements such as a net tangible assets requirement.

Do you need to provide the custody yourself?

A DAF can either provide the asset holding function itself or can appoint one or more sub custodians to hold some or all of its digital assets. This is often referred to as outsourcing custody.

In deciding whether you should outsource custody, it can help to consider:

• what your capital requirements will be
• your organisational capability
• available custodial solutions and transactional functionality
• risk appetite and issues

Does outsourcing custody change your NTA requirement?

Yes, it is proposed that DAF providers will get a discount on their NTA requirement when using an external custodian, but only if the custodian is itself a licensed DAF itself that meets the $5 million NTA requirement. This means DAFs can’t access the NTA discount if they use a global custody provider that is not licensed as a DAF locally. This can raise issues for businesses seeking to access global custody solutions that don’t have a presence in Australia.

If a DAF outsources custody to another DAF-licensed custodian, the DAF must hold 0.5% of the value of the assets held. This means that, from an NTA perspective, there is real value in outsourcing custody where digital asset holdings are less than $1 billion. When DAFs hold more than $1 billion of digital assets there is no NTA discount.

Since nothing is yet set in stone, it is quite possible that the NTA requirements will change as part of the legislative drafting process.

Do you have the right organisational competence?

There are very few businesses in the Australian market that have digital asset custody experience.  This is because very few traditional custodians have forayed into digital asset custody and existing crypto businesses are experts in crypto solutions but don’t necessarily have traditional custody expertise.

Once the reform becomes law, DAFs will need to demonstrate that they have the right organisational competence to provide asset holding services. It is unclear what education and experience requirements will apply or the extent to which ASIC will recognise or grandfather current experience in running a crypto business. Ideally, unregulated crypto experience will be sufficient to support an application for an Australian Financial Services licence for a DAF that will hold assets, but this remains to be seen and may affect who is able to obtain such a licence.

What are the current digital custodial solutions in Australia?

Digital asset custody today is broadly split into two categories: custodial software providers and true custodians. Custodial software providers generally provide software for clients to manage keys, whereas true custodians hold those keys themselves, in the same sense that custodians of fiat assets hold those assets directly.

For those DAFs who are able and willing to custody assets themselves, and intend to hold the appropriate licenses and applicable NTA, custodial software providers are an attractive option. However for those DAFs who are not able or willing to custody themselves and see value in outsourcing their custody to a specialist provider, true custodians like Zodia Custody provide comprehensive solutions.

What should you consider / do before outsourcing custody?
Appointing a custodian is no small task, especially for APRA regulated businesses that need to comply with the requirements in CPS 231 Outsourcing, CPS 234 Information Security and CPS 235 Managing Data Risk. Often custody appointments for traditional financial products are managed via a tender process with an RFP, which includes detailed due diligence and contract negotiations. It sometimes can take up to 6 to12 months to run a custody outsourcing project.

These are the key things you should think about before appointing a custodian:

• What is the custodian’s experience?
• Where is the custodian based?
• Does the custodian have a local presence? Are they committed to the local market with provable local investment?
• Can you access a global network of trading venues and service providers from the custodian?
• What security controls are in place?
• How are the assets held and are there any co-mingling risks? If so, how are these risks mitigated or managed?
• How does the custodian manage concentration risk and counterparty risk?
• What transactional functionality is available? Can you access real-time trading and, if so, how?
• What fees are charged?
• What ancillary services and benefits can you access via the custodian?

What are the different custody solutions and transactional functionality?

Today, in Australia, the primary true custodians operating in the market include:

• BitGo – privately owned, US based custodian, with hot and cold wallet functionality and 24 hour withdrawal SLAs
• Gemini – privately owned, US based custodian, with hot and cold wallet functionality and 24 hour withdrawal SLAs
• Coinbase – publicly-listed, US based exchange with hot and cold wallet functionality and 24 hour withdrawal SLAs
• Zodia Custody Australia – bank-owned, locally operated custodian with real-time transactional capability from the security of cold wallets

As mentioned, it is yet to be seen which global custodians will invest in acquiring the necessary licenses and significant NTA holdings required to operate as a DAF once licensing is in place.

Risk appetite

In working out whether you want to hold digital assets yourself or outsource to a professional custody provider, it is important that you understand the risks with both approaches and choose the options that best aligns with your risk appetite and operating or regulatory requirements. Self custody may be feasible for smaller firms, but it is unlikely to be sufficient for firms requiring specialised services including audits and reporting.

How can Zodia Custody Australia help you?

Zodia Custody offers a proprietary custody platform that combines air-gapped, cold wallet storage built to government standards with real-time asset access for unparalleled security and operational efficiency. Our platform supports secure exchange connections, minimising counterparty risks with robust post-trade settlement processes. Enhanced by stringent monitoring, including tailored transaction approvals and fraud detection checks, our platform ensures full regulatory compliance.

Zodia Custody Australia, in collaboration with NAB, launched in Australia in February 2024, following its affiliates being registered with regulatory bodies globally including the Financial Conduct Authority (FCA), Central Bank of Ireland (CBI) and Commission de Surveillance du Secteur Financier (CSSF) across the UK, Ireland & Luxembourg. Zodia Custody Australia has five local FTEs and intends to be licensed fully as an operating DAF with necessary NTA in time for legislation changes to come into effect.

If you’re considering delegating or outsourcing custody as a value-add to keep your clients’ assets safe, please get in touch with our friendly Zodia Custody team in Australia.

This blog series on regulating digital asset platforms in Australia is produced in collaboration with Hamilton Locke, an award-winning team of lawyers advising forward-thinking businesses and innovators on their most pressing challenges. Special thanks to Michele Levine and Jaime Lumsden.