Can Standard Chartered’s spinout Zodia get institutions into crypto?

Despite today’s “cryptopocalypse”, it was only a short time ago when it seemed nothing could stop the soaring prices of just about any cryptocurrency on the market.

Remarkably, those market caps were driven by retail investors – individuals buying and selling tokens. Big institutional money has been more hesitant to wade into the volatile market – getting that flow in will require levels of trust that have so far been hard to establish in crypto, but Zodia Custody — a startup formed as a venture of financial services firm Standard Chartered’s corporate venturing unit SC Ventures and backed by fellow financial institutions Northern Trust — is looking to fill that gap.

In theory, cryptocurrencies are a trustless ecosystem: an environment in which trust between counterparties is unnecessary because everything is verified on the blockchain anyway. You don’t need to have confidence in a third-party or financial intermediary, because that trust is distributed across a network.

Large institutions handling other people’s money have still been hesitant to invest in cryptoassets. This is for a number of reasons, including the fact that the market is young and still highly volatile — exceeding their risk appetites — and that crypto tokens have largely been seen as speculative instruments without the range of use cases that come with having a robust ecosystem in place. If institutions can’t be sure their assets will be safe, easily accessible and firewalled when service providers go bust, their grip on the purse strings will remain tight.

Zodia is trying to assuage some of the security concerns. Maxime de Guillebon, chief executive of Zodia Custody, says the company is probably the only custodian on the market capable of cold storage — meaning crypto wallets that are disconnected from the internet, as opposed to “hot” storage that is connected and therefore more vulnerable to cyber incursions — with 24/7 real-time access.

“Custody for us is very similar to custody of conventional assets or traditional assets,” de Guillebon tells Global Corporate Venturing.

Simply put, custody is about safekeeping assets – recording legal title or legal ownership, avoiding loss or misuse of assets, retaining reporting functions and so on. It’s something every bank does for its clients, but there have been questions over how that would work in the brave new world of the blockchain and Web3. De Guillebon says, however, that custody for crypto works in much the same way as custody for traditional assets.

“Because we have that DNA of conventional finance, but we navigate in the crypto space, we can really move into the two and very easily help our clients,” says de Guillebon.

How Zodia Custody was born

De Guillebon joined Standard Chartered in 2006, serving in a number of roles before becoming part of the SC Ventures team in early 2018. Eventually, it became clear that there was an opening in the market for a service to provide crypto custody services for institutional clients, but what form that would take was unclear at first.

“The whole idea started with innovation within the firm and then intrapreneurship. Because the intention was never originally to make it a new business. The genesis of what is now known as Zodia was that nobody actually understands what custody for cryptoassets really is, and it’s no different from traditional custody. That’s how we started to first identify the opportunity and look at the risks,” he explains.

The decision to create a separate entity was made around the end of 2018, and it was agreed that a venture model – the creation of a subsidiary as opposed to another department within Standard Chartered – had the greatest chance of success.

With most of its team coming from a Standard Chartered background, Zodia differentiates itself from crypto-native technology firms that have to reverse engineer what institutional custody is. More often than not, for other firms this means limiting themselves to securing private keys, he says.

“One of the strong beliefs from a Zodia standpoint is that crypto doesn’t operate completely in isolation from conventional markets or other types of assets, so cross-margining, cross-asset transactions will have to be mainstream as well for these to be part of general mainstream adoption. It’s not working against the bank or traditional finance, it’s actually working together getting both conventional assets and crypto or digital assets a lot more fungible in whatever you do.”

Flexibility around culture and geography was one of the main drivers behind the decision to make Zodia a separate company; the bounds and incentives of a traditional regulated financial institution like Standard Chartered are not the most conducive to attracting crypto talent, and the bank’s footprint is strongest in the markets such as the Middle East, Africa and Asia, for example, while the main crypto hubs are in North America and Europe.

Attracting that talent, of course, is crucial for developing from scratch a fit-for-purpose technology stack that you just wouldn’t find within the legacy technology of a large financial services company. Paired with the need for a purpose-built entity was the retention of the banking DNA – in terms of compliance, risk management, financial crime and overall governance – that came from its SC Ventures origin.

Zodia Custody was one of the first ventures to come out of SC Ventures’ crucible, and it was also the first to raise external capital.

Reeling in the whales

The first key to bringing institutional money into the fold, according to de Guillebon, is education. They need to be made to understand that there’s a way to be safely crypto-active while maintaining the commitments they made to shareholders and regulators, without exceeding their existing risk appetites. Having the imprimatur of a large, trusted financial services corporate goes a long way to establishing that trust.

More important, however, is the regulation that is being put in place around crypto assets. De Guillebon explains: “For me, by far the most critical [factor] is regulatory. Whenever you’ve seen regulatory clarity and framework being put in place – you look at Canada for the exchange-traded funds, you look at Australia more recently – all of a sudden investors, asset managers and asset owners are much more comfortable in getting exposed to the asset class because they have a regulatory framework.

“That’s probably the biggest blocker today to broader adoption. This will change – MiCA in Europe is expected to really be a game changer because you now have a framework to do it in a regulated fashion. Most firms today are either authorised or semi-licensed, but here you have a regulatory framework for both the providers and the investor.”

MiCA – Markets in Crypto-Assets – is the EU-wide legal and regulatory framework that will govern service providers, bringing together fragmented rules that differ from country to country.

Even as asset managers want to dip their toes into the space, they don’t feel comfortable doing so in the absence of certain assurances.

“They want to make sure that the assets are safe, that they can trade safely, that the custodian applies the same principle of traditional custody. This means not co-mingling assets, not losing assets, not going down, not committing fraud, not being subject to cyber-attacks and having the right controls in place. Having Standard Chartered and Northern gives to our clients that stamp mark,” explains de Guillebon.

It’s not just the client’s worries that are assuaged. The byzantine process of obtaining regulatory clearance is also streamlined when regulators see an application that has the hallmarks – in terms of knowing and meeting a host of standards and compliance requirements they may ask for – of a bank. Zodia received registration with the UK’s Financial Conduct Authority last July, and last month became the first cryptoasset custodian to register with the Central Bank of Ireland.

Keeping up with the cryptodians

The fast-moving nature of the crypto-native segment of the market is such that you need to move fast and adapt to stay relevant, says de Guillebon. It initially launched with custody services for Bitcoin and Ethereum, but the market had already moved on not just to more coins, but to a wider range of services such as trading and facilitating yield. Zodia has been keeping pace, supporting between five and 10 coins and readying up pilots for staking and access to decentralised finance.

Even institutionals, whose initial entry can be slow, are not immune to inertia.

“You have the large portion of the institutional that take a lot longer to come to crypto because of their internal processes, their regulatory approvals, their own due diligence, which is totally understandable. What’s super interesting is that once they get in, they actually move equally fast through the crypto chain. You start with Bitcoin and maybe you take 18 months to get the green light, and then you take three months to do any the further currencies,” says de Guillebon.

Education is something Zodia itself needs to continually do for its own sake, too. Each coin has its distinct blockchain architecture, protocol and way of behaving – complacency with what you know is a recipe for disaster, and complicating the issue is the fact that unchartered waters don’t have clear paths to follow.

“I can safely say that where we started back in 2018 to where we are now, the learning curve has been significant for us, but also for Standard Chartered in Northern Trust overall.  I think there were so many unknown unknowns back in 2018,” says de Guillebon.

“It’s a constant learning curve, and the issue with crypto is you don’t have a guide. You don’t have a guide to coin and blockchain due diligence, you don’t have a guide to managing counterparty risk, you don’t have a guide to assess smart contract. You need to sort of create on the go, and in order to create these guides and put your own framework in place, you need to try.  It’s very important from our side to keep the research and development team constantly sniffing for things that are new, things they are seeing in the market.”

Trial by fire

The boom we saw in token prices over the past couple of years has more recently been followed by a “crypto winter” that has seen billions in coin value wiped off the market. The scale of the volatility, argues de Guillebon, is largely a feature of the market’s immaturity.

“There are ups and downs for any asset class. I think everybody also agrees that crypto adds a zero to volatility, so it doesn’t move 4-5% anymore, it moves 40-50%. That is something that will probably ease a little bit as the market matures,” he says.

More than that, a market crisis presents an opportunity for recalibration, testing your risk management model, volatility model, commercial model and trading model. It’s a necessary evil for the market to mature.

“What we’ve seen is a definite flight for quality. If you think about risk-reward prior to the crash, especially after 2020, when crypto sort of rose 400-500%, I think most investors disregarded risk management, and it was just a rush to make money,” says de Guillebon

“There was a disregard for what everybody would consider as genuine good governance, counterparty risk, market risk. You could just make money out of everything. Now I think the balance has come back.”

Not all players have made it out unscathed, of course. Firms like crypto lender Celsius – which arguably fall under the broad custodian umbrella – filed for bankruptcy in July. Just a couple of months earlier cryptocurrency exchange Coinbase’s chief executive Brian Armstrong sent jitters through the market saying that a court may consider customer assets as part of the company should bankruptcy proceedings take place.

For Zodia, making it clear that there is that wall protecting its clients’ money from a black swan event is extremely important.

“[Insolvency remoteness of your assets as a custodian] is really number one. If we become insolvent, can our clients still retrieve the assets or will the assets placed in custody be part of the insolvency state of Zodia? The tweet from the Coinbase CEO has triggered a lot more questions from our clients than Celsius, asking: Hey, how do you segregate that? It’s got nothing to do with crypto wallets. It has to do with our legal construct, the use of English law that recognises crypto assets as property, being able to have trust and beneficial ownership of property and assign the beneficial ownership to your clients.”

The company’s purpose-built platform is such that building more functionality on top of it can be done faster than ever, according to de Guillebon, enabling it to be a fast follower of market movements without compromising its bank-grade structure.