The Internet has shaken up the finance industry, transforming financial transactions and investments. Yet, while the Internet has profoundly reshaped the global financial landscape, the development of a so-called ‘natively digital’ online financial infrastructure is still only in its infancy. Today’s payments and other financial transactions may be digital but they often still rely on third-party providers and less efficient rails – or sometimes even manual processes hidden behind the scenes.  

The next generation of the Internet – sometimes called Web3, or the decentralised web – is leveraging blockchain technology and tokenisation to create a more open and transparent Internet where users have greater control over their data and digital assets. It aims to enhance security and trust using decentralised protocols. The full progression from our current Web2 world to Web3 entails embedding finance natively in the online world.  

The Finternet 
In April 2024, Agustín Carstens, General Manager of the Bank for International Settlements, gave a speech proposing the concept of the “Finternet” as “a vision for the future financial system. The Finternet concept describes multiple financial ecosystems interconnected with each other – much like the Internet. The Finternet would be “designed to empower individuals and businesses by placing them at the centre of their financial lives”. 

The Finternet is based on the idea of unified ledgers that combine all necessary financial assets and transactions onto common platforms. Tokenisation (converting assets into digital tokens on these ledgers) plays a crucial role. Programmable ledgers would support smart contracts, which are self-executing contracts with the terms directly written into code. These can automate various financial processes, enhancing efficiency and reducing the role of traditional intermediaries​.  

Central Bank Digital Currencies (CBDCs) are central to this new financial ecosystem. They could exist in both wholesale and retail forms, serving as digital equivalents to central bank reserves and banknotes. The integration of CBDCs with tokenised deposits would form the backbone of the Finternet​. While the Finternet concept is still theoretical, and there are challenges to the idea of how a unified ledger could be implemented, the proposal shows the continuing mainstream acceptance of distributed ledger technology and tokenisation in financial circles. It also fits with wider tech trends already taking place in finance. 

The Parallel Growth of Embedded Finance and Web3 
Embedded finance and Web3 are both transformative concepts which are concurrently reshaping today’s financial landscape. Embedded finance integrates financial services directly into non-financial platforms, making it easier for consumers to access banking, lending or payment services seamlessly within apps and websites they already use. Solutions meet users where they are with a financial option they need, whether that be a loan, payment program, insurance plan, or easy way to make a payment.  

The convergence of embedded finance and Web3 could significantly amplify the benefits of both. Web3’s decentralised infrastructure can enhance the security and transparency of embedded financial services, while embedded finance can help Web3 applications reach a broader user base by integrating decentralised financial services into everyday platforms. Together, they have the potential to create a more inclusive, efficient, and user-centric financial ecosystem.

Custody in a Tokenised World

In a world where people and businesses transact on an internet of finance and where finance is embedded into our everyday experiences, it’s not too hard then to imagine individuals and firms all becoming token holders whether they hold CBDCs, tokenised deposits, cryptocurrencies or tokenised real-world assets. 

In this new universe of multiple tokens, custody presents several significant challenges, reflecting the complexity and evolving nature of managing digital assets securely. These challenges include: 

• Security Risks: Digital assets are vulnerable to hacking, phishing, and other cyber threats. Ensuring robust security measures, such as multi-signature wallets and hardware security modules, will be critical. 

• Regulatory Compliance: The regulatory environment for digital assets is still maturing and varies significantly across jurisdictions. Token holders must navigate a complex landscape of regulatory requirements, including anti-money laundering (AML) and know your customer (KYC) obligations, which can be challenging to comply with comprehensively. 

• Technological Complexity: Managing digital assets requires sophisticated technological infrastructure. This includes secure storage solutions, reliable blockchain network access, and regular software updates to mitigate vulnerabilities. The rapid pace of technological change adds to the complexity, as token holders must continuously adapt to new protocols and standards. 

• Insurance and Risk Management: Insuring digital assets is more complicated than traditional assets due to their unique risk profile. 

• Operational Challenges: Efficiently managing digital asset transactions, especially across different blockchain networks, requires robust operational processes. This includes maintaining secure backup and recovery solutions, managing private keys, and ensuring transaction integrity. 

• Interoperability: The diverse range of blockchain platforms and token standards can lead to interoperability challenges. Token holders will need to manage assets across multiple blockchains seamlessly, which requires specialised knowledge and infrastructure. 

The digital asset custodians of the future will need to adopt a multifaceted approach, combining advanced technology, stringent security practices, regulatory compliance, and continuous innovation to stay ahead of emerging threats and evolving industry standards. On the Finternet, in whatever form it emerges, the role of the custodian will become more complex and critical than ever before.  

Disclaimer: This article is provided to you for your information and discussion only. It should not be regarded as a solicitation or an offer to buy or sell any products or services in any country to any person to whom it is unlawful to make such an offer or solicitation. View full disclaimer here: zodia.io/marketing-disclaimer.

As the digital asset market has matured, financial institutions now look to custodians for ease of transacting and speed of access to their assets. While the safety of assets is non-negotiable, reduction of counterparty risk is also paramount in a blockchain-based settlement environment. Connectivity and a move towards a secure and functional ecosystem create more opportunities.  

Different layers of complexity exist in the market for custody of digital assets, partly due to regulatory differences between jurisdictions, which may affect the choice of custody solution. How clients may want to deploy their digital assets also affects their choice of solution – would they like the flexibility to wrap their assets, stake them or borrow against them, for example? Below we unpack and explain some of the key terms used in digital asset custody today and examine how they are shaping the custodial choices of the future. 

Hardware-Based Security Modules (HSMs) 
HSMs are tamper-proof servers that typically require multi-signatory verification to access and move digital assets. HSMs have been used by banks and payments providers for many years and are now used by more regulated digital asset custodians to hold keys. They are designed to repel any unauthorised attempt to break into them and are independently certified to validate this design principle. Using co-located facilities minimises risk, adding a further layer of operational resilience. Holding the master keys within a custody solution in an escrow account or using a trust structure also adds extra layers of security and resilience, as it provides resilience in the event of the failure of the custodian.

Air Gapping 

An air gapped wallet is a hardware wallet disconnected from the Internet and generally never plugged into an internet connected computer. Instead, they communicate by using encrypted messages or specialised hardware (e.g. data diodes).  

Sharding and Multi-Party Computation (MPC) 
Another technique used to increase the protection of holding digital assets is multi-party computation (MPC) technology. MPC splits the client’s private key into ‘shards’ and distributes those shards (a portion of the original private key) to as many trusted parties as required. When the asset needs to be moved, the users coordinate as part of a signing scheme so there is no single point of failure. This reduces the risk of hacking and the threat of human error or theft.  

Optionality – the future of digital asset custody 

Institutional custodial services have now become ‘temperature agnostic’. The narrative has moved on from cold versus hot storage. Instead, a mixture of techniques exist which can be combined in different forms – including on-premise, physical storage; cloud-based SaaS solutions and multi-signature HSM solutions. Where once there were only a few options that would meet the need for institutional-grade digital asset custody, there is now increased optionality to choose from and clients can pick the one that best suits their needs. Regulation forces certain technical solutions in some jurisdictions limiting what can be done with assets and limiting access to wider ecosystems, stifling innovation.  

Custodians are also becoming facilitators, enabling institutional participation in digital assets through access to wider networks of providers and services. Zodia Custody’s ecosystem, for example, is built on an integration layer working with multiple partners with a network which extends beyond crypto exchanges to market makers, OTC desks, exchanges and wider service providers, all with the aim of mitigating counterparty risk.  

Clients can ensure regulatory compliance by selecting different custody solutions for different jurisdictions, as regulatory requirements vary so much from one place to another. Rather than needing to onboard with a whole range of providers, access to varied custody options can come via a single source allowing for faster settlements, streamlined workflows, and increased capital efficiency. 

The future of digital asset custody will entail support for the increasingly sophisticated and dynamic needs of institutional clients, ensuring that their assets are not only safe but also readily accessible and deployable in a rapidly changing financial landscape. This ongoing evolution highlights the critical role that innovative custodial solutions will play in the broader adoption and integration of digital assets into mainstream financial systems.

Disclaimer: This article is provided to you for your information and discussion only. It should not be regarded as a solicitation or an offer to buy or sell any products or services in any country to any person to whom it is unlawful to make such an offer or solicitation. View full disclaimer here: zodia.io/marketing-disclaimer.

As the race to attract the digital assets industry gathers momentum, Singapore has emerged as one of the global leaders and a key hub in the wider Asia-Pacific region.  According to Statista data, revenue in the Singapore digital assets market is projected to reach €501.6m in 2024, while Fintech Global reports that Singaporean blockchain and digital asset companies raised almost half of FinTech seed deals in 2023. 

Known for expertise in both finance and technology and with a high-value pool of talent to draw upon, digital assets have found a genuine home in the Lion City. Indeed this is the case too for, Zodia Custody, a venture of Standard Chartered which has 165 years of history in Singapore, where its first branch was opened in 1859. The Group’s longstanding commitment to business in the country is another key factor in making Singapore a safe and secure home for digital assets. 

MAS – The Innovative Regulator 

Most regulators tend to keep a lower profile but, the Monetary Authority of Singapore (MAS) has become known as an innovator in its own right. It was early to recognise both the utility of stablecoins, as well as the transformative economic potential offered by tokenisation of assets.  

The list of projects spearheaded by MAS is mounting up and notably includes Project Guardian launched in May 2022 and Project Orchid launched in October the same year. Project Guardian is a collaboration between policymakers and industry to test the feasibility of applications in asset tokenisation and decentralised finance. Pilots under Project Guardian include tokenising money market funds through a variable capital company structure; institutional mechanisms on bilateral digital asset trades; and cross-border FX payment solutions. Project Orchid is testing the applicability of digital money in Singapore while this year MAS intends to begin developing wholesale Central Bank Digital Currency for interbank settlement. 

MAS is also working with international policymakers and financial institutions to explore the design of an open, digital infrastructure to host tokenised financial assets and applications. The wide variety of projects being worked on and the commitment to exploration is marking Singapore out as a thought leader in all areas of digital assets – be that cryptocurrency, tokenisation or digital fiat currency. 

Clarity, Consistency and Connectivity 
Singapore is gaining competitive advantages from this regulatory approach. Digital assets firms based in the region – or wanting to locate there – have a clearer policy framework and can feel comfortable approaching the regulator to explore new business models and innovative approaches. MAS has become well-known for its progressive approach, not just on policy. It is working to create connectivity across the ecosystem in Singapore and APAC more broadly and has actively collaborated with others including Hong Kong and Japan to share knowledge and best practices. 

This connectivity is much needed to remain competitive on the global stage. With the Markets in Crypto Assets (MiCA) framework now being implemented across the EU, European countries will begin to benefit from a more cohesive policy regime. Other regions now need to keep pace with that change and MAS is working hard to raise the watermark of the APAC region. 

Just as London is a gateway to other financial markets, Singapore’s innovative ethos, as well as its timezone, make it a valuable hub for Zodia Custody’s activities in Asia-Pacific. Singapore is now providing greater regulatory clarity around digital assets. In April, it expanded the scope of regulated cryptocurrency-related activities to include custodial services covering both cross-border money transfers and the transmission of crypto between accounts and exchanges. This clarity is vital for a future in which tokenisation of real-world assets is set to grow.  

In 2023’s Global Crypto Adoption Index published by Chainalysis, Singapore ranks 77^th in the index ranking and is ranked 57^th for DeFi value received. Regionally, Central & Southern Asia and Oceania (CSAO) is the third-largest crypto market in transaction volume, accounting for just under 20% of global activity. However, when purchasing power and population are accounted for to measure grassroots adoption, CSAO dominates.  

The future certainly looks bright for Singapore’s economic potential when it comes to digital assets. It’s time to hear the Lion City roar. 

Disclaimer: This article is provided to you for your information and discussion only. It should not be regarded as a solicitation or an offer to buy or sell any products or services in any country to any person to whom it is unlawful to make such an offer or solicitation. View full disclaimer here: zodia.io/marketing-disclaimer.

The institutional future of digital assets depends on three elements: an infrastructure providing comprehensive market access, opportunities for yield and bank-grade security.  

Custodians play a significant role across all three of these elements. Drawing from a deep understanding of delivering digital asset security, this blog dives into the current digital asset security landscape, the threats lurking for institutions, and how Zodia Custody utilises industry-leading security practices to safeguard your assets.

Evolving security challenges in digital assets

The early days of the digital asset landscape were littered with examples of breaches, theft and cybercrime. Fortunately, the threat landscape of today is much improved, primarily due to the maturing ecosystem with players building rigorous and secure environments. 

The 2024 Crypto Crime Report produced by Chainalysis notes that funds stolen from crypto platforms fell by more than 50% in 2023 – driven perhaps in part by a cooler market, but also by a maturing ecosystem.

But the job isn’t done — yet. The Chainalysis report notes that individual incidents are still on the rise, and finds a total of $1.7 billion worth of digital assets were stolen in the past year alone. The current cybersecurity threats impact both individual retail and global institutional investors alike, though of course institutions may face a greater concentration of risk through exposure to larger value of assets. 

These risks entail anything from simple human error to cybercrimes committed by sophisticated adversaries such as private key theft, account takeover, and application hacking. External threats can be bigger, and potentially more insidious — such as “bad actors” or states actively trying to hack and disrupt businesses in the digital asset ecosystem using various hacking techniques and vulnerabilities, to negligence and fraud from within the ecosystem itself. 

We see this in the same Chainalysis report. It notes how compromised private keys were driving the largest share of hacks in the second half of 2023, followed closely by smart contract-related abuses. Likewise, hacking groups affiliated with certain states were also more active last year, but, again the good news is they were able to steal less compared to 2022 – partially due to the overall muted market conditions.

Falling prey to any of these issues presents a dual risk of loss impacting the bottom line, alongside long-term reputational damage. 

So, with a mindset of prevention being better than cure, it is imperative that we are open and transparent when discussing security measures. Below, we’ll do exactly that — diving into how a custodian can safeguard against these vulnerabilities, but also put protections in place for other eventualities.

Staying ahead of the risks

If security is a major element of the pathway to greater institutional adoption, then it is crucial that our ecosystem is able to apply the rigour and robustness learnt through decades of providing financial services into digital assets. It has to be more than a first line of defence — security has to be weaved into everything we do. 

Much like in traditional finance, custodians have a leading and vital role to play here. Be it risk management, counterparty insolvency protection, or regulatory compliance – a similar framework of safety can be applied to digital assets as evolved from a solid foundation of traditional finance. And that’s exactly what we’ve done. We work the full threat spectrum; protecting against various potential vulnerabilities and mitigating evolving threats. 

Third-party cold storage infrastructure is a powerful and proven defence against a variety of threats. By adhering to the principle of isolation and storing client assets offline in specialised hardware wallets, we can provide an added layer of protection against unauthorised access and cyberattacks.

While isolation as a whole boosts security, it can create fresh operational hurdles and delays, particularly during transactions if they are reliant on manual processes which are also vulnerable to human error. 

To mitigate this, we use a combination of the security of cold storage infrastructure with a measure of automation for transactions. This involves mirroring the data import pattern as per best practice outlined by the UK’s NCSC for moving data in and out of our disconnected environments, and rigorously verifying information integrity before any transfer occurs. This means institutions benefit from both security and instant access to holdings.

We also actively and routinely test our defences. We undertake regular security audits, penetration testing, and private bug bounties. Taking this proactive approach and enlisting the help of third-party experts to meticulously assess the resilience of our systems, processes and protocols, ensures any potential weaknesses and vulnerabilities are found and addressed. We have also done extensive scenario analysis to ensure there is no single point of failure – as a result, our defences do not hinge on one person or control. Should the worst happen, institutions will always be able to regain their holdings.

Through these measures and active testing of defences, we are strengthening our infrastructure continuously as demand for digital assets grows, meaning investor assets always remain safe. We’re also keeping an eye on the wider industry, and learning from the latest threats and breaches to improve our own controls as the landscape evolves. Security is not a stagnant, single activity, but a constant process of vigilance and enhancement — this is core to our DNA.

Zodia Custody – a partner for institutions 

Security is an industry-wide challenge. By prioritising it, we pave the way for greater institutional adoption. As an institution-first custodian, we provide robust security measures and foster open dialogue in the industry.

Security is a crucial conversation, and we’re committed to leading it. Let’s build a future where digital assets are a secure and trusted asset class for institutions. Partner with Zodia Custody, and unlock the full potential of crypto with complete peace of mind.

Get in touch with us here.

Disclaimer

This article is provided to you for your information and discussion only. It should not be regarded as an offer or solicitation to buy or sell any products or services in any country to any person to whom it is unlawful to make such an offer or solicitation. View full disclaimer at: http://zodia.io/marketing-disclaimer

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.

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:

1. What is the custodian’s experience?
2. Where is the custodian based?
3. Does the custodian have a local presence? Are they committed to the local market with provable local investment?
4. Can you access a global network of trading venues and service providers from the custodian?
5. What security controls are in place?
6. How are the assets held and are there any co-mingling risks? If so, how are these risks mitigated or managed?
7. How does the custodian manage concentration risk and counterparty risk?
8. What transactional functionality is available? Can you access real-time trading and, if so, how?
9. What fees are charged?
10. 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.

Some of the key risks you need to consider are:

Self custody	Outsource custody
* Regulatory risk	* Regulatory risk
* Financial risk	* Financial risk
* Concentration risk	* Concentration risk
* Operational risk	* Operational risk
* Market risk	* Market risk
* Asset risk	* Asset risk
* Security risk	* Security risk

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.

 

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.

As discussed in the first blog in this series, “Will you be custodying digital assets?“, anyone who has factual control of digital assets will, under changes proposed by the Australian 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).

The current proposal is that DAFs will need to meet the minimum standards for asset holding.  There’s not much detail about the minimum standards but it appears they will include:

• A requirement to hold digital assets on trust

• A net tangible assets (NTA) requirement

• Other financial requirements including a solvency and positive net assets requirement and cash needs requirement

• Requirements relating to adequate organisation structure, staffing capabilities, and capacity and resources to perform core administrative activities.

What does it mean to hold digital assets on trust?

In a digital asset context, holding assets on trust essentially means that the DAF provider will hold the private key for the digital assets. By holding the private key, the DAF provider essentially holds legal title to the digital assets on behalf of its customers. Customers are beneficially entitled to those digital assets and this entitlement is reflected in the DAF provider’s records. These records are normally kept in ledgers which identify what digital assets are credited to a customer’s account. 

What is the NTA requirement?

Treasury’s Consultation Paper proposes that DAF providers will be required to hold NTA of at least:

• 0.5% of the value of the DAF (if using a sub custodian digital asset facility that has $5 million NTA); or

• $5 million (if performing the custody function itself). 

This requirement is broadly based on the NTA requirements for margin lending facilities. It is unclear why this approach was adopted, especially given that DAFs are more akin to platforms and schemes given the trust requirements that will apply.  

Net tangible assets is not defined in the Consultation Paper, but it is likely to have the same meaning as in ASIC RG 166, which sets out the financial requirements for AFS licensees. Net tangible assets are essentially all your unencumbered assets, less your liabilities, and there is a formula for determining this in ASIC RG 166.

We expect that at least some of the NTA must be held in cash or cash equivalents, with the remainder to be liquid assets. There isn’t much detail on this in the Consultation Paper, and presently RG c166 prescribes no cash equivalents or liquid assets rules for NTA for margin lending facilities, so we’ve had reference to these requirements in ASIC RG 166 for funds, IDPS operators, and custodians, who all have a cash equivalents and liquid assets rule. This means it is likely that the DAF NTA must be:

• held as:
  • at least 50% as cash or cash equivalents, such as:
    • cash on hand, demand deposits and money deposited with an Australian ADI that is available for immediate withdrawal; 
    •  short-term, highly liquid investments that are readily convertible to known amounts of cash that are subject to an insignificant risk of changes in value;
    • certain specific financial undertakings or commitments made by third parties and which are permitted by ASIC; and 
  • the balance of the NTA in assets where the market value can reasonably be expected to be realised within 6 months.

However, as no detail has been provided in the Consultation Paper, it is possible that Treasury or ASIC could propose different cash equivalent and liquid asset rules for DAFs. It will be interesting to see if stablecoins will be permitted and, if so, what requirements will apply.

The rationale for the NTA obligation is to:

• address the costs of an orderly wind-up in the event the DAF provider fails (i.e. to provide a financial buffer to decrease the risk of a disorderly or non-compliant wind-up); 

• balance the need to avoid concentration of digital assets among a small number of custodians with the need to ensure robust NTA; and

• ensure that as a facility expands, and the operational risk exposure of the platform provider grows, the provider will maintain a corresponding level of financial resources.  

 

Look out for part 3 in this series “Should you custody digital assets?”.

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.