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Offering Cryptocurrency as an Investment Option - Where Do I Start?

Picking the right partners then preparing for what’s next.

Many wealth managers have opted to wait on the sidelines to see what the client demand is for crypto or are delaying action as they wait for their vendors to ‘solve the problem’. This strategy could turn problematic for many firms. Resolving the technology challenges and expanding your ecosystem is only the start. The bigger efforts for many are in the development of the control framework and operational processes needed to support day-to-day activities. Broadridge Consulting is estimating it could take 12-18 months to fully incorporate crypto into your target operating model. This is driving many to adopt an expanded partner approach to simplify and expedite moving forward.

The longer an organization waits to start, the further away from completion they are. What you do next, matters most. For digital assets, it is time to get started.

What the market looks like “today”

As the crypto market grows at a rapid pace, many firms are struggling with how to begin their journey to offer exposure and keep up with the competition. One issue that they are facing is that cryptocurrency can be as unpredictable as the weather — just wait a minute and the landscape will change. It is unlike anything that has hit the markets in the recent past. The requirements to process, value and custody are considerably different than most securities. As regulations evolve, there is a greater need for Know Your Transaction (KYT) and Know Your Product (KYP), concepts that are not as common with traditional securities.

Most firms are turning to partners to help solve the many challenges. Depending on how your firm intends to give your clients access to crypto and how you intend to support your advisors will dictate the breadth and scope of your efforts to expand your ecosystem. Our focus will be on how firms are addressing liquidity, trading, and custody through centralized exchanges and what is being done for operational readiness.

Crypto Exchanges

Crypto exchanges range from simply providing access to trading to providing custody, customized investment product, lending and borrowing. The wide range of services demonstrates the need to have a plan when picking a technology partner. Chainalysis reports that there are 672 active crypto exchanges as of August 2021. While down from a peak of 845 in August 2020, it is still a healthy number to contemplate, and the differences can be considerable. You will need to ensure you align technically and decide which coins to support. Defining where you want to deliver value and differentiate your offering becomes just as important. This leads to questions on supported investment product, ability to lend or borrow and even settlement options. Further, you will want your platform strategy to consider how you can maintain a nimble operating model, allowing your firm to respond quickly to the next disruption and maturity of expanded services.

Operational Readiness

Despite the increased utilization in the industry, many firms lack a ‘playbook’ for operational readiness. Best practices specific to crypto can be limited especially when you consider the different operating models, technology deployed, and services offered. Some have adapted processes from traditional securities. That is a good start especially when performing your due diligence for custody, where the evaluation criteria is somewhat similar. Where it doesn’t work is when considering the market calendar. There are additional components that will need to be contemplated because of the digital nature of the crypto. They range from the clear and obvious, addressing real-time or near real-time settlement and 24 x 7 x 365 trading, to the more obscure such as your pricing policy, ensuring best execution and level of precision for reporting and reconciliation.

How do you navigate unchartered waters?

Every organization must start with clearly articulating their strategy and desired outcome. Even if it is at a high level, the decision on the investment approach and desired outcome must be made before engaging any partners otherwise the selection process will start with a flaw. You must have a plan, as there are many available options in the value chain to consider. The next step is evaluating if you have the skillset and capacity internally to refine the strategy and execute on the necessary components, which may be hard because you don’t know what you don’t know. This could be the first opportunity to engage a partner.

To select the right technology partner, the evaluation needs to go much further than a review of fees. At a high level, you should start with understanding the access to coins or investment product and the safety and security of the custodial offering. You should understand how your partners technology stack can support the evolving regulatory landscape. You will want to drill down into what regulatory changes they expect, how they plan to address those requirements and what they would do if things change. Other questions that you need to consider are:

  • Does the firm provide what is needed to achieve your value proposition? If not, what are the options? Is your value proposition realistic?
  • Can the platform scale as adoption grows or handle spikes in volume during periods of high volatility?
  • Is the solution tightly integrated with your core?
  • How is the quality of information (e.g., pricing, trading volume across all exchanges)?
  • How can they help in meeting the requirements of Bank Secrecy Act (BSA), Anti-Money Laundering (AML), and other regulatory requirements?

Cryptocurrency is one area where the technology needed to support is more advanced than where we are operationally. Some have compared the processing requirements to the foreign exchange markets. That may be true when we look at ensuring best execution or to a lesser degree settlement. However, your overall control framework needs to be reviewed. There is much more than having to understand how you will support markets that do not close. Very few securities require consideration of 8 or even 18 decimal places which will impact pricing, reconciliation, client reporting and potentially performance. Inefficient or variations in market data requires a different approach to updating your pricing policy. Even with a fintech providing custody, you may be faced with the need to host a wallet because a client may acquire a coin that your tech partner may not be able to hold.

Clearly there are many more pieces to the puzzle to be considered. Broadridge Consulting Services has identified nearly 150 questions that a firm needs to answer during the development, planning, and execution of your strategy. The takeaway is, regardless of asset allocation you need the infrastructure to reduce operational risk and ensure scale.

Where is the market going and how do you start your crypto journey?

Clarification from the regulators is a given as regulatory uncertainty has caused many firms to put their crypto plans on hold. The expected focus will be on providing oversight on stablecoins and protection against money laundering, terrorist funding, ‘rug pulls’ and Ponzi schemes. As more guidance becomes available, more firms will begin to offer exposure to cryptocurrency, increasing the competition for assets.

Having a point of view had been table stakes. You now need a clear strategy and plan to execute the transformation of your ecosystem. Engaging partners is a must. Even the largest of firms have leveraged external expertise for their success. The criticality in selecting the ‘right’ firms to partner with is obvious. What may not be as apparent is the challenges you will face in identifying where you will deliver value to your clients, determining who to work with and creating your target operating model.

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