CryptoTalking Shop

Talking Shop: Managing Credit Risk for Crypto Custodians

By June 16, 2022No Comments

Editor’s note: NeuGroup’s online communities provide members a forum to pose questions and give answers. Talking Shop shares valuable insights from these exchanges, anonymously. Send us your responses: [email protected].

Member question: “How should corporates manage credit risk for cryptocurrency custodians?”

Peer answer 1: “We’ve thought a lot about this. One point to make: Anchorage Digital Bank is federally chartered by the OCC; most others are state chartered. We look at things like that. Most of these licenses have pretty high standards for capitalization, so it might be as simple as learning more about that.

  • “In addition, we looked at the probability of default on their loan portfolios (percentage of liquid collateral vs. loans outstanding), their ability to repay their obligations and what level of insurance they offer.
  • “Ultimately, we did purchase dedicated insurance on top of the insurance that the custodian holds. I’d also look at assets under management and if they can disclose any of their top customers. In my experience, they’re all willing to share their latest financials.
  • “We thought Fidelity had a less impressive solution from a technical standpoint, but it might be the easiest sell if you’re looking for a counterparty that fits within the traditional credit risk framework. We found that Anchorage had the best platform in terms of security and a really great leadership team.”

Member response: “All great thoughts, in line with what we are thinking. We think about credit risk from two angles: balance sheet and cash flow. Do the custodians function like a bank or a corporate? Are there any risk assets (loans or investments)? What is the debt/EBITDA ratio (your point on ability to replay the obligations)? By answering those questions, we think getting the latest financial statement is a start, then we can run credit analysis and categorize them as an IG or non-IG company.”

Peer answer 2: “Great question. Since it is really hard to ‘KYC’ someone in this space, our thought process was to ask our banking partners, who have strict KYC reviews, who in this space met their standards.

  • “Since the majority are not publicly traded companies, it is near impossible to get completely comfortable. To avoid credit issues as best we can, we currently have rules in place that immediately trade any crypto received to USD and then wire to our preferred banking partner.”

Peer answer 3: “I echo several of the same sentiments of Peer 1. Here are some other points to consider:

  • “Regulation of custodians: How is the custodian regulated and by whom?
  • “Regulation of your firm: We had to work with our regulators to have our custodians approved. Our regulators spoke to the regulators of those custodians to feel comfortable. This would apply to broker-dealers and financial firms but unlikely to corporations.
  • “Strength of balance sheet: Typically this information is shared and is part of the counterparty due diligence process.
  • “Insurance policies.
  • “Business continuity policies/processes.
  • SLAs on transactions.
  • “Executive team.
  • “Overall technical abilities of the custodian.
  • “Any adverse media.”
Justin Jones

Author Justin Jones

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