As the crypto market matures, financial institutions compelled to participate Earlier this week we hosted a call with Tom Jessop, President of Fidelity Digital Assets.

The call focused on crypto market structure, how it may evolve and the competitive landscape. The discussion reinforced our belief that all financial institutions should ultimately develop a digital asset competency. Timelines will vary with the largest institutions likely facing the biggest regulatory hurdles. Furthermore, the opportunity itself is complex to define as there are many avenues (and more emerging use cases) including: full service institutional brokerage, custody services, on-ramp & off-ramp of commercial/institutional deposits for trading (e.g. Signet), crypto collateralized lending, commercial payment solutions, and tokenization of legacy asset classes. Meantime, we believe the more nimble banks and first movers, like Signature (Buy) are well-positioned to benefit as they capitalize on increased trading activity as a means to embed their products & services into the ecosystem.

A "perfect macro storm" pushes institutions off the fence and into the arena Fidelity Digital Assets operates as a brokerage for hedge funds, family offices, corporates, and other institutional investors. In the early stages of the pandemic, Fidelity experienced a step function increase in demand for Bitcoin. With a backdrop of unprecedented monetary / fiscal stimulus, the "superior store of value" thesis was the key motivation for many institutions previously on the fence to step into the asset class.

In Fidelity's 2020 annual survey of ~800 institutions, roughly 30% of respondents indicated an active allocation to some form of digital assets while among traditional investors it was in the single digit range. The results were a significant increase from prior years but the survey notably closed pre-pandemic. Results of the 2021 survey will be out in July and likely show an even sharper increase. As a platform, Fidelity Digital Assets is asset agnostic and views the store of value thesis as aspirational as BTC is 5x more volatile than gold. Notably, in recent months interest in Ethereum has increased.

Infrastructure & regulation continue to evolve pacing the sector's evolution Significant strides have been made in recent years to improve market infrastructure.

Previously, institutions had to go directly to a crypto exchange to transact - this required opening up multiple exchange accounts, putting up cash separately at each of these accounts (pre-funding), and monitoring separate order books for best execution.

Extremely inefficient. This is not the case anymore with emergence of agency execution service (like Fidelity) that can perform order routing. Importantly there is also more and better liquidity in the market now than in the past. From a regulatory perspective, what is allowed in terms of non-security digital assets (e.g. BTC) is fairly straightforward with approval from FinCEN as a money services business and certain states as a money transmitter (e.g. New York) are required. It is less clear the requirements for tokenized assets that could be deemed securities, but the SEC & CFTC are taking steps to harmonize regulation. Some overseas jurisdictions are ahead but the US is making steady progress.

Implications for Signature?

SBNY's existing market presence, collaborative relationship with the NYDFS on digital banking and ongoing development of new uses and applications should keep it in poleposition in the sector, in our view. SBNY's strategy is a deposit focused one at the moment. It has accumulated nearly $15bn in deposits over the last several quarters through a combination of crypto companies (e.g. exchanges), stablecoin reserves, and institutional investors that use Signet as an on/off ramp. The discussion on the conference call did not suggest there is an imminent threat to this strategy. So far, SBNY has not indicated a move to offer brokerage services akin to Fidelity. The near-term monetization opportunity centers on crypto collateralized lending which SBNY expects to launch at least on a small scale basis by mid-year. Yields could be in the high single digits (at very low LTVs) as this product is introduced, but competition will pressure these levels over time (as noted on the call).