Fidelity's Crypto Play: A Calculated Leap into the Digital Realm

Under CEO Abigail Johnson, Fidelity has embraced blockchain technology, mining Bitcoin since 2014. Despite an unsuccessful experiment with Bitcoin payments, the firm has established itself as a leader in crypto, offering a Bitcoin ETF, custody services, and trading platforms. As the crypto market booms, Fidelity plans to expand its offerings, exploring staking, custody for other cryptocurrencies, and tokenization, while navigating regulatory uncertainty and maintaining a cautious yet innovative approach.

Fidelity's Crypto Gambit: A Prudent Embrace of the Digital Frontier

Under the visionary leadership of CEO Abigail Johnson, Fidelity Investments, the venerable Boston-based financial behemoth, has embarked on a strategic foray into the realm of blockchain technology, a move that has catapulted the firm to the forefront of the burgeoning crypto asset industry.

Early Explorations and a Failed Experiment

As early as 2014, Fidelity ventured into the uncharted waters of cryptocurrency mining, establishing a Bitcoin mining operation within its own offices. "We recognize that the evolution of technology is poised to disrupt our industry," Johnson declared at a blockchain event in 2017.

Despite the company's enthusiasm, an experiment that allowed employees to purchase hamburgers using Bitcoin proved unsuccessful. As Michael O'Reilly, president of Fidelity's digital assets division, candidly admitted to Fortune, only the project's architects showed any interest in the payment option.

A Resounding Success in Crypto

Undeterred by the lackluster reception to its Bitcoin-based employee perk, Fidelity's broader crypto gamble has yielded resounding success. Today, the firm boasts the second-most popular Bitcoin exchange-traded fund (ETF) with nearly $7 billion in inflows since its inception in January. Fidelity has also established a custody service for Bitcoin and Ether, giving it a competitive edge over rivals scrambling to catch up.

Moreover, Fidelity's multiyear head start in the blockchain market positions it advantageously as crypto prices surge once again. O'Reilly and his colleagues are adamant that the company is just getting started.

A 'Qualified Custodian' in the Crypto Landscape

Fidelity's foray into crypto commenced in earnest in October 2018 when it became the first traditional financial institution to offer custody services for Bitcoin on behalf of institutional investors. This move was followed four years later by BNY Mellon. In the same month, Fidelity launched its Bitcoin trading platform, further solidifying its presence in the digital asset space.

The following year, Fidelity secured a license from the New York Department of Financial Services (DFS) to provide both trading and custody services. Unlike cryptocurrency exchanges like Coinbase, Fidelity's platform operates as an execution service, with Fidelity acting as the counterparty in every trade and sourcing liquidity providers for buyers and sellers.

In 2022, Fidelity expanded its custody and trading services to include Ether, recognizing the growing importance of the Ethereum blockchain. Terrence Dempsey, a product manager at Fidelity, emphasized that this approach not only ensures more consistent pricing but also facilitates clients' entry into the volatile world of crypto by providing a familiar financial framework.

Navigating Regulatory Uncertainties

While Fidelity's Bitcoin ETF is its most prominent crypto product, its custody and trading platform have laid the groundwork for its success. As the Securities and Exchange Commission (SEC) deliberates on the regulatory framework for crypto asset custodians and their accounting practices, Fidelity finds itself in a unique position.

Fidelity's trust charter from the DFS places it within the proposed category of "qualified custodian," and the firm has actively advocated for state-chartered trust companies to be included in this definition. Additionally, Fidelity's status as a non-public reporting company may exempt it from the controversial accounting bulletin (SAB 121) that would require custodians to treat digital assets as liabilities on their balance sheets. However, the financial industry's understanding of this guidance is still evolving.

Advantages of Private Ownership

Unlike publicly traded competitors, Fidelity remains a privately held company, with the Johnson family retaining 49% ownership and voting power. O'Reilly believes that this private status gives Fidelity a significant advantage in taking a long-term perspective on sectors like crypto, where many competitors have hesitated to venture.

The Bitcoin ETF: A Cornerstone of Fidelity's Crypto Strategy

When the SEC approved the first slate of spot Bitcoin ETFs in January, eight of the ten issuers chose Coinbase as their custodian, including BlackRock. Fidelity and VanEck were the only exceptions, with Fidelity opting to use its own custody service.

This decision may seem surprising given Coinbase's current legal entanglements with the SEC. However, even though Fidelity's custody service operates as a separate subsidiary from Fidelity Investments, which issues the Bitcoin ETF, it still represents a challenge to other issuers.

"As a firm, we are offering an exchange-traded product (ETP)," explained O'Reilly. "In many cases, you would not want to entrust the assets of your ETP to a competitor."

Cynthia Lo Bessette, head of Fidelity's ETF team, anticipates that this situation will change as issuers begin to diversify their custody arrangements. "Diversification seems to be on people's minds," she told Fortune.

Despite not serving as a custodian for other issuers, Fidelity's own ETF has flourished. According to Bloomberg data, its Wise Origin Bitcoin Fund has attracted the second-largest inflows among the new ETFs, trailing only BlackRock's offering.

Expanding Offerings and Exploring New Horizons

While the Bitcoin ETF remains Fidelity's flagship crypto product, the company is actively expanding its offerings. Fidelity is among seven firms seeking to launch a spot Ether ETF, although analysts predict that these applications will be rejected before the May deadline.

Nevertheless, Ether represents a significant opportunity for Fidelity. Unlike Bitcoin, which utilizes the energy-intensive proof-of-work consensus mechanism, Ethereum transitioned to proof of stake in 2022, allowing Ether holders to earn a yield by staking their assets.

While Fidelity does not currently offer staking services, Bessette confirmed that the company is exploring product iterations that include staking. On March 18, Fidelity submitted an amendment to its ETF application, seeking permission to stake a portion of its assets.

Regulatory uncertainty could still hinder Fidelity's entry into the staking market, as the SEC is likely to deny the ETH ETF applications and has recently filed lawsuits against Coinbase and Kraken for offering staking-as-a-service products.

Dempsey also indicated that Fidelity's digital assets subsidiary aims to launch trading and custody services for other cryptocurrencies. "We did not set out to be a Bitcoin and Ethereum-only shop," he said, although regulatory challenges surrounding the security status of various assets, including Ether, remain obstacles.

Exploring Tokenization and a Cautious Approach to Regulation

As competitors like Franklin Templeton and BlackRock begin to tokenize traditional assets such as money market funds, Bessette revealed that Fidelity is investigating the potential of tokenization, though she declined to provide specific examples.

While Fidelity's pace of innovation may exceed that of many traditional financial institutions, the company remains somewhere between crypto-native firms like Coinbase and industry stalwarts like Vanguard. This position allows Fidelity to pursue blockchain experimentation while maintaining a cautious approach to regulatory developments.

"In the crypto world, years are almost like decades," O'Reilly observed. "That has really given us an advantage."