Custody Consolidation: Challenges in the U.S. Crypto Trust Model

By: Eva Baxter

The recent shutdown of Fortress Trust by Nevada regulators has highlighted significant challenges in the digital asset custody industry. The decision, made on October 22, was driven by the financial instability of Fortress Trust, which held just $200,000 in cash against $8 million owed in fiat and $4 million in cryptocurrencies. This marked the second major collapse of a trust company in Nevada in two years, following the receivership of Prime Trust in June 2023. Both companies shared the same founder, raising concerns about the governance and financial practices in the state's trust companies.

Nevada's Financial Institutions Division described the condition of Fortress as "unsafe and unsound," having barred the institution from making deposits and transferring assets. Furthermore, difficulties in providing financial documentation spanning from July through September illuminated deeper structural issues. With over 250,000 clients, the collapse had far-reaching implications. The rebranding of Fortress as Elemental Financial Technologies in the wake of a 2023 vendor breach—costing approximately $12 million to $15 million—compounded its challenges. Following the breach disclosure, Ripple retracted its acquisition interest, demonstrating the market's wariness towards Nevada's retail trust companies.

This situation raises critical questions about where customer assets actually reside and which regulatory frameworks mitigate the risk of asset loss. U.S. digital asset custody is regulated by four main frameworks: Nevada retail trusts, New York limited-purpose trusts and BitLicense custodians, OCC national trust banks, and Wyoming's SPDI framework. Each provides varying levels of regulatory oversight and asset protection mechanisms, balancing operational freedom with rigorous segregation requirements. The New York Department of Financial Services' 2023 custody guidance and the OCC's fiduciary standards impose stringent requirements on custodians concerning asset separation and operational controls.

For investors and exchanges, the Fortress Trust shutdown acts as a stark reminder of the importance of understanding where assets ultimately lie within custody structures. Failures at any operational level, such as lost keys or poor reconciliation, put customer funds at risk despite a custodian's solvent appearance. As the industry evolves, companies might need to consider migrating to more heavily regulated jurisdictions or engaging multiple custody solutions to mitigate risks effectively. Ultimately, the U.S. crypto trust model is expected to see consolidation around better-capitalized, transparent, and supervised firms that align with the systemic risk management of holding extensive customer assets.

The overarching theme is clear: Custody solutions must adapt to maintain relevance in a rapidly evolving financial landscape, and only by enhancing operational discipline can firms hope to avoid fate similar to Fortress Trust.