In 2017, amid crypto’s first full-blown bull cycle, Fidelity allowed employees to start paying for their lunch in the staff cafeteria using Bitcoin. From the outside, adopting crypto would seem to be an odd choice for an old-line firm like Fidelity, which launched in 1946 and manages trillions of dollars in assets.
But under CEO Abigail Johnson, the granddaughter of Fidelity founder Edward Johnson II, the firm began dabbling in blockchain, including mining Bitcoin at its offices since 2014. “We at Fidelity can see that the evolution of technology is setting our industry up for disruption,” Johnson said in 2017 at a blockchain event.
The experiment allowing employees to pay for hamburgers with Bitcoin didn’t work out, Michael O’Reilly, the president of Fidelity’s digital assets division, told Fortune in an interview. He joked that the only people who tried it out were the staffers who worked on the project. Fidelity’s broader gamble on crypto, however, has been a resounding success.
Today, the firm offers the second-most-popular Bitcoin ETF with nearly $7 billion of inflows in the red-hot investment class approved in January, has set up a custody service for Bitcoin and Ether as competitors scramble to catch up, and has a multiyear head start on peers like BlackRock and Franklin Templeton that are rushing into the blockchain market. As crypto prices boom once again, O’Reilly and three other employees working on Fidelity’s digital asset products told Fortune that the company is just getting started.
“For us, it isn’t whether digital assets are going to happen,” O’Reilly said. “It’s how we’re going to play in the space.”
‘Qualified custodian’
The Boston-based Fidelity may have started mining Bitcoin in 2014, but its first serious foray into crypto came in October 2018 when it began to custody Bitcoin for institutional investors, the first traditional financial firm to offer the service, with the next coming four years later with BNY Mellon. The same month in 2018, Fidelity also launched its trading platform for Bitcoin. The company officially received a license from the New York Department of Financial Services to offer trading and custody services the following year.
Unlike exchanges such as Coinbase, Fidelity’s product operates as an execution service, meaning that Fidelity would serve as the counterparty on every trade and find liquidity providers for the buyer or seller, rather than matching buyers and sellers. Fidelity expanded its custody and trading services to include Ether in 2022.
Terrence Dempsey, the head of product strategy at Fidelity’s digital assets subsidiary, said that approach not only provides more consistent pricing, but also helps ease clients into the volatile world of crypto with a more traditional financial wrapper. “We’re trying to abstract away a lot of the market structure and nuances of crypto for our customers and provide them with a very familiar experience,” he told Fortune.
While Fidelity’s flashiest crypto product is its Bitcoin ETF, the custody and trading platform helped set the foundation. As the Securities and Exchange Commission debates rulemaking over which type of companies should be allowed to custody crypto assets—and how firms should account for them—Fidelity sits in a unique position.
With its trust charter from DFS, Fidelity will likely fall under the key category of “qualified custodian” that’s being considered by the SEC, and the firm has sent letters to the agency advocating that state-chartered trust companies should meet the definition. And as lawmakers fight the agency on a controversial accounting bulletin called SAB 121 that would require custodians to count digital assets as liabilities on their balance sheets, Fidelity could fall outside of the guidance as a nonpublic reporting company, although the financial industry’s understanding of the suggested practice is still developing.
Unlike publicly traded peers, Fidelity is a privately held company, with the Johnson family still owning 49% of shares and voting power, according to SEC filings. Beyond avoiding the potential pitfalls of SAB 121, O’Reilly said that the firm’s private status allows it to take a more long-term view on sectors where competitors have steered clear, such as crypto. “Being privately held gives us quite an advantage there,” he told Fortune.
The Bitcoin ETF
When the SEC approved the first slate of spot Bitcoin ETFs in January, eight of the 10 issuers to launch chose Coinbase to custody their Bitcoin, including BlackRock. The only exceptions were VanEck, which went with the Winklevoss twin–run Gemini, and Fidelity, which chose its own custody service.
That every other issuer went with Coinbase, which is currently embroiled in litigation with the SEC, may seem surprising, especially with Fidelity serving as a clear alternative. But even though Fidelity’s custody service is technically part of a separate subsidiary from Fidelity Investments, which issues the Bitcoin ETF, it’s still a challenger to the other issuers.
“We are, as a firm, offering an ETP,” or exchange-traded product, O’Reilly said. “Often, you don’t want to give assets of your ETP to a competitor.”
Cynthia Lo Bessette, head of the team within Fidelity responsible for the ETF, said that she expects that to change as issuers begin to tap secondary custodians for their products. “Diversification seems to be on people’s minds,” she told Fortune.
But even without serving as a custodian for other issuers, Fidelity’s own ETF is thriving. According to data from Bloomberg, its Wise Origin Bitcoin Fund has the second-largest inflows of the new ETFs at nearly $7 billion, trailing only BlackRock’s.
Cointucky Derby update for the #bitcoin ETFs. Last week was -$888 million for the group. Outflows were likely related to bankruptcy — they were mostly Gemini/Genesis selling. *Expecting* that to slow over the next ~week. They had a total of ~$3.9 bln of $GBTC to sell. pic.twitter.com/qXiog228z8
— James Seyffart (@JSeyff) March 25, 2024
Lo Bessette pointed to Fidelity’s structure as a competitive advantage, serving as the only issuer to rely on its own custody and trading services, as well as providing its own index for pricing. “The way that we’ve designed the product is as a Fidelity full-stack offering,” she said.
Amid speculation about whether the field of issuers would consolidate over the next year, Lo Bessette demurred but did say it would be up to the individual sponsors whether the scale of their products makes it worthwhile to continue operating. Even with an arms race over fees, the lowest-performing funds have seen less than $400 million of inflows, with WisdomTree collecting only about $60 million as of March 25.
What’s next?
While the Bitcoin ETF remains Fidelity’s top crypto product, the company still plans to expand its offerings. Fidelity is one of seven companies hoping to launch a spot Ether ETF through an approval process pending with the SEC, although analysts predict they will be rejected by the May deadline.
Still, Ether represents a potent new field for Fidelity. Unlike Bitcoin, which operates under the energy-intensive proof-of-work consensus model, Ethereum switched to proof of stake in 2022, meaning Ether holders can receive a yield in return for staking their assets.
While Fidelity currently does not offer staking services, Lo Bessette said that it’s looking at product iterations that include staking. On March 18, Fidelity added an amendment to its ETF application to include a provision that would allow the fund to stake a portion of its assets.
Regulatory uncertainty could still prevent Fidelity’s entrance into the space, with the SEC likely to deny the ETH ETF applications, and staking itself fraught due to recent lawsuits brought by the agency against companies like Coinbase and Kraken that offered staking-as-a-service products.
Dempsey said Fidelity’s digital assets subsidiary also hopes to launch trading and custody services for other cryptocurrencies. “We did not set out to be a Bitcoin- and Ethereum-only shop,” he told Fortune, although the regulatory challenges around the security status of different assets—including Ether—continue to pose a challenge.
As competitors like Franklin Templeton and BlackRock begin to tokenize different assets such as money market funds, Lo Bessette said Fidelity is exploring the potential of tokenization, although she declined to provide specific examples.
While Fidelity may move faster than many of its TradFi peers, it still sits somewhere in between the crypto native firms like Coinbase and the mainstays like Vanguard. The result is a methodical approach that’s still cautious of regulators while pushing further into blockchain experimentation.
“In crypto, years are almost like decades,” O’Reilly told Fortune. “That really is what has given us the advantage.”
