How banks can play in the booming crypto space
Cryptocurrencies are enjoying an increase in popularity and acceptance by the general public. Once dismissed by serious investors as too volatile to trust, or even as inherently worthless, crypto is finding favor with governments and financial institutions as they seek to explore a world of payments and transactions outside the banking system. traditional.
There are a number of drivers behind this shift from pariah status to legitimacy. On the one hand, crypto in general and the main currency Bitcoin in particular have experienced a good pandemic. As economies locked in early 2020, predictions that Bitcoin’s time had arrived as a safe investment haven seemed unfounded as its value collapsed alongside that of other assets and markets. . Then it rebounded, much faster than regular currencies, and remained fairly stable, losing much of its reputation for volatility along the way.
This phase of constant success has been accompanied by a greater awareness of the virtues of cryptography outside the clique of risk takers and early serial users who have been its main supporters to date. Ordinary citizens are starting to embrace it, especially in developing regions where traditional banking services are often not available or trusted, such as Africa, Asia and South America. Central banks from Brazil to South Africa recognize its viability.
Regulators, for their part, have moved from treating with the greatest possible suspicion to attempting to make it somehow within their purview. One example is the European Commission which has adopted a digital finance package refining its legislative position on crypto assets and digital resilience. FCA is talking about something similar. Stricter rules may be on the way for something that has always been meant to be outside regulatory scope, but it may just be the harbinger of even wider acceptance.
One thing is for sure: As the divide between crypto supporters and detractors narrows and its popularity spreads to new areas, traditional financial institutions have questions. Do they continue to maintain the position that crypto is a threat to the traditional banking industry and to the status quo of the capital markets? Or do they find a way to embrace it and capitalize on it, leveraging their unique strengths along the way?
Let’s start with the question of why banks might be interested in embracing crypto. While crypto has had a good time during COVID, banks haven’t. While they may have benefited from a post-COVID M&A boom with record revenues, this is not seen as sustainable for the future. Capital ratios are falling and threats to solvency are higher than at any time since 2008. Some say the impact of COVID will outweigh the disastrous impact of this historic crash in the long run. Interest rates remain moderate. Growth is slow. The future is not particularly bright and new ideas are needed.
It is partly in response to this worrying scenario that banks are accelerating the digital transformation of their processes and structures. A positive stance on crypto should be seen as fully in line with this dynamic, building on some of the gains already made in areas such as digital resilience, blockchain and GRID and the deployment of AI, ML and advanced analytics to improve the customer journey and fight thwarting the threat of money laundering.
The huge investment banks have already made in digital technologies and capabilities gives them the ideal set of capabilities to expand into new markets and product areas previously deemed too risky and unmanageable to follow. Crypto is one of those markets. The trick is to find a way to engage in this new market while maintaining the competitive advantage they enjoy over their disruptive digital competitors in areas such as security, compliance, risk analysis, scale, experience and reputation.
Digital matching, something that many banks have already explored as a way to test innovative ideas on the road, appears to be a great tool for exploring the opportunity offered by crypto without adding to existing risk profiles. Using a digital twin of their business could give institutions the opportunity to demonstrate to central banks and regulators how they and their clients could potentially lose or win in multiple crypto scenarios. The virtues of crypto tether, for example, could be presented to show how volatility can be controlled. Banks could safely create and then try out a bunch of crypto products, presenting them as so-called Institutional DeFi, that is, blockchain-based financial products designed for institutions governed by institutions. strict compliance rules.
Digital twinning allows them to close their exposure in the market, while also allowing them to demonstrate how valuable their traditional strengths could be in a new digital world. They have a proven knowledge of KYC, as well as expertise and experience in combating money laundering and fraud. In fact, traditional banks might argue that they are better positioned than anyone else to develop and deliver secure and efficient crypto solutions.
There has never been a better time for banks to explore this exciting opportunity – ideally partnering with another party who can bring to the party experience in analytics, digital twinning, blockchain, algo trading and innovation in financial services. Better to move past your rivals now than to wait for them to be left behind in the wake of the crypto success of others.