How banks can ‘cash in on Crypto’

Banks have an opportunity to 'cash in' on the creation of a new asset class. They should seize it.

The success of Bitcoin, Ethereum and other virtual assets is becoming self-evident. In December, Bitcoin reached new all-time highs to become the 16th largest currency in the world by market cap. In equity terms it is just behind Alibaba and ahead of Berkshire Hathaway(1).  This week it even made it to the front page of the FT!

Confronted with virtual assets, banks have tended to focus on exploiting the underlying blockchain technology to improve operations such as trade finance and securities settlement. Although these are activities with potential long-term benefits, this misses the short-term opportunity arising from the creation of an entirely new asset class.

To address this opportunity, banks need to rapidly change tack to offer a range of relevant virtual asset products to drive revenues with new virtual asset customers (both crypto-businesses and freshly ‘minted’ virtual asset millionaires) as well as existing customers as they become increasingly interested in virtual assets. Although these services are currently offered by an array of new players, banks have a real advantage in terms of their trustworthiness, customer base and the ability to offer holistic solutions with other asset classes. First movers will be able to benefit from significant hype and get ahead of competitors.

What to offer?

No rocket science here. Banks should offer traditional products with some tweaks to cater to the idiosyncrasies of virtual assets. Trying to avoid too much detail, a brief overview of these products – roughly in order of easiest to hardest – is listed below(2).

1    Third party funds: Offering regulated third-party crypto funds from reputable managers is a quick win that can be added on top of existing infrastructure. There are several that have investments from major institutional investors and with appropriate due diligence can be onboarded to existing platforms relatively easily.

2    Custody/deposit: Holding deposits is a core function of a bank and it is a logical extension to hold virtual assets. A number of regulators have made it clear this is permissible and it can be relatively easily implemented with appropriate technology, partners and controls. Margins are thin (or negative), but it is a relatively easy way for banks to dip their toes into the virtual asset water. Such an account could start ‘closed-loop’ where inbound or outbound payments (and the associated AML challenges outlined below) are not offered and exchange/FX is made only through the bank’s platform (how Paypal is currently set-up for virtual assets). It could then become ‘open-loop’ where payments are permitted which is much more appealing - especially to existing holders of virtual assets.

3    Exchange/FX: This is another traditional bank product and can be executed through established third parties (or by establishing a trading desk), starting with liquid reputable coins. This will appeal to retail customers and the far-sighted corporates using virtual assets for treasury purposes.

4    Payments: This is where things start to get tricky as payments ‘on chain’ cannot be altered or withdrawn and there a range of AML/CFT implications to transferring funds. Adequate controls will need to be put in place to mitigate these risks, but there are a number of providers that monitor transactions and wallet addresses for AML/CFT purposes.

5    Asset management: Bank asset management divisions have requisite rigour in portfolio selection, trading and risk management to be effective managers of crypto assets. Offering a fund may be permissible depending on the jurisdiction.

6    Collateralised lending: This is getting further away from banks’ comfort zones, but there are several platforms offering lending against virtual assets. This serves both a prime brokerage function for institutional customers and enables retail customers access to funds without triggering a taxable event through sales. Once banks get used to virtual assets (and their volatility) as an alternative form of collateral then this should be an area they excel at.

7    Structured products: Virtual assets can be used along with traditional assets to manufacture a range of structured products. For example, combining virtual asset upside with some form of capital protection could be an attractive proposition to gain exposure to cryptocurrencies. Clearly offering structured products will be at the higher end of complexity and risk appetite and should only be attempted once sufficient comfort is reached.

How to get there?

The challenge to implement is only partly technical. There are a number of established platforms and technologies that can facilitate relatively rapid make or buy decisions. The real challenge comes from integrating with banks’ existing systems as well as ensuring adequate risk and compliance controls are in place. This will need significant changes and approvals from risk appetite statements downwards taking significant time and perseverance to implement. This will require senior leadership and active sponsorship right from the top and the dedication of a cross-functional core team to drive through the many barriers to execute. However, the challenge will be worth it. The first movers will steal a march on competitors and will likely attract significant inflows from customers who are interested in the asset class but are looking for a reliable name through which to access it.

Notes: (1) https://companiesmarketcap.com/, https://fiatmarketcap.com/ (2) STOs, although revolutionary in their own right, are not considered in this article as the underlying asset is an existing asset