Leading the Way: 7 Lessons for Banks from Crypto Nation Switzerland

Decoding Switzerland's Crypto Success: A roadmap for international finance on embracing crypto, staking, NFTs and tokenization in the banking offering.

As a tech entrepreneur, I recall the early days of cloud computing, especially with my first start-up pioneering the cloud among the Swiss private banks and family offices. These technologies were initially met with skepticism, even though all facts indicated that they were not only more efficient but also more secure. It's astonishing to see how things have changed today. Cloud computing and SaaS (software-as-a-service) have become the new normal, and it is treated as if it's nothing out of the ordinary. What was once a source of excitement, such as the location of data centers, has now become commonplace, and no one seems to care. Blockchain and DeFi will follow a similar path.

The Rise of Crypto Nation

Sygnum, Seba, and Bank Frick were among the first to offer crypto custody services to banking clients in Switzerland and Liechtenstein. Earlier, when you were running a crypto-related business, you had trouble opening a bank account. Today, crypto banks are followed by traditional banks like Vontobel and Julius Baer, and even local banks such as Luzerner Kantonal Bank have jumped on the bandwagon.

Lesson 1: Every bank will become a crypto bank

Switzerland has managed to navigate the challenges of failing CEXs (centralized exchanges), like FTX, thanks to its regulations. The question of where to securely store private keys has plagued many. I've even lost some crypto due to lost my private keys! While keeping assets at a centralized exchange or crypto bank may seem against the decentralization movement, it can be a pragmatic solution. For most of society, it will likely be the preferred crypto-holding method.

Swissborg, with its mobile-first approach, has made trading crypto assets remarkably simple. It quickly introduced staking options through its mobile app, along with easy client onboarding (just scanning your IDs via webcam).

Lesson 2: Mobile-first crypto-exchanges are a way to go

The reason why tokens should be staked is simple - it is a protection against token inflation. All PoS (proof-of-stake) blockchains “print“ new tokens. The rewards for staking protect against loss of value. The Staking Rewards presents a staking overview:

In Switzerland, there are already companies specializing in staking for institutions. The notable examples are Bitcoin Suisse and Crypto Finance. Bitcoin Suisse is actually one of the largest validators set for Ethereum, in general.

As a financial institution, you can also consider running your own Ethereum node (requires 32 ETH), or a node for liquid staking protocol. For instance, with Rocket Pool, running a node can be more profitable-requiring only 8 ETH. Bitcoin Suisse recently announced a collaboration with a liquid staking protocol - Liquid Collective.

Lesson 3: Offer staking for leading blockchain and DeFi tokes

As presented in my previous blog, perpetual futures are poised to be the next big thing in crypto. Some banks have already begun incorporating futures into their crypto offerings, like Vontobel. If your institution does not have any crypto offerings yet, the introduction of derivatives might be a good start. There are numerous perps platforms, and white-labeling one of them might be a smart move.

Prediction: Perpetual (Crypto Futures) will dominate the next crypto bull market

Tokenization and NFTs

Most banks, also Swiss ones, started their blockchain initiatives by stepping into the world of art tokenization, primarily for PR purposes. In such projects, NFTs represent ownership in tokenized pieces of art.

NFTs, however, are emerging as proof of certification, with more luxury brands, incl watchmakers getting involved. Yet, to build a new economy, NFTs are somewhat limited functionally. A token with more potential is needed, and SocialFi is addressing this shortfall, a topic I'll delve into in the next newsletter.

Tokenization of Financial Instruments

It is the tokenization of financial instruments, especially bonds (government, or corporate), or equities, that drives the demand for tokens.

Consider SMEs that plants to raise new capital. Access to the bond market is limited, as banks are interested in issuing bonds for SME (bonds are too small). With blockchain-enabled services, SMEs have new options for capital raising: tokenized SME bond, or tokenization of its equities (or part of it). In both cases, the SME get access to a new liquidity market and new investors that can offer any size of tickers (often smaller than in TradFi). On the other hand, the holder of such tokens get access to the investment opportunities that are limited in TradFi to just larger ticket.

Lesson 4a: Tokenization of financial instruments, not art, has a business model and disrupts the status quo

Lesson 4b: Clients buy tokenized bonds not to hold them in the crypto wallet but to use these tokens in DeFi (to leverage the yield)

How (not) to build a Secondary Marketplace

Once you have tokenized RWA (real-world assets) like bonds, equities, or art, you want to create a secondary market on which these tokens will be freely traded (by the KYCed participants).

Building such a marketplace on a private blockchain is not the right approach, based on the lessons from Switzerland. First, the private blockchain runs on ca 7-10 nodes, which raised questions about whether such networks are really decentralized, and how long they will last. Once you store something in the blockchain, it stays there forever - or to be more precise - as long as your blockchain is still there.

The other issue (most important) is that tokens and DeFi protocols are built on public blockchains and are not compatible with private ones. Last but not least, the token holders do not want to just hold tokens but want to make use of them, e.g. swap for other tokens, use collateral to borrow new tokens, etc

The marketplace worth following took place in Singapore, in which JP Morgan set up a permission Layer-2 blockchain on top of Ethereum - the first smart contract blockchain (and home to 75% DeFi today). In its setup, JP Morgan, not only tokenized some currencies but also used DeFi protocol - Uniswap and Aave - to trade, borrow, and lend them. The pilot concluded in the success - both from the technology, security and regulatory points of view.

Lesson 5: The secondary marketplaces for tokens should be built on top of public blockchains, as permission protocols, or Layer-2s

The Rise of DeFi Asset Managers

Crypto offers not only a new asset class for diversification. With blockchain as a settlement layer, a whole new financial system arose - DeFi (decentralized finance). Swiss asset managers and hedge funds quickly jumped on the opportunities in this new world:

• market making at exchanges and lending protocols (aka yield farming)
• arbitrage trading

Asset managers can adopt market-neutral strategies and engage in activities once reserved for large institutions in TradFi (traditional finance). This exemplifies how blockchain has democratized access to financial services, opening the door for small asset managers.

These DeFi asset managers work directly with crypto exchanges and DeFi protocols. However, thanks to institutional wallets and other providers, e.g. GenTwo Digital, they can wrap their offering into AMC (actively manage certificate) that has an ISIN number and can be easily investable

Many Swiss banks already offer crypto AMCs or funds to their clients. AMCs allow to have some exposure to DeFi, without investing in any crypto-related infrastructure by banks. The selection process of such AMCs is always proceeded by the due diligence process.

Lesson 6: Offering crypto and DeFi-backed AMCs/funds does not require any infrastructure investment and gives clients exposure to DeFi

Interbank Payments

Swiss National Bank (SNB) and Swiss Banking Association in various initiatives and pilot projects, design the blockchain-based systems for future interbank payments settlements.

Pilots of Central Bank Digital Currencies (CBDCs) are currently limited to wholesale usage in Switzerland. Project Helvetia was a multi-phase investigation by the BIS Innovation Hub, the Swiss National Bank (SNB) and the financial infrastructure operator SIX. I'm particularly excited about the project Mariana - the potential use of Automated Market Makers (AMM) from DeFi for the future fx market, which is tested by the Bank for International Settlement (BIS) and SNB.

I won't delve into the topic of retail CBDCs that like any other, must be rooted in social consensus and supported by thorough research. In its wholesale CBDC initiatives, SBN actively fosters constructive discussions while acknowledging the importance of privacy.

Lesson 7: Wholesale CBDCs as the inter-banking payment system

Regulatory Headwinds

Unfortunately, regulatory challenges loom on the horizon, with Basel IV requirements set to classify crypto assets as very risky. Consequently, banks may cease offering custody services in response. With banks effectively barred from offering crypto custody, crypto investors are inadvertently pushed towards offshore platforms like the infamous FTX, all in the name of protection.

There is currently a heated discussion in Switzerland about regulatory requirements to offer staking services. Again, a poorly designed regulatory framework would push crypto investors to unregulated markets.

CV Summit

If you find this post interesting, I invite you to join my talk at the upcoming CV Summit on October 3-4 in Zug. I hope to see you there. And remember, innovation is key, and early adopters will be the future winners.

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