Six Takeaways for Banks Before Leaping Into the Crypto Market
December 19, 2022
Six Takeaways for Banks Before Leaping Into the Crypto MarketDownloads
Despite the volatility around cryptocurrency, incumbent banks are intrigued by its potential. Here are six ideas ways they can seize the moment.
Cryptocurrency is a major long-term disruptor. Banks, financial services firms and regulators all know this. Even after wild fluctuations that saw two of the largest digital currencies, Bitcoin and Ethereum, drop in value by more than 50%1 from their all-time highs in 2021, the market maintained high valuations. As of November 2022, the total value locked in decentralized finance (DeFi) protocols,2 one of the most-followed metrics in the crypto industry, was approximately US$56 billion — a 141% compound annual growth rate over the last two years.
All kinds of financial products and services have sprung up in the market, including crypto-backed mortgages,3 personal loans4 and revolving credit.5 But given speculation, risks and scant regulation, it doesn’t make sense for every financial institution to offer cryptocurrency services right now. Just the expense of building out an infrastructure to custody the assets properly makes the process a nonstarter. Other technology and regulatory hurdles are also daunting.
Yet momentum is reaching a point at which certain products are likely to move more quickly than others, with multiple participants jumping into the market in a short period of time. The question for incumbents is whether they will seize the moment or be forced to play catch-up with the competition. (See sidebar “Incumbents at the 3.0 Crossroads.”)
Incumbents at the 3.0 Crossroads Incumbent financial services today are investing heavily and innovating in digital assets. However, there is a reluctance to implement these assets due to the current lack of regulatory guidance. Incumbents rightfully expect that they’ll face regulatory scrutiny as they roll out digital assets offerings, and until regulations are clearer, they will likely remain cautious and implement more slowly and methodically than crypto natives.
Below are six ideas for financial institutions to consider now so they are ready when the moment arrives.
Map the Signposts: Financial institutions will want to start mapping and re-mapping signposts that mark the progress of emerging technologies that correspond with Web 3.0. That means staying current with technology and looking ahead to find new use cases that align with business objectives. It’s important to remember that crypto assets will touch nearly every aspect of the business, whether it’s recruiting talent or bolstering the organization’s cybersecurity, so be mindful of advances in areas that may not seem as obvious.
Build the Infrastructure: As organizations begin to reevaluate their standing and adjust their signposts, they should consider how they’re going to build out a future-proof operational infrastructure. This will include developing the systems for deposits and withdrawals, bringing on a team that can navigate the complexity of compliance requirements and working with tech enthusiasts who can predict how the digital banking landscape will evolve. While there is no one-size-fits-all approach, financial institutions should aim to be as flexible as possible so that they can continually adapt as new Web 3.0 capabilities are uncovered.
Become a Crypto Custodian: When a financial institution feels ready to dip its toes into the world of crypto, it must be able to custody crypto assets. Put simply, banks will need to secure the private key — a variable employed alongside an algorithm to encrypt and decrypt data — to prove they own the crypto assets. Regulators like the Office of the Comptroller of the Currency have already issued guidance (in the form of a letter) on being a custodian of crypto assets, so financial institutions will want to make sure they’re operating in accordance with those guidelines.6
Partner With a Digital Asset Custody Platform: Building out the capabilities to custody digital assets doesn’t have to come from in-house. Consider how the French bank BNP Paribas partnered with Metaco, a Swiss digital asset custody firm, to create the necessary infrastructure7 to integrate custodial offerings. Similarly, financial institutions need to look within and identify opportunities where they can partner to capture and create value. In doing so, banks will find ways to fully embrace the crypto technology in the long term. (See sidebar “Seeing the Bigger Picture.”)
Seeing the Bigger Picture From a short-term perspective, cryptocurrencies are simply speculative assets within the financial sector. But the long-term perspective recognizes cryptocurrency as an integral part of Web 3.0.
Unite an Ecosystem of Partners: After becoming a qualified crypto custodian, financial institutions should build out their ecosystem of partners. In some cases, that may consist of bringing existing partners into the fold to diversify the bank’s crypto offerings, like using crypto to buy goods from a retailer. In other instances, banks may want to be the sole issuer, while another partner provides the operational background. Many possibilities of Web 3.0 have yet to be realized, so look for opportunities to work with trailblazing digital natives.
Lead by Example: If a bank has taken all these steps and put itself at the center of a thriving ecosystem, then it’ll have an opportunity to lead the sector into the next generation. By viewing the future through the lens of young, entrepreneurial technology enthusiasts, established players can wed their long-standing expertise with relentless innovation. Gaining minority stakes and joining boards of companies in key crypto ecosystems are just a few ways for leaders to place themselves at the forefront of tomorrow’s financial landscape.
Following recent high-profile events in the crypto market, it’s likely that regulatory scrutiny will grow. Digital asset teams at banks can get ahead of potential new regulations if they:
- Develop and evaluate fraud risk management, anti-money laundering and sanctions compliance programs (including accounting for key components such as compliance structure, policies and procedures, risk assessments, transaction monitoring, Know Your Customer due diligence, control effectiveness, training, and governance)
- Ensure that the compliance program accounts for risk factors that are relevant to the bank
- Create a plan for the required remediation efforts to bring a current program into compliance with regulatory requirements and develop or enhance any existing program remediation plan
- Independently validate the compliance program or the remediation plan to ensure that governance, controls and risk management structures are in place and operating effectively
- Design a target operating model that includes an independent assessment of the current state of the compliance program
- Establish an active team of in-house domain experts to support regulatory response efforts
As recent developments make clear, the financial sector is evolving at a rapid pace. For those looking to stay one step ahead of the crypto craze and make the most of this latest disruption, a proactive approach is key.
1: Alex Gailey and Ryan Haar, “The Future of Cryptocurrency: 8 Experts Share Predictions for the Second Half of 2022,” NextAdvisor (October 31, 2022), https://time.com/nextadvisor/investing/cryptocurrency/future-of-cryptocurrency/.
2: “DefiLlama – DeFi Dashboard,” DefiLlama (last visited December 8, 2022), https://defillama.com/.
3: Krisztian Sanor, “Crypto Mortgages: How You Can Buy a House Using a Crypto-Backed Loan,” CoinDesk (May 23, 2022), https://www.coindesk.com/learn/crypto-mortgages-how-you-can-buy-a-house-using-a-crypto-backed-loan/.
4: Zina Kumok, “Crypto Loan: Use Coins As Collateral For Your Loan,” Forbes (September 9, 2022), https://www.forbes.com/advisor/personal-loans/crypto-loans/.
5: Ronita Choudhuri-Wade, “How Do Crypto Loans Work?” NerdWallet (June 29, 2022), https://www.nerdwallet.com/article/loans/personal-loans/what-is-a-crypto-loan.
6: Office of the Comptroller of the Currency, “Federally Chartered Banks and Thrifts May Provide Custody Services for Crypto Assets,” (July 22, 2020), https://www.occ.gov/news-issuances/news-releases/2020/nr-occ-2020-98.html.
7: Shawn Amick, “The Largest Bank in the Eurozone to Launch Bitcoin, Crypto Custody Platform,” Bitcoin Magazine (July 19, 2022), https://bitcoinmagazine.com/business/bnp-paribas-to-partner-with-metaco-for-digital-asset-custody.
© Copyright 2022. The views expressed herein are those of the author(s) and not necessarily the views of FTI Consulting, Inc., its management, its subsidiaries, its affiliates, or its other professionals.
About The Journal
The FTI Journal publication offers deep and engaging insights to contextualize the issues that matter, and explores topics that will impact the risks your business faces and its reputation.
December 19, 2022
Senior Managing Director, Co-Leader of Financial Services
Senior Managing Director