The early 2020s are bringing a major transition in banking: the adoption of cryptocurrencies. Retail banking clients and institutional investors are increasingly interested in this financial vehicle and the distributed-ledger technology (DLT) that underpins it, especially innovations like blockchain. Many investors, fintechs, and venture capital funds now view cryptocurrency as the future of money, making it an opportunity banks can no longer afford to ignore.
While some financial leaders remain skeptical due to cryptocurrency's volatility and past associations with criminal activities, its potential is undeniable. Cryptocurrencies can outperform conventional banking products by offering greater efficiency, reduced bureaucracy, and enhanced transparency.
Why Cryptocurrency Matters for Banks
Cryptocurrencies represent more than a speculative asset; they are a transformative force in finance. As early as 2012, industry observers suggested banks could offer services like payment processing, escrow, international transactions, and even loans in cryptocurrencies. However, widespread adoption has only recently gained momentum.
Major institutions are now leading the way. JPMorgan Chase introduced JPM Coin for faster transaction settlements, Morgan Stanley offers blockchain-based investment products, and Goldman Sachs has strengthened its digital assets leadership. Over 100 banks have tested instant payments using Ripple, and central banks in China, Sweden, and the UK are exploring digital currencies. Even the European Central Bank is investigating a digital euro to stay ahead of trends.
Technology firms are also entering the fray. The Libra Association’s Libra system aims to reduce transaction costs to nearly zero, though its launch has faced delays. Despite these advancements, many banks remain uncertain about implementation, risk management, and regulatory compliance. However, those who act now can differentiate themselves and become first movers in their regions.
Crypto’s Continuing Momentum
Understanding cryptocurrency trends is crucial for bankers. While Bitcoin remains highly speculative, institutional investment is growing steadily. Capital per deal has risen from $5 million in 2015 to nearly $20 million in early 2020, indicating strong investor confidence.
Several factors drive this growth:
- Professionalization: The industry is maturing, attracting larger investments.
- New Investment Vehicles: Options like initial coin offerings (ICOs), illiquid funds, and hedge funds are becoming safer due to regulatory involvement.
- Blockchain Familiarity: Applications like smart contracts and settlement processes boost confidence.
- Diversification: Cryptocurrencies often don’t correlate with stock markets, making them attractive for portfolio diversification.
A structured market for institutional trading is emerging, supported by digital ecosystems that facilitate cryptocurrency-related activities.
The Right Mix of Crypto Offerings
Banks face increasing pressure from tech-driven competitors. As Sir Jon Cunliffe of the Bank of England warned, non-bank stablecoins could divert capital from traditional accounts, challenging banks’ lending capabilities. However, banks’ trusted reputations give them an edge in entering this market.
Banks can explore various business use cases:
- Currency Services: Facilitating ICOs, direct investments, tokenization, and currency trading.
- DLT Applications: Using blockchain for real estate investments, smart contracts, and transaction verification.
Integration with existing offerings is key. For example, Revolut allows customers to transfer money in cryptocurrencies alongside traditional currencies, enhancing convenience and portfolio flexibility. 👉 Explore integration strategies
Customer demand should guide banks’ strategies. Large investors may seek crypto-based growth assets, venture capital funds prefer designated crypto funds, and retail clients look for diversification options.
Mitigating Risk
Cryptocurrencies pose unique risks, including volatility, illicit activities, and regulatory uncertainty. The Basel Committee on Banking Supervision emphasizes due diligence, robust governance, transparency, and regulatory dialogue.
KYT: Beyond Customer Verification
Traditional know your customer (KYC) checks are insufficient for cryptocurrencies. Know your transaction (KYT) leverages blockchain technology to trace transactions back to their sources, detecting patterns associated with criminal activity. KYT complements KYC by providing a scoring system based on transaction partners, timing, and geography.
Banks must enhance their capabilities for KYT, including:
- Data connectivity and analytics
- Real-time illicit transaction identification
- Regulatory relationship management
KYT, combined with KYC and know your data (KYD), addresses challenges like offline transactions and experimental cryptocurrencies.
Structured Regulatory Compliance
Global regulatory approaches vary widely. Europe and the US have divergent stances, with Germany enforcing existing rules and US agencies evolving their frameworks. Emerging policies, like the European Commission’s draft framework and Liechtenstein’s robust model, add complexity.
Key unresolved questions include:
- Legal definitions of cryptocurrencies
- Treatment as assets, securities, or commodities
- Regulatory consistency across jurisdictions
Banks should develop consistent guidelines through:
- Regulation heat maps and gap analyses
- Risk management diagnostics
- Implementation plans for compliance
👉 Learn about regulatory frameworks
Innovation of Custodian Services
Cryptocurrencies are prone to fraud and cyber threats, creating demand for custodian services. Banks are ideal providers due to their cybersecurity expertise and reputations. The US Office of the Comptroller of the Currency has affirmed banks’ authority to offer these services.
Technology choices include:
- Cold Storage: Secure but less accessible
- Hot Storage: Convenient but vulnerable
Fintechs like Gemini offer custodian services, but institutional investors remain hesitant due to risks. Banks can leverage their regulatory skills and track records to capture this lucrative market, though broader regulatory consensus is needed.
Frequently Asked Questions
What are the main benefits of cryptocurrencies for banks?
Cryptocurrencies offer efficiency, transparency, and new revenue streams. They can attract tech-savvy clients, diversify offerings, and reduce operational costs through blockchain technology.
How can banks manage cryptocurrency volatility?
Banks can mitigate volatility through diversified crypto offerings, risk management frameworks, and custodian services. Educating clients about risks and rewards is also essential.
What regulatory challenges do banks face?
Regulatory inconsistency across jurisdictions is a major hurdle. Banks must navigate varying definitions, compliance requirements, and evolving policies while maintaining transparency.
Are custodian services profitable for banks?
Yes, custodian services can be highly profitable, with estimates suggesting fees up to 1% of asset value annually. Banks’ reputations and regulatory expertise give them a competitive advantage.
How does KYT improve security?
KYT uses blockchain analytics to trace transactions and detect suspicious patterns, reducing risks like money laundering and fraud. It complements traditional KYC checks for comprehensive security.
What is the future of central bank digital currencies (CBDCs)?
CBDCs are gaining traction globally, with central banks representing 20% of the world’s population likely to issue digital currencies within three years. They promise greater financial inclusion and efficiency.
Conclusion
The next few years will integrate cryptocurrencies and DLTs into mainstream finance. Banks that embrace innovation, mitigate risks through KYT and custodian services, and navigate regulatory landscapes will lead the industry. The real uncertainty isn’t risk—it’s missing opportunities. By acting now, banks can shape the future of money and secure their competitive advantage.