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Cryptocurrencies: Partnering Banks Towards a New Era in Finance

A few years ago, cryptocurrencies or cryptos would have appeared as a page out of a science fiction novel, shrouded in skepticism and a vision of a distant future. However, now, this future is nearer than ever for many banks and financial institutions worldwide, compelling BFSI leaders to reposition on cryptocurrencies. Recently as cryptos gained traction, powered by popular demand, the industry, the regulators, and the markets are gradually coming to terms with their relevance.

So how has the story unfolded, transcending cryptos from being a pariah in the global financial community to partnering with banks towards a new era of financial transformation?

Against all Odds

For cryptos, the start has indeed been turbulent and uncertain. Perhaps at the root of their predicament has been the nearly obsessive attachment of the global financial industry to control and drive predictable value: things that cryptocurrencies do not guarantee. In 2014 as the NY Stock Exchange looked for ways to control Bitcoin, the Wall Street insiders were apprehensive that regulatory oversight might actually legitimize cryptos, threatening financial industry dynamics.

That year, at the World Economic Forum in Davos, Switzerland, the top executive of JPMorgan Chase, one of the apex global banks and financial services providers, described them as a ‘terrible’ store of value and complicit in funding illegal operations. While the supplementary allegation is indeed true, as we have witnessed, it hasn’t been enough to push cryptocurrencies to obscurity. Interestingly, over the years, the industry leaders have been consistently vocal on the role of crypto assets like Bitcoin in providing an alternative to fiat money like the Dollar and Euro for autocratic regimes to bypass sanctions.

Cryptocurrencies: Growing in Strength

Despite this, the mainstreaming of cryptos continued unabated. Predicting the future, regulators like the New York’s Department of Financial Services have been early in embracing the change, issuing licenses for Bitcoin based businesses since 2015. Today, there are nearly 600 cryptocurrency exchanges worldwide, and estimates that the global crypto population has surged by 178% in 2021. It is slated to touch 1 billion by the end of 2022. It means that, on average, 1 in every eight people worldwide is a crypto holder at present!

In the wake of the pandemic that has driven home the need to digitize, digitalize and decentralize, 2022 has been a surprisingly strong year for cryptos, with its ownership rising from 106 million in January to 295 million in December. It is a spectacular bounce back from the crash it suffered at the onset of the COVID-19 wave in 2020. However, it recovered much faster than traditional asset classes, shedding its disrepute of volatility along the way.

Similar trends have been witnessed in APAC, where Gemini reports that the crypto user base doubled in 2021. In fact, The Business Insider found that Asian countries like India and Vietnam are leading the global crypto adoption among retail investors. However, the adopter mindset is highly diversified across the region. For instance, in countries like India and Indonesia, it is used to hedge against the devaluation of fiat currencies and other asset classes. But in countries with greater regulatory transparency, cryptos are growing as an investment vehicle.

Are Cryptocurrencies in Conflict with Conventional Banking Interests?

But what has made bankers and financial services leaders repulsive to the idea of a currency that exists solely in the digitized form? To be fair, for an industry that has been slow and conservative to disruptive changes, BFSI finds it off-key with several crypto fundamentals. Firstly crypto assets have been designed to run without an intermediary and are not tied to a sovereign, central bank, or agency. Instead, the trust is placed on blockchain technology and is ensured through the immutability of a decentralized ledger. Secondly, cryptocurrencies allow peer-to-peer transactions that are faster and need no transaction charges. This pseudonymity leaves enough space for dubious actors to effectively bypass anti-money laundering (AML) nets and know your customer (KYC) requirements. Lastly, the price of various cryptocurrencies has been volatile in the short term leading to a notion that their values are based on speculation and not their actual worth.

It is due to this that a joint study by the Association of Certified Anti-Money Laundering Specialists (ACAMS) and the U.K.’s Royal United Services Institute found that nearly 63% of BFSI insiders still perceive cryptocurrency as a risk rather than an opportunity. Further, the speech by the Deputy Governor of RBI in February this year on the risks involved in crypto investments and the Indian Central Bank’s deliberations on the matter gives a glimpse of the mistrust that still veils the industry mindset.

However, this veil is lifting fast. The Library of Congress that reviews the stands of the nations on cryptocurrencies and Bitcoin found that as of November 2021, at least 103 countries worldwide have issued mandates for the domestic financial regulators to prioritize the development of standards for banks and financial businesses on cryptocurrencies and assess their impact on AML provisions. Although many financial services insiders will only tacitly agree, conventional institutions and crypto can be natural allies! In fact, there is no need for banks and financial institutions to invest millions for reaping the rich dividends and transformative benefits that cryptocurrencies promise. Many organizations already have the required systems, processes, and cultures that can be upgraded and scaled to propel them towards a crypto-enabled future for global finance.

Scope of Cryptocurrencies in Banking

Here is a take on the scope of how banks can embrace cryptocurrencies and the methods of aligning them with recent financial innovations:

Bank as an infrastructure: The IT landscape of banks can be used as infrastructure for running crypto transactions and providing customers with services like credit, payment, and new account opening. It can rake in profit for financial services. Also, Open Banking can be another value stream for banks using APIs for delivering services like currency exchange, credit access, and payment through multiple financial and nonfinancial platforms. Notably, VISA launched its crypto API suites last year with First Boulevard to enable transactions in crypto assets.

Regulatory participation: Banks and financial services can proactively come forward to participate in regulatory exercises that aim to develop the crypto ecosystem further and make it more compliant. For instance, the European Commission recently undertook an initiative to introduce a common EU pilot program for probing into Digital Ledger Technology-based market infrastructure. Being a stakeholder in such efforts can help the industry to better understand how to fine-tune its offerings using the crypto advantages.

Co-branding: Across industries, there are several institutions that don’t hold licenses but are still permitted to offer their products and services through co-branding with partners who do have the necessary permissions in place. Similarly, operations with cryptocurrencies can also follow the model to proliferate, building on existing partnerships between banks and other financial and nonfinancial services.

Custodian services: Banks, due to the inherent nature of the business, hold expertise in custodian services and secured storage of assets. It can be leveraged to ensure more secured, transparent, and accountable storage of cryptocurrencies, adding to the trust that is alleged to be lacking at the moment.

Joint venture: Another way in which banks can contribute to enriching the cryptocurrency ecosystem is by bringing their proven technology and management expertise in joining projects with relevant companies to build favorable public opinion on cryptos. However, due to the fast-evolving nature of cryptocurrencies, banks will continuously have to be in an innovation mode to ensure that their IT landscapes are in sync.

A Perceivable Change in Status Quo that Banks Should not Ignore

But why should banks and financial institutions consider these scopes and renew their focus on cryptos? It is due to the intersection of various factors that are redefining the global financial landscape at present. One such factor is the Gen Zers and millennials who are growing up to be tomorrow’s banking and financial services customers. They are entirely attuned to cryptocurrencies. This study found that 94% of the crypto buyers are either Gen Z or millennials and have substantially broadened their exposure to cryptocurrencies in 2021. Also, a survey reported that 59% of the current generations believe that cryptocurrency investments can make them millionaires. Other factors include:

  • A growing consciousness of the global investors on the general professionalization of the cryptocurrency industry. Cryptos are no longer a hobby! It is corroborated by the growth of average capital invested per deal. In fact, in 2021, venture capital funds worldwide have invested $30 billion in cryptocurrencies.
  • A proliferation of crypto-focused investment vehicles that allows the investors the freedom to choose and which can be flexibly used to launch other ventures.
  • A heightened familiarity of institutional and individual investors with other blockchain-based applications like smart contracting and settlement processes. Their effective functioning is indeed consolidating investor trust in crypto products.
  • A growing industry opinion on the usage of cryptocurrencies for portfolio diversification as their movement often does not correlate to the stock market. It, in turn, is fueling the demand for a market structure for more institutionalized trading in cryptocurrencies.

What Are The Benefits of Banks Embracing Cryptocurrencies?

Embracing cryptocurrencies and their normalization into the banking and financial services ecosystem can help organizations sustainably bridge various pitfalls and make offerings more responsive to the new business demands. Some such benefits can be as under:

Boosting service delivery: Like all other sectors, in banking and financial services, seamless customer experience and convenience has emerged as chief differentiators. However, processes persist that are still difficult to disrupt and transform using conventional means. For instance, cross-border money transfers currently involve time and cost due to many intermediaries. Here cryptocurrencies can accelerate international fund transfer using blockchain technology for verification, enriching the customer experience.

Expanding globally: As discussed, several major economies worldwide have either embraced or are embracing cryptocurrencies as a mode of payment. Additionally, many multinational corporations and institutional investors have a steady exposure to cryptos. Banks with a favorable crypto posture will be positioned to strike a chord with their global customers immediately.

Innovation at speed: Cryptocurrencies offer limitless opportunities for banks and financial businesses to innovate and modernize. For instance, the underlying blockchain technology provides unique means to reinvent trade settlements, asset transfers, digital ownership, title transfers, smart contracts, and many more use cases. Such innovations will enable bankers to cut costs and service customers in unimaginable ways.

Banking the unbanked: While good banking services are often taken for granted, the World Bank reports that half of the global population is still either unbanked or underbanked. The unbanked are shut out from the benefits of a flourishing economy and are often subject to economic exploitation. This paper published at Columbia’s School of International and Public Affairs delved deeper into how cryptocurrencies and blockchain can take financial services to the grassroots. Although still a vision in the making, with its decentralized nature, cryptocurrencies can go a long way in bypassing bureaucratic complexities and making financial services more accessible on demand.

Final Thoughts

Understandably cryptocurrencies are poised to impact the banking and financial industry in ways that some stakeholders may see as threatening. However, the bankers and financial services leaders should be more worried about missing the opportunities rather than the disruptions and risks involved. The crypto domain is currently evolving at breakneck speed. Will the banks be able to keep pace and integrate its benefits into existing operations at scale to transform financial service deliveries? While undoubtedly it will take some effort and a sea change in perception, the dividends will be richer than ever, heralding a new era in finance.

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