Six reasons why banks should stay ready for crypto
Traditional financial institutions have had an up-and-down relationship with cryptocurrencies. Against them in the early days, many banks are now actively looking for ways to serve retail crypto clients. Despite this year’s crypto market meltdowns and scandals, there are reasons to believethe adoption of digital assets will continue.
When Jamie Dimon, Chairman of JP Morgan, famously described Bitcoin as a “fraud” in 2017, his view reflected the skepticism of many in the traditional financial sector against cryptocurrencies.
Since then, crypto has gone mainstream in many ways. To take a few examples: today JP Morgan offers its clients exposure to cryptocurrency markets and is very bullish on the use of blockchain and crypto in financial services. Peers like Morgan Stanley, Citigroup and Goldman Sachs offer crypto-related products for qualified investors, while retail clients can purchase and use cryptocurrencies via large mainstream institutions like Visa and PayPal. With consumer demand rising, over the past several years traditional retail banks around the world have been looking to develop crypto offerings as well.
Recent events, however, may cause some to reconsider. From the crash of the Luna stablecoin to dramatic drops in cryptocurrency prices to the recent meltdown at FTX, confidence in the crypto industry has been shaken this year.
In our opinion, we see strong signs that crypto markets and consumer demand for crypto will rebound. Interested banks will still want to be positioned for the next upturn. Here’s why.
Six reasons for crypto optimism
One: What we are witnessing is not a failure of crypto
The terrible irony of the FTX meltdown for the legitimate crypto industry is that this was not a failure of the decentralised finance model that lies at the heart of the crypto ethos. This was an old-school, centralised finance type of fraud, perpetrated by a charismatic CEO who charmed and conned investors, politicians, regulators, celebrities and consumers on a scale not seen since Bernie Madoff.
Crypto was designed to make such failures of trust in individuals obsolete. We believe that, after the dust settles, investors and consumers will come to see the distinction, driving renewed interest in crypto and DeFi.
Two: Crypto markets have always recovered
Cryptocurrency markets have a long history of booms and busts, with swings of 25-40 percent over short periods of time not uncommon. Up to now, they have always recovered at higher levels. But of course, we should'nt project crypto's future solely on the grounds of previous price patterns.
The current (Dec 2022) bitcoin price of almost USD 17,300 is a fraction of the over USD 66,000 peak it reached in November last year. A scant six years ago, in November 2016, bitcoin was worth USD 700. Even today it still represents one of the best-performing assets of the last decade. Banks looking at the longer-term cycle may want to take note of this.
Three: Crypto markets are much cleaner than they used to be
From Mt. Gox to the Silk Road to fraudulent ICOs and hacked wallets, traditional financial institutions have in the past had good reason to worry about criminality and fraud in crypto markets. But crypto’s wild west days are now mostly behind it.
With the rise of crypto forensics, it has become much harder for criminals to use cryptocurrencies. While crypto investors still must be wary of scams and hacks, overall, the industry has matured and investors have become more knowledgeable.
Today crypto consumers have many more resources, including reputable service providers, that can help protect them. If, as we believe, markets rebound, demand for such reputable service providers will grow.
Four: Regulatory clarity for banks is coming
Regulators around the world have struggled to come to terms with cryptocurrencies, and regulatory uncertainty has been a major barrier for traditional financial institutions wanting to enter this space.
The situation has however been steadily improving. Jurisdictions like the EU (with MiCA) or Switzerland (where crypto clarity has long been established), have provided clear ground rules for cryptocurrency investing. For instance, under Swiss law, crypto falls under the same rules and regulations as real monetary assets, meaning those who invest in crypto can do so with legal certainty. On the back of FTX, we will likely finally get regulatory clarity in the US too.
The coming rules may or may not be palatable to the crypto industry, but banks can at least expect to know where they stand.
Five: Digital assets are here to stay
While many regulators have had their misgivings about cryptocurrencies, most jurisdictions have embraced blockchain and distributed ledger technology, and recognised it as an important innovation worth fostering.
Whether via CBDCs, tokenization, NFTs or in other forms, few doubt that digital assets are the future. Banks will need to understand the tech, and how to service these markets.
Six: The crypto infrastructure and DeFi model have proven to be extremely resilient
Despite severe market dislocations, the underlying cryptocurrency and DeFi infrastructure has proven itself to be extremely robust.
Neither the Bitcoin nor the Ethereum blockchains have ever been successfully hacked, despite being under constant attack and handling extremely large volumes (last year the Ethereum Mainnet settled more value than Visa). As encouragingly, DeFi protocols like Uniswap have weathered this year’s storms very well too.
Decentralised models are proving their worth, and here too we believe investors and consumers will over time notice.
DeFi will be part of the industry’s future
For the reasons discussed above, we think crypto will weather the current storm as it has done with similar crises in the past, and that the pieces are in place for it to thrive again as the DeFi model continues to prove itself.
This means that DeFi products will continue to compete with traditional banking products, but it is likely that the two will blend at some point. By leveraging DeFi’s technical components and CeFi’s KYC and AML requirements, “CeDeFi" -based models are beginning to take shape. Financial institutions will need to keep this in mind.
That said, we have never believed that the DeFi model is destined to supplant the traditional one. In our view, the two will rather enhance each other. DeFi represents significant innovations in the technology of finance, allowing for greater flexibility, more efficient systems and innovative products and greater autonomy for users. Traditional Finance, or CeFi, brings hundreds of years of experience in financial systems governance and customer servicing.
We think that financial institutions able to bridge both worlds, and prepared to do so, will find many interesting opportunities in the evolving Future Finance landscape.
Learn more about digital asset banking at Sygnum here.
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