Banks can get on-board the digital asset train

Daniel Lee, Head of web3 at Banking Circle explores the Payments Bank’s latest research and looks at how banks can fast-track crypto engagement by working with third parties

Cryptocurrencies are moving into the mainstream, and growth will be fastest once traditional banks step fully into the race. Commonly considered a relatively new concept, the idea of cryptocurrency was first conceived in the Netherlands as early as the 1980s. The 1990s saw some important leaps forward in digital cash, such as David Chaum’s DigiCash, but it was not until 2009 that Bitcoin was launched, and quickly became the most widely used cryptocurrency. Progress for the new currency was slow, despite rapid technological advances that gave most households access to crypto if they wanted it.

Cryptocurrencies were designed to allow payments without banks, but this perceived benefit could be exactly what has held digital assets back from the mainstream for decades. The regulation and legacy that crypto sought to swerve – to make payments faster, cheaper, and more convenient – also give customers vital protection and stability that engenders trust. Without that, the customer base and potential growth are limited.

However, recent research reveals that crypto usage is growing faster than ever before, with total transaction volume reaching USD 15.8 trillion in 2021, up 567% from 2020. Around 300 million people now hold crypto worldwide, and 75% of users would like to use crypto to pay for goods and services.

Source: Comply Advantage

There are still hurdles to overcome for crypto to gain greater acceptance by mainstream banks. The ongoing volatility has meant crypto is far beyond most banks’ risk appetites. And this is particularly the case when considering how regulators began to see banks as more of a target post the 2008 financial crisis. 

The recent crash of the algorithmic stablecoin TerraUSD, or UST, and the knock-on effect the crash had on Bitcoin, Ether, and Tether, demonstrate just how important it is that crypto is fully regulated. It also clearly shows the opportunity for bank-based stablecoins tethered to fiat currencies to ensure they are more stable than Terra, which originally used a complex mix of code and its sister token, Luna, to stabilise the process. Since the crash, Terra has been redesigned as a blockchain associated with the Luna token.

The Central Bank Digital Currencies (CBDCs) promise many of the advantages of crypto, but much lower volatility since they are digital versions of national currencies backed by government commitment. However, unlike cryptocurrencies, CBDCs are usually controlled centrally, thus it does not provide the benefits of a decentralised governance structure. Similarly, ‘stablecoins’ linked to assets such as fiat currencies or more established cryptocurrencies are less volatile than classic cryptos such as Bitcoin or altcoins, thereby reducing risk.

Alongside improvements in risk, volatility, and security, regulation in this area is also developing, giving banks vital reassurance. Throughout 2021, regulators around the world began to roll out legislation related to handling virtual assets including crypto, covering investment rules, and consumer protection. Leading the way, the US passed more than 20 pieces of legislation by the end of 2021, defining how cryptocurrencies should be treated in areas from taxation to investment and payments.

With security improving, a coherent regulatory environment emerging, and CBDCs and stablecoins improving stability, we are moving to a new phase in crypto’s evolution. Now is the time for banks to get on board, or they risk having to catch up later. They must develop a sound approach to web3 and crypto that helps them to stay ahead and build a competitive offering.

Importantly, due to their direct engagement with the clearing and settlement system, enduring consumer trust, and experience in shaping consumer protection regulation with governments, banks hold a significant advantage over Non-Bank Financial Institutions in powering the mainstream use of digital currencies. As such, the acceptance, transaction, and settlement of crypto will undoubtedly grow fastest when banks play a full role. Indeed, their overall absence from crypto to date may have hampered progress.

Stablecoins are already being accepted as legal tender by major payment networks such as Mastercard, Visa, and PayPal, demonstrating their clear move into the mainstream. And, as stablecoins and CBDCs become more widely accepted and used, banks’ customer relationships and high levels of trust mean they are likely to play an increasingly significant role.

Now, to prepare for the widespread adoption of digital currencies, banks should be working with third parties as part of their ongoing digitalisation strategy, to develop payment service infrastructures that can seamlessly intersect with crypto exchanges and wallets. This will help them add value for customers and generate revenue by acting as a bridge between the fiat and crypto environments. Expert third parties could manage the technical and regulatory issues, helping to deliver a seamless, end-to-end experience for bank customers looking to use stablecoins and CBDCs.

As web3 and crypto continue to grow in popularity, banks should prepare for the much wider propagation of stablecoins and CBDCs in the next two to three years. These currencies, more stable and secure, will soon overtake the more volatile classic cryptocurrencies including Bitcoin and altcoins. Hard to imagine today, perhaps, but it is also possible that CBDCs will soon begin to replace pure fiat currencies, particularly for digital payments.

So, there’s no time like the present for banks to get on-board. Any bank without a coherent web3 or crypto strategy will quickly be left behind and forced to play catch-up.

Banking Circle has published a white paper looking at the opportunities in the virtual asset marketplace: ‘As crypto evolves, how should banks approach CBDCs and stablecoins?’

This editorial was initially published in our Crypto Payments and Web 3.0 For Banks, Merchants, and PSPs Report. The first edition of our report aims to provide a go-to payment resource of crypto terms and concepts for those interested to understand the basics of crypto payments and their long-term impact. Furthermore, it shares practical examples of cryptocurrency-enabled ecommerce and banking services and presents the latest developments in the regulatory landscape. Also, it reveals what are the most innovative companies in this space, that are building the crypto rails.

About Daniel Lee

Daniel Lee is responsible for the web3 initiatives in Banking Circle and relationships with the digital asset community. Formerly at DBS for 22 years, Daniel has extensive experience in the digital assets world. Prior to the DBS Digital Exchange, Daniel was the Executive Director and Head of Electronic Trading servicing intermediaries (broker-clients), digital exchanges, high- frequency traders, and market makers in the electronic trading space. He has experience in dealing with various regulators and exchanges across the region and was also responsible for the ETF business.

About Banking Circle

Banking Circle is a fully licenced next-generation Payments Bank, designed to meet the global banking and payments needs of Payments businesses, Banks, and online Marketplaces. Banking Circle solutions power the payments propositions of more than 250 regulated businesses.