Banks are deep into crypto – but not Bitcoin
The noise around Bitcoin hitting US$50,000 obscures foundational work in blockchain finance.
Big banks and payment processors are HUGE into digital assets. They usually don’t talk about it.
Most of the media and commentary in venues like Twitter or Clubhouse is around Bitcoin, which topped $50,000 this week. This is a sideshow – the equivalent of a GameStop mania that obscures what’s really happening in equity markets.
There is a steady drumbeat of headlines about the next financial institution adopting a crypto strategy. Last summer, PayPal began to accept transactions in bitcoin. In December, DBS announced the launch of its own digital-asset exchange. Last week, BNY Mellon said it is building the capacity to store, issue and trade cryptocurrency on behalf of asset-management clients. Mastercard also said it would add crypto to its payments network.
Most of these activities are not about Bitcoin, however, except in cases where the institution is confident about the regulatory and compliance status of underlying assets. PayPal, for instance, is not a place to trade crypto. Mastercard said it will begin by adding stablecoins to its network: assets that come with know-your-client protections and that are compliant with local regulations. It is unlikely that Mastercard will directly process Bitcoin.
Picking up the pace
The popular association of Bitcoin with all things crypto obscures innovation in blockchain and digital assets that is relevant to licensed financial institutions. Where will we see big banks move? What does institutional acceptance mean to them?
Banks do see institutional investors allocating more to cryptocurrencies and central banks exploring the issuance of digital currencies. Banks are watching the rapid experimentation in the world of decentralized finance, or DeFi, where activities such as market making, liquidity pooling and collateral management are being reinvented.
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Banks are experimenting in a range of product areas, from foreign exchange and rates to securitization and loans. They are partnering with regulated exchanges and clearing houses, blockchain vendors, and fintech startups.
Instead of being disrupted by crypto finance, banks are embedding themselves at the center of the action. They recognize the threat to their legacy infrastructure and high-cost processes, but they also see that their clients will eventually demand the same level of operational efficiency, transparency and safety that blockchain-based systems can provide.
Where banks can go
There is also big upside for banks, if they can grow innovative capabilities without interference from the “mothership” organization. Tokenization opens up the possibility of digitizing commercial paper, asset-backed securities, structured products, and other instruments at the heart of interbank lending. In turn this will drive volumes and velocity among all kinds of instruments, from FX to equities, making capital markets much bigger and even more amenable to automated trading and processing.
When it comes to cryptocurrencies, banks will facilitate those that have the confidence of regulators. That includes central-bank digital currencies, corporate stablecoins like Facebook’s Diem, their own payment tokens such as JPMCoin, and securities tokens trading on regulated digital exchanges.
Banks are increasingly committed to smart contracts and are exploring DeFi inventions such as yield farming, collateral treatments, and securities lending. To an extent, financial institutions are inserting themselves into the new market structure that crypto brings. This can mean blurred lines (an exchange may also be a broker or an OTC venue, for example) or different business values (a tradeoff between liquidity and transparency versus insisting on legal contracts in interbank lending).
Crypto’s biggest tradeoff
But while banks will try to accommodate client interest in investing and speculating in Bitcoin and other crypto, they are unlikely to directly involve themselves with any instrument that is not compliant. They are making strides to help put crypto into their accounting and reporting frameworks, but they will need to be wary of getting too caught up in headlines about Bitcoin prices.
You can either be green or you can be buying bitcoins
Bitcoin is too volatile to work as money. It is not suitable for payments. Bitcoin’s architecture limiting its supply makes volatility a feature, not a bug. While there’s nothing wrong with investors chasing a hot asset, banks should not encourage corporate clients to follow the hyped moves of Elon Musk or Michael Saylor.
The biggest reason for banks to steer clear of Bitcoin is the unit’s vast energy inefficiency. You can either be green or you can be buying bitcoins, but you can’t be both.
Supporting Bitcoin or any proof-of-work protocol is bad for ESG ratings. Any bank that is trying to win credence for its green credentials must think twice before associating itself with an environmental disaster in the making.