Cryptocurrencies – Threats and Opportunities for Banks

By Baker Newman Noyes September 22, 2022

What is cryptocurrency?

Cryptocurrency (or crypto) is a digital currency in which transactions are verified and records maintained by a decentralized system using cryptography, instead of being managed by a centralized authority, such as a bank. Bitcoin became a synonym for cryptocurrency for the sole reason that it was the first ever cryptocurrency, and it is by far the most popular one of all. However, there are over 20,000 different cryptocurrencies, with the number still rising. The common denominator of all of them is blockchain technology, which makes it impossible to counterfeit or double-spend digital money.

All digital assets can be divided into four categories:

• “Traditional” cryptocurrencies such as Bitcoin or Ethereum
• Stablecoin such as USD Coin or Tether
• Central Bank Digital Currencies (CBDCs) such as Digital Dollar and Digital Yuan‍
• Non-fungible tokens (NFTs) – though not technically cryptocurrency, most NFTs are part of the Ethereum blockchain

What does the current crypto landscape look like in 2022?

Since 2009, when the genesis block of the blockchain was minted by Satoshi Nakamoto, the crypto market exploded. As mentioned, there are over 20,000 different cryptocurrencies, with a combined market cap of just under a trillion dollars! The crypto market is highly volatile, increasing from $250 billion in May 2020 to $3 trillion in November 2021, then falling sharply to under $1 trillion in September 2022. NFTs were introduced in October 2021 immediately attracting $1.2 billion dollars.

In the wake of this activity, native crypto companies such as exchanges, crypto custodians, stablecoin companies, or crypto payment companies are forming banks. Sometimes these companies are buying out banks, as a way to acquire a bank charter.

Recently, the Federal Reserve, the Office of the Comptroller of the Currency, and the FDIC have each issued requirements that banks notify their primary regulator prior to engaging in any crypto and digital asset-related activities. These agencies have also indicated they plan to issue further coordinated guidance on the rapidly emerging crypto and digital asset sector.

What threats does cryptocurrency pose to banks?

Cryptocurrencies, although volatile, do appear to be here to stay. As they continue to migrate to the mainstream, financial institutions should be aware of the threats cryptocurrency poses to the traditional banking structure:

• Banks risk losing a generation of customers. A recent study by Piplsay shows that 38% of Gen X, 49% of Millennials and 13% of Gen Z own cryptocurrencies. Gen Z is natively mobile, and the youngest Millennials are less likely to have bank accounts or credit cards. This trend will only accelerate with Generation Alpha (the early 2010s – 2020s).
• Banks risk losing an important source of inexpensive funding as over time, crypto will capture core deposits from consumers. It is increasingly common for twenty-somethings to only have a Robinhood or Coinbase account and a digital wallet. Corporations such as Tesla and Square have started using crypto as a way to “solve payments.” If these pioneer companies succeed, many more will follow, leaving banks on the sidelines.
• Banks risk losing their role as a payment solution if crypto (through stablecoins) creates a viable medium of exchange. This is especially important because international exchange rates and transaction fee issues cease when crypto is involved.
• Some crypto companies are now offering loans using cryptocurrency as collateral to get a loan instantly without credit checks. If this model proves viable, many more crypto companies and exchanges will follow, displacing banks from the loan market.
• Decentralized Finance (DeFI) use cases in payments, derivatives, investments, and stablecoins, continue to develop and become more attractive over time, as the crypto matures.

What opportunities do cryptocurrencies present to banks?

As is often the case, with risks, there are also opportunities:

• The crypto industry continues to grow and requires services that traditional banks can offer immediately, mainly cash management. Crypto-native companies welcome (and seek) traditional banking services. Not many banks are active in the crypto space, which can be advantageous to those who get in early.
• Banks have something incredibly valuable to many crypto companies, not only compliance and regulatory experience, but also a bank charter! Crypto-native companies want to offer banking services, such as debit and credit cards, checking, and savings accounts. Only the largest crypto companies will be able to get a banking license, the others will be looking to partner with a bank.
• New regulations are in the works to allow banks to compete and work with native crypto companies. Recently, on July 19, 2022, Michael S. Barr took office as the Vice Chair for Supervision of the Board of Governors of the Federal Reserve System, signaling that the Fed will be focused on the cryptocurrency industry. He also said that he hoped that Congress will work “expeditiously” on legislation to bolster regulators’ authorities to oversee stablecoins.

What should banks be doing now?

If banks want to stay ahead of the curve, we have a few recommendations for first steps:

• Appoint a chief innovation officer or create an innovation committee. Look internally and you’ll probably find at least one person who is a crypto enthusiast.
• Find ways to partner with FinTech and crypto companies in banking-as-a-service and synthetic banking solutions.
• Talk to customers about crypto and survey individual and business customers to identify areas of common interest.
• Consider what other banks have done in the crypto arena; Vast Bank is a success story, as an early adopter.
• Evaluate how crypto can fit in your strategic business plan.
• Research and monitor trends in crypto, related regulations, and developments in CBDCs, both US and worldwide.

Conclusion

Cryptocurrencies are a hot topic, known for their volatility and attracting money, both from individuals and businesses. If you think you are too late to capitalize on crypto, you are not! Remember that Bitcoin was created in 2009, NFTs were introduced in October 2021, and the current market cap is just under $1T. Some people compare the current crypto market to the internet before browsers. Educate yourself, assess how this new technology can fit into your strategic business plans, and only then you will be able to make a decision whether or not this is a form of currency to integrate with your bank.