From ICOs to DeFi, NFTs to stablecoins, the list of cryptocurrency and blockchain innovations would have made an investment banker in the dotcom era green with envy.
Timothy Hwang fiddled with his cappuccino. Sitting in the posh dining hall of the high-end French restaurant Les Amis, in downtown Singapore, he lamented to his private banker how he struggled to understand the so-called “new economy.”
Hwang, a thin streak of gray hair the only physical trait suggesting he was somewhat older than his youthful frame revealed, was seated with his mother who was in her nineties, alert and the indisputable matriarch of a family business that spanned several generations.
The Hwang family had spent a lifetime dedicated to building the family business, a brick-and-mortar empire that revolved around commodity trading, real estate, and hospitality.
And as Timothy, now in his late 50s, look set to continue the family’s legacy, he couldn’t help but feel consternation that he, and many from his generation were being left behind in a new age of information and technology.
The stories of crypto millionaires and billionaires bidding inconceivable amounts of money for digital artwork and minting fortunes beyond the dreams of avarice from tokens were becoming so prevalent that they had become virtually impossible to ignore.
While the Hwang family had been understandably skeptical about the nascent cryptocurrency asset class, even they were not immune from the fear of missing out, on what has been touted as a transformative technology, let alone their bankers.
Fear of Missing Out
Away from the spotlight, a growing number of traders at some of the world’s most storied financial institutions have been lobbying for some time to gain access to cryptocurrency trading.
Many took matters into their own hands, discreetly trading cryptocurrencies on the side without the knowledge of their employers.
Yet ever since cryptocurrencies soared in interest and value, the pressure from clients has forced even the most conservative compliance departments at financial institutions to reconsider their blanket ban on the digital asset class.
But it’s not just compliance officers and governance boards who are standing in the way of a wider embrace of cryptocurrencies at financial institutions, many face genuine infrastructural challenges as well to adapt to the new technology.
At some venerated financial institutions, the coding language for internal settlement is still Fortran, a programming language originally developed by IBM in the 1950s for scientific and engineering applications and while still used in specific applications, does not appeal to a wide coder base.
Trying to adapt trading desks to cryptocurrencies would be akin to strapping a Ferrari engine to a lawnmower, legacy financial institutions are just not ready yet from a technology perspective.
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Not Just the Tech Stack, The Legal One Too
Moreover, the substantial compliance burden laid on financial institutions means that change, when it comes, is often at a glacial pace.
But financial institutions are increasingly realising that they can’t afford to ignore cryptocurrencies indefinitely, especially when the total market cap for digital assets has soared to some US$2.6 trillion.
In a recent research note dedicated entirely to cryptocurrencies, Bank of America wrote,
“The digital asset universe is too large to ignore, We believe crypto-based digital assets could form an entirely new asset class.”
And some of the largest US and European banks have either made announcements revealing their involvement in cryptocurrencies all this while, or say that they are planning to start exploring the space.
Even some of the most staid and conservative financial institutions have caved under mounting pressure both from clients and internally, to give cryptocurrencies a more serious look.
This February, the research team of German lender Commerzbank sent out a note to explain why its analysts did not cover bitcoin, noting,
“[Commerzbank] does not consider it to be its responsibility to comment on the price development of purely speculative investments or to predict it.”
But by September, the German lender had established its own digital asset team.
Financial institutions have always been somewhat duplicitous when it’s come to cryptocurrencies, with many being forced to publicly deride the nascent asset class, while in private, pursuing the development of opportunities around them.
In October 2017, JPMorgan Chase CEO Jamie Dimon infamously remarked about bitcoin,
“If you’re stupid enough to buy it, you’ll pay the price for it one day.”
Yet soon thereafter, Dimon’s bank would announce the rollout of JPM Coin, its own internal settlement digital currency.
And as it turns out, “stupid” saw the price of bitcoin soar to some US$67,000.
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If You Can’t Beat Them, Regulate Them
For financial institutions, cryptocurrencies represent both an irresistible opportunity and an existential threat.
Advancements such as decentralised finance or DeFi, threaten to undermine the role of banks in economic life, but the inefficient price discovery mechanism and decentralised nature of cryptocurrency markets also provide a potentially lucrative source of revenue for trading desks.
But for the Masters of Planet Finance, deciding how to get involved in cryptocurrencies is anything but straightforward.
For starters, storing cryptocurrencies for institutional custody is technologically complex and risky, and insurance, where available, is costly.
There’s no guarantee that financial institutions will win at trading either because right now, they can only buy and sell cryptocurrency futures, which makes it difficult to generate the sort of returns that firms native to cryptocurrencies can.
Even the launch of bitcoin ETFs in the U.S. doesn’t solve that problem for financial institutions, because the product has CME Group’s bitcoin futures as the underlying asset.
Take for example a popular basis trade that cryptocurrency traders typically undertake, which involves buying a token on the spot markets and selling the long-dated future for that same token, and pocketing the spread between those two prices.
Because almost all of the on-ramps for financial institutions into the cryptocurrency markets are cash-settled, they can’t necessarily take advantage of such a trade — CME Group’s bitcoin futures are cash settled and don’t call for physical delivery.
And lending, a mainstay in the DeFi space, with yields as high as thousands of per cent per annum, are out of the question.
Never mind that DeFi instruments such as flash loans don’t execute if the trading conditions are met, the idea of putting a client’s or the financial institution’s crypto assets onto a smart contract would be enough to give even the most adventurous risk manager a heart attack.
For financial institutions, the main problem has been they have been slow to innovate for decades, and cryptocurrencies present a particularly prickly predicament in that they develop and evolve extremely quickly.
Years of under and over-regulation, consolidation and mergers, has meant that few financial institutions have kept abreast of technological developments.
Today, the technology that underpins some of the biggest banks in the world is creaky, fragmented, and more often than not, antiquated.
The other issue is the inability to attract talent.
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No Company for Good Blockchain Developers
Traders and software engineers who found the promise and prospect of cryptocurrencies more attractive than working at a bank, have been leaving financial institutions in droves for years, and well before the most recent rally in cryptocurrency prices.
Cryptocurrency firms on the other hand are often seen as being sexy, cutting-edge tech-centric firms unshackled by regulation (for now) and have hoovered up much of the very talent that financial institutions would need to get their digital asset game up.
But all is not lost.
Banks have significant client bases like the Hwang family, for whom reputation, brand and relationship, are integral to their choice of partner when it comes to venturing into this brave new world of cryptocurrencies.
Whether it’s family wealth or an insurance fund, more conservative investors may prefer to deal with their trusted banker and a known brand, than with a trading app promising attractive APYs.
And that’s why the cryptocurrency bubble hasn’t peaked just yet.
With the first futures-backed US bitcoin ETF out the gates, more will follow.
And if Grayscale Bitcoin Trust manages to convert its US$38 billion worth of bitcoin in custody into a bitcoin ETF that actually has the digital asset as the underlying, things could get even hotter for bitcoin and cryptocurrencies.
To be sure, financial institutions which may initially have been reluctant to embrace cryptocurrencies may now feel that they no longer have any choice but to at least tread and trade cautiously in the nascent sector.
And with the crypto-savvy Gary Gensler at the helm of the US Securities and Exchange Commission, the prospect of more comprehensive regulation of the digital asset space is becoming increasingly probable.
Regulation will work out well for financial institutions because that is the one area where they have an advantage over crypto-native firms which have spent years trying to avoid regulation.
As more institutional-grade products start becoming available not just for retail investors, but for institutional investors as well, that increase in flow will provide the perfect backdrop for crypto-asset inflation and the next cryptocurrency bubble.
By Patrick Tan, CEO & General Counsel of Novum Alpha
Novum Alpha is the quantitative digital asset trading arm of the Novum Group, a vertically integrated group of blockchain development and digital asset companies. For more information about Novum Alpha and its products, please go to https://novumalpha.com/ or email: email@example.com
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