Crypto faces some tough – but not insurmountable – challenges ahead

The spectacular failure of FTX in November 2022 and the subsequent charging of its founder with fraud has created a crisis of confidence in cryptocurrency circles. The demise of FTX coincided with the downfall of several other high-profile crypto exchanges, lenders and hedge funds, concluding what has been a defining moment for the crypto native world, with the crypto currencies market capitalization slipping from a $3 trillion peak in 2021 to $798 billion at the end of 2022.

While some financial institutions have largely avoided crypto currencies for a variety of reasons, most are still open to the idea of investing and interacting with this asset class. But the longer term, bigger opportunity lies in regulated digital securities. Aside from being a new source of investment returns, institutions see tokens – in particular – as being an effective risk diversifier. Accordingly, the pulse of the event participants, as well as research reports, suggest that the token market will enjoy healthy growth over the next few years, with HSBC and Northern Trust estimating that between 5% – 10% of all assets could be tokenized by 2030 – that represents a $20 trillion market opportunity in the near-term.

“FTX is a disaster for the crypto industry, for the crypto fintechs, for regulators, and for end-clients. It is harming the overall public opinions about the industry –  but that does not mean that crypto is dead,”

according to Jan Rosam, Partner, Technology Consulting & EMEIA Consulting Lead for Digital Assets & Digital Currencies at EY.

Although the market capitalization of cryptocurrencies has taken a significant dent, Jose Antonio Colomer, Head of Blockchain and Digital Offering at BBVA, suggested the asset class should not be written off entirely.

“Some people would say that crypto is still a very small market. I’m not sure about that, because not long ago, the market size was $3 trillion, which if compared to the S&P is very small. But if it is compared with the  gold market, then crypto was about a fourth of the size.”

He continued that even after the crypto winter, the asset class still had a market capitalization which was greater than that of J.P. Morgan and Visa.

“I think in terms of the state of the ecosystem, we are in a place similar to where the internet was in the 1990s. There you need to look at adoption. Today we have over 200 million users in crypto, which is about what we had using the internet in 1999 or so. Today the internet has 4.6 billion users. What does that mean for crypto in terms of what we can have in a few years, and also what does it mean for where the market cap of crypto could be in 10 or 15 years? If you believe in this narrative, the opportunity is huge.”

added Colomer.

Nonetheless, it is clear that there will need to be some sort of regulation or oversight of cryptocurrencies if the market’s fortunes are to recover.

“It really appears that we as humans cannot self-regulate. It has unfortunately been shown time and again. After Terra USD, Three Arrows Capital and now FTX, it is clear that regulation is inevitable,”

pointed out Kelly Chia, Deputy Head of Research Asia at Bank Julius Baer.

Regulation of digital assets – including cryptocurrencies – is already in motion across a number of leading global markets.

“We have seen the Markets in Crypto Assets Regulation (MICA) in the EU, while the Hong Kong Monetary Authority (HKMA) and Securities and Futures Commission (SFC) have published detailed circulars regarding the framework that financial institutions must implement in terms of their operating model,”

said Adrien Barquissau, Director at Synpulse Hong Kong.

In fact, Hong Kong’s authorities have since announced that crypto-exchanges will be subject to the same antimoney laundering and terrorist financing rules, as traditional financial institutions from June 2023.

CBDCs , NFTs, and tokens gather momentum

Outside of cryptocurrencies, CBDCs, namely digital fiat money issued by Central Banks,  are generating interest in institutional and retail circles, as they could potentially expedite cross-border payments and settlements.

“I strongly believe that we will have a CBDC one day, sooner rather than later. The European Central Bank (ECB)  has made multiple announcements related to the digital Euro prototype, with the goal potentially to deliver a true digital Euro by 2025. It is pretty short term when you think about it, especially when you consider the impact it could have on the financial markets, but also on things like cross border payments and retail payments. Again, the needs are there; either for a wholesale CBDC, meaning a CBDC which will apply to large cash transactions – especially in the banking sector; but also for a retail CBDC, which can support smaller payments.”

explained Jean-Marc Stenger, CEO at Societe Generale – FORGE.

Elsewhere, non-fungible tokens (NFTs) are also gathering momentum, with crypto enthusiasts spending more than $41 billion on them in 2021 alone. NFTs are tokens which exist on a Blockchain and are digital representations of real world assets. Already used extensively in the world of art and collectables, NFTs are now permeating into luxury goods.

“NFTs for the luxury industry is a way to enable ownership and authentication or provenance, and transparency. We are able to use the digital certificates to prove the authenticity of the piece. But we are also able to prove the authenticity of the digital token, which is equally important. When we speak about ownership in terms of tokens, (we are talking about) a customer owning the digital certificate. But who has created this digital certificate is equally important. I say that because I am convinced that we are going to see a surge of counterfeiting in the digital realm. There will be counterfeiters creating fake NFTs.”

said Pedro Lopez-Belmonte, Blockchain Lead at Richemont, the Swiss-based luxury company,  and owner of Cartier, Montblanc and Net-a-porter.

In order to prevent counterfeiting in this burgeoning market, he highlighted organizations need to educate customers about how NFTs work.

However, it is asset tokenization, which is eliciting the most excitement in the banking world. Through tokenization, assets – including regulated traditional securities (equities, bonds) and illiquid financial instruments (i.e. real estate, private equity funds, commodities, fine wines, etc. ) can be digitalized and fractionalized on a distributed ledger technology, making them cheaper for retail investors to acquire. Not only will this democratize investment, but it could help shore up liquidity in what are very illiquid markets.

According to Catherine Guay-Chenard, Subject Matter Expert at Metaco, the market capitalization of tokenised assets is expected to skyrocket to more than $20 trillion in the next few years, and could potentially even exceed $350 trillion plus in the longer-term.

“Eventually the entire capital market could be moving on-chain for all kinds of assets.”

she stressed.

Banks look to respond to the digital asset transformation

Banks are looking for ways by which to capitalize on the surging interest in and demand for digital assets. If anything, the failure at FTX – along with a number of other crypto exchanges, lenders and funds – has reinforced how important it is for investors to engage the services of institutional and regulated providers when participating in these markets. Jan Rosam, Partner, Technology Consulting & EMEIA Consulting Lead for Digital Assets & Digital Currencies at EY, underlined:

“Clients will look for a much more trusted party in this business going forward. There is a big role to play for the banks.”

Nonetheless, he conceded that cryptocurrencies is not necessarily the main priority area for many banks, and they do not want to necessarily support activities like cryptocurrency trading, as the asset class is unregulated and volatile. Additionally, Basel capital requirements for banks holding crypto are likely to be very high,  potentially carrying a 1,250% risk weighting,  which will be another major deterrent. However, some banks – especially those in emerging markets which are home to vast unbanked populations – are increasingly recognizing the benefits of leveraging crypto assets, such as stablecoins, as a means to facilitate greater financial inclusion.

“An estimated 65% of the population in APAC is unbanked,”

according to Richard Swainston, Business Development Director at Metaco.

In 2019, UnionBank of the Philippines issued its own stablecoin – PHX – which is pegged to the Philippine Peso and can provide automatic execution of payments. It is being implemented on UnionBank’s I2i (island to island, institution to institution and individual to individual) Blockchain-based platform, which enables connectivity between rural banks in the country.

“The idea of PHX stems from two things. First of all, it was our desire to respond to the call of pushing for financial inclusion. The fact that not everyone has access to financial products or the right financial products for their needs has always been one of the pressing issues here in the Philippines, and probably in most developing markets.  We knew that in a country like the Philippines, with more than 7,100 islands, it is a bit difficult and not to mention costly, for banks like us to reach everyone in each of these islands. I think probably everyone knows by now that digital is key to this,”

explained Catherine Bautista-Casas, Head of the Blockchain Centre of Excellence, Digital Asset Markets at UnionBank of the Philippines.

However, the real opportunity for traditional financial institutions lies with tokenization. Guay-Chenard said Tire 1 banks are currently leading the way in terms of building up  digital asset custody solutions, adding they see tokenization as a huge market opportunity. Custodians are certainly scoping out ways to support tokenization.

“We need to build a common infrastructure. If we are embarking on a path where we are tokenizing real world assets, what is the infrastructure needed for that?”  

highlighted Nitin Gaur, Managing Director at State Street Digital.

With investors still reeling from the events at FTX and other high-profile failures, many will be looking to incumbent custodians with strong balance sheets and excellent risk and compliance controls to safeguard their private keys. Maximilian Ruf , Business Solutions Consultant, Digital Assets and Web3 at Metaco, noted the first wave of crypto-native providers are now making way for a second wave of established, regualted institutional providers, including banks. He noted:

“We are seeing this paradigm shift from the first wave to the second wave, to the wave of established top tier regulated financial institutions who are building serious institutional grade market infrastructure.”

Security and agility

Despite the empowerment a Web3 environment could offer investors, experts believe custodians will have an invaluable role to play in safekeeping digital assets.

“Being your own bank is hard. The reason being your own bank is hard is because if you have ever tried to carry around all of your net worth, it is a little bit of a personal risk or a security threat. Banks and custodians play a useful role in society. They store the stuff that really matters to you in this one space, and will make sure it is not stolen. But the way custody works in Web3 is so powerful because it has created this global CRM of assets.“

said Simon Taylor, Head of Strategy and Content at Sardine, and co-founder at 11FS.

Banks also have the added advantage that they can support clients who are trading traditional securities in parallel with digital assets.

“We do not look at digital assets as being different from traditional financial assets.”

acknowledged Michael Clayton, Chief Technology Officer at LevelField, a U.S. challenger bank.

Although banks can potentially offer excellent security when custodying digital assets, this cannot come at the expense of agility, a traditional strength of the fintechs and Wave 1 service providers.

“Our view is that the source of future competitive advantage, for all institutions that enter the space, is to operate with no trade-offs. You need to have the ability to have high agility, flexibility, and (not “or”) to be highly secure and compliant.“

said Seamus Donoghue, Chief Growth Officer at Metaco.

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