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September 16, 2021updated 29 Jun 2022 7:00am

Cryptocurrency: Coming to a bank near you

Mainstream financial institutions are getting interested in Bitcoin and Ethereum. Regulators are, too.

By Greg Noone

For Alex Manson, the moment when his employers at Standard Chartered first became interested in crypto is still sharp in his memory. “Peter Sands, who was then our CEO, put a pitch on my desk about a crypto-related company,” says Manson. “He literally threw over this and said, ‘Interesting, no? Don’t you think we should look into it?’”

Manson was ambivalent. It was 2014, and Standard Chartered had just been fined $300m by US financial watchdogs for anti-money laundering violations. “Maybe our regulators don’t want to hear that we’re doing crypto today,” Manson recalls telling Sands. “Maybe tomorrow, but not today.”

The matter was dropped. Even so, Manson – and the bank’s – interest in crypto kept being piqued over the following months, interest that would culminate in a significant investment by Standard Chartered in Ripple. The start-up’s distributed ledger technology, the bank reasoned, could be transformative. Standard Chartered was hardly alone in its curiosity. Word was spreading about how distributed ledgers could transform everything from payments to auditing and KYC processes. By the time Manson left his position as head of Standard Chartered’s transaction bank in 2018, “blockchain was at every conference,” he says.

Banks and cryptocurrency

Will we soon be able to withdraw Bitcoin at an ATM? Big banks are increasingly interested in cryptocurrencies. (Photo by ImYanis/Shutterstock)

That year Manson was appointed to head up the bank’s innovation unit, SC Ventures. The new role gave him a broad remit to invest in start-ups and business models that stood out as the future of banking. By then, Manson felt it was the right time to explore how a major bank like Standard Chartered might facilitate cryptocurrency trades. But for that to work, there needed to be a safe place for institutional investors to park their money – something glaringly absent in the Wild West that is the crypto ecosystem. “And so, instead of trading the currency, we decided to go ahead and set up a cryptocurrency custodian,” says Manson.

The result was Zodia, an ‘institutional-grade cryptoasset custody’ solution that offered investors the chance to store their coins in a place carrying the imprimatur of a trusted financial organisation. While it isn’t the first solution of its kind – Swiss investment bank Vontobel, for example, launched a similar scheme in 2019 – the launch of the SC Ventures-backed platform in July signifies a much broader foray into crypto by mainstream financial institutions. Over the past six months, several international banks that include Goldman Sachs, Morgan Stanley, Wells Fargo and BNY Mellon have all made announcements that they will allow their richest clients to invest and trade in cryptocurrencies.

Millions more have been invested by international banks into blockchain companies, with institutions like JPMorgan Chase, Nomura and ING pouring money into start-ups little-known outside the niche world of decentralised finance (DeFi). For his part, Manson believes that these banks share his conviction that the future is bright for crypto. “Digital assets are here to stay,” he says, which means that the sector not only needs to be equipped to service them, but “safeguard them, trade them, and sell them.”

How this will be achieved without undermining mainstream banks themselves remains an open question. The world of cryptocurrencies is one that some consider a financial morass, a closed community where scams are common and true investing nous is hard to come by. If financial history has anything to tell us, it’s that bubbles are more common than we think – and a danger that regulators around the world are keen to avoid at almost any cost.

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Matthew Shillito first heard about cryptocurrencies around the same time as Manson. “It was around the time Bitcoin had just gone through its big drop, and then it was heading back over the $100 mark,” recalls the University of Liverpool law lecturer. “Family members were asking me, ‘Should we invest in this?’” (They didn’t.)

Since then, retail interest in cryptocurrencies has boomed, with some individuals investing their life savings in certain coins. Banks, by contrast, seem late to the party, even going so far as blocking account holders from transferring their money directly to exchanges. This seems altogether prudent, explains Shillito, when considering the anti-money laundering rules most financial institutions operate under. Crypto, after all, is hardly lacking for stories about scams and other nefarious transactions.

“That financial risk, and the risk to their reputation of being linked to money laundering, terrorist financing and other crimes, means that they’re going to be hesitant to allow us to seek our own investments using our bank accounts,” explains Shillito.

Even so, that’s hardly stopped banks, hedge funds and other major investors from speculating in cryptocurrencies. Not only is it much easier to comply with AML regulations by whitelisting five big investors instead of five thousand small ones, but the capital such institutions can access is far larger – and potentially, the returns, too.

[Banks] have seen the massive price rises of cryptocurrencies and have a bit of a fear of missing out.
Susannah Streeter, Hargreaves Lansdown

“It’s no surprise that banks also want a piece of the action,” says Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown. “I would say that they’ve seen the massive price rises of cryptocurrencies like Bitcoin and Ethereum and have a bit of a fear of missing out.”

This isn’t to say that such interest is confined to trading. For many banks, cryptocurrencies constitute a new asset class, one that is rapidly establishing itself as viable for investment. As such, “what these banks are doing is really diversifying the assets that they’re holding, and including crypto within the mix,” explains Streeter, reflective of a basic inclination among financial institutions to hedge their risk by exposing themselves to as many different types of asset as possible.

Banks are also investing heavily in start-ups operating in the space, says Shillito. “That seems to be a more steady way for these banks to see a return on their investments” in crypto, he says, providing a useful hedge against the risk inherent in trading in coins. “The kinds of institutions they’re investing in, the crypto businesses, don’t seem to have that same volatility in their share price.”

Not every bank has proven enthusiastic. In May, HSBC’s group chief executive Noel Quinn announced that it was highly unlikely to either invest or trade in cryptocurrencies thanks to their volatility and lack of transparency. This, says Streeter, is indicative of a wider bifurcation within the banking community as to the ultimate utility of crypto investments. For its part, she explains, HSBC’s reticence is unsurprising “given its strong foothold in Asia, and in particular China,” where a crackdown on mining has been underway since spring.

The reluctance of others is likely down to a mixture of size and the importance of their retail business relative to investment and trading, says Shillito. “One of the really interesting things is that the big UK banks aren’t moving into the investing space with the same kind of urgency as the big international banks,” he explains. “The biggest UK bank at the moment is still Barclays, but they’re only just in the top 15” who are investing in the crypto market. Even then, adds Shillito, “they are really just investing in companies, predominantly”.

Taming the frontier

Many of these international banks are also investing in the future of crypto itself. While the market may have come a long way from its early days as a closed community of libertarian-minded blockchain enthusiasts – the total market value of cryptocurrencies was recently estimated at some $2trn – it still lacks the ecosystem of financial instruments and institutional safeguards necessary to protect the assets of major investors.

And so, big banks have been building just that. “Custody was a big one,” says Manson, with not only SC Ventures but Goldman Sachs, BNY Mellon and JPMorgan announcing moves to build dedicated solutions. “Exchange and brokerage are going to be big, too. And there may well be other bits and pieces over time because, essentially, what we’re trying to do is build a financial institution of the future, with DeFi in mind.”

All of this takes time, adds Manson. Zodia, for example, was almost four years in the planning. Similar projects at other banks are likely to have experienced similar timelines, he argues. “It’s not just the technologists you need,” says Manson, but risk specialists, legal experts, and many other support personnel. Even then, the trigger is generally only pulled on crypto schemes once the bank in question has made the assessment, after years of observation, that involvement in an element of the crypto market is merited.

Even then, the publicity surrounding these moves often belies the size of the commitment made. “I think it’s very contained,” says Manson. “Actually, I think that the vast majority of financial institutions have not really come into the space.” Rather, says the SC Ventures chief, it’s better to think of mainstream banks’ interest in crypto as equivalent to dipping their toes in the water rather than wading straight into the river.

A woman buys cryptocurrency through the Dashboard portfolio app. An upsurge in retail investor demand for Bitcoin, Ethereum and other crypto coins has attracted the attention of regulators, who fear that banks and consumers alike are exposing themselves to unnecessary financial risk. (Photo by Getty)

Banks and taking the crypto out of cryptocurrency

That might be prudent given the increasing interest of regulators in the space. A recent proposal from the Basel Committee on Banking Supervision, a forum for the world’s most important financial regulators, suggests that banks cover 100% of all potential investment losses in the space. This, says Streeter, would put a “high price tag on trading and holding cryptocurrencies,” threatening to dampen enthusiasm for the asset class across the sector. "They’re certainly not putting that type of financial buffer against their current investments," she says.

SC Ventures' Manson isn’t worried. Indeed, he believes that increased regulatory interest in crypto is probably a good thing. “It’s obviously a headwind if you believe, as the founders of Bitcoin did, that regulations are bad per se, and that the world of cryptocurrencies needs to exist outside of all regulations,” he says. “In my mind, [that] wasn’t even realistic in the first place, and is not a good thing.”

If anything, Manson believes that more discussions among regulators about crypto is a sign that the market is reaching a new level of maturity. “It’s a natural stage in its evolution,” he says.

When it comes to risk, however, Manson believes that the easiest way for the crypto market to mature is for institutions such as Standard Chartered and others to broaden their existing commitments. “It’s going to sound a little arrogant – and I really don’t mean it this way – but one of the mitigating factors, I believe, is the fact that we’re getting in there,” he says. While Manson acknowledges that moving into crypto comes with its own unique risks related to financial crime and volatility, every mainstream financial institution that’s announced new projects in the space comes equipped with  deep institutional experience in trading many different - and regulated - asset classes.

For many who have been in the space for a long time, we always felt that this was both inevitable and essential.
Jason Deane

In time, we may finally see the cloistered world of DeFi enter the mainstream. That, however, “will take more than a few banks to make that into reality,” says Manson. Only after banks, regulators and policymakers work together to establish strong legal frameworks for the market will we see the benefits of DeFi experienced by the public at large.

Somewhat surprisingly, crypto veterans have greeted the arrival of institutions like Standard Chartered with enthusiasm. “For many who have been in the space for a long time, we always felt that this was both inevitable and essential,” says cryptocurrency consultant Jason Deane. “‘Inevitable’ in the sense that as Bitcoin grew, it would eventually become impossible for institutions to ignore it, but also ‘essential’ in that large-scale institutional involvement would almost certainly accelerate regulatory clarity.”

It’s also the end of an era. The creation of Bitcoin at the height of the 2008 financial crisis was itself a comment on the fragility of the current fractional reserve banking system; embedded in its first block was a newspaper headline referring to plans for a second UK bank bailout. The new, decentralised marketplace that resulted was an attempt to show what was possible by working outside of that system. Now, the major establishment players have come to settle in this new frontier – and may succeed in taming it.

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