Digital assets bear their own risks

Here is how our framework will help you manage these risks

Mark Hussey
Director, Blockchain, DLT and Token Business Advisory Lead, PwC Switzerland

In 2022, the crypto scene has taken some major hits. High profile players such as Terra (Luna) and FTX (FTT) have experienced serious failures, wiping out billions of market capitalisation. It’s clear that the offering of digital assets bears its own risks, which need to be managed specifically. Having been engaged with clients across the spectrum of products and services offered within digital assets, PwC is well placed to support your business with risk management considerations when launching your own offering or as a validation if already live.

Traditional risk management is well-understood. But what about digital assets risk management?

Risk management is a crucial part of a modern financial institution offering traditional products. Over the years, financial institutions have established and fine-tuned their risk frameworks for their product and service offering to ensure effectiveness. These frameworks have been improved over the years and benefit from the lessons learned from internal and external events, as well as being adapted to the extensive and ever-changing laws and regulations. It’s safe to say that the regulatory environment and risks related to the traditional financial services offering are typically well-understood and well-managed.

When it comes to the offering of digital assets, things look slightly different. As the topic is relatively new, the corresponding risks are much less understood, and the state of the regulatory environment differs significantly among all the jurisdictions. Consequently, many questions may arise within a traditional financial institution offering (or intending to offer) digital asset services:

How should we adapt our existing risk and compliance policies and frameworks?
What are the new risks that need mitigation and monitoring?
What are the market best practices?

Given the complexity and constant change in the industry, with newly emerging technologies and risks, we believe it’s important to work with partners who can not only provide challenge and assurance to the business approach, but also solve the problems along the way and allow businesses to take advantage of the vast opportunities.

What aspects of digital assets risk management will be considered?

Digital asset activities expose businesses to traditional risks as well as new types of risks. Given the maturing nature of the products and services, the list of potential risks is extensive and growing, with new risk typologies being uncovered as the technology and the ecosystem evolve. It’s important to note that risks faced by companies will vary in terms of type and exposure, based on their business model and where they operate in the crypto ecosystem. So it’s important that firms set up and tailor their own enterprise risk management framework to correctly define their firm-specific risks and taxonomy for a robust risk management process.

Below we’ve listed a few topics and considerations that are of specific relevance from a risk management perspective when offering digital asset services and products. Those considerations represent a small fraction of questions businesses might have to ask themselves, and are to be taken into account in conjunction with other considerations and topics (such as financial risks).

Products and services:

How will you manage bifurcation of the service when offering traditional products as well as a blockchain-based equivalent?
Are you concerned that your new offering may cannibalise your existing products? Or are they complimentary?
Are your customers aware of the risks and are you able to adequately communicate the potential volatility, contagion and liquidity risks?

Operational risks:

Do you have all elements of the technology stack to offer these new products? Or have you had to limit the exchanges, trading options or tokens in scope?
How has your business continuity management been altered to reflect the real-time ‘always-on’ nature of the underlying assets as well as the heightened vendor risks?
Do you have critical dependencies related to your custody solution? Specific vendors? Or trade-offs on the storage approach?
Have you performed enhanced due diligence on your vendors? Are you aware of their dependencies on other third parties in the market? Is there any risk of contagion?

Similarly, the rise of cryptocurrency payments has brought with it new challenges relating to the compliance function, as the nature of such transactions differs significantly from traditional payments. Generally, it can be said that financial institutions are due to deliver on, at a minimum, the same regulatory requirements as for fiat currencies.

While the topics to be covered may be similar to those of a traditional financial service offering (e.g. AML, CFT or KYC), it’s important to note that new methods to launder and obscure transactions are prevalent in digital assets. Once again, this highlights the need to monitor the external environment, identify new patterns of criminal activity and regularly update the compliance framework, specifically with the digital assets offering in mind.

Given the fast-pacing and complex environment, it's essential to find the right partner for your digital assets endeavors

The risks and regulatory environment in a financial institution’s traditional service offering is reasonably well-understood and well-managed. But there’s far greater uncertainty and potential for new risks to arise when it comes to digital asset offerings. If you’re providing (or intending to provide) such an offering in a fast-moving environment, it can be very challenging to assess, manage and monitor market developments across all categories of risk. We believe it’s beneficial to partner with a firm that has a team of dedicated experts, who can provide insights into the latest developments and market best practices. Given our extensive, multi-year experience and cross-industry role in the Swiss market, we’re confident that PwC will be the ideal partner for any endeavours in the field of digital assets and blockchain. For more details on the topic and how PwC can support you, please also have a read through our latest publication.

Download the publication

Navigating the dangers and risks in your digital asset product launch

Have we caught your interest? Are you offering or intending to offer digital asset services? Please also have a read through the following publication, which provides a more in-depth view on the topic.

Download the publication