How do I become a crypto bank?

Patrick Akiki
Partner, FS Management Consulting Lead, PwC Switzerland

Rise of crypto in banking

Amid the expansion in digital assets, the global financial landscape is evolving and changing forever. From the over US$3 trillion market cap of cryptocurrencies in 2021, stablecoins, non-fungible tokens (‘NFTs’) and de-centralised finance platforms (‘DeFi’), all the way to central bank digital currencies (‘CBDCs’), digital assets have the potential to impact virtually all areas of life and business in the years to come.¹

And now, the revolution in digital money and assets is moving into banking as cryptocurrency starts to reshape the way people borrow and save. Why has this been made this possible? First and foremost, there’s huge (and continually increasing) demand by consumers to hold and trade in cryptocurrencies – the number of crypto owners globally was estimated at approx. 300 million at the end of 2021, having grown by 178% from the start of the year.^2,3 There are projections that this number will reach one billion by the end of 2022. Secondly, retail investments and retail trading through digital channels are on a steep upwards trend, having been majorly propelled by the pandemic as people spent more time online. And lastly, the enabling blockchain technology that we’ve been talking about for the past few years has finally arrived allowing for tangible, applied cryptocurrency investment.

Given these reasons, traditional banking institutions and FinTechs that want to earn new revenue streams and support the demands of their customers are moving rapidly into the crypto banking space and exploring what products and services to offer.⁴ This is a transformational moment in financial services where players can benefit from leaning in, understanding the underlying blockchain or distributed ledger technology, and creating a strategy to navigate this blue ocean effectively and securely.

How do I become a crypto bank?

The tide is turning, and customers are demanding exposure and access to crypto and digital assets products. In the face of this important change, banks and other financial institutions are now asking themselves the question: so, how do I become a crypto bank? We’ve experienced two major avenues among others: to become a virtual asset service provider (‘VASP’) and/or a crypto custodian.

Virtual Asset Service Provider (VASP)

The Financial Action Task Force (‘FATF’) has defined a VASP as a business that conducts one or more of the following activities:

Exchange between virtual assets and fiat currencies (e.g. fiat-to-crypto exchanges).
Exchange between one or more forms of virtual assets (e.g. crypto-to-crypto exchanges).
Transfer of virtual assets, and safekeeping and/or administration of virtual assets or instruments enabling control over virtual assets (e.g. crypto custodians).
Participation in and provision of financial services related to an issuer’s offer and/or sale of a virtual asset.⁵

Based on this definition, banks or other financial institutions can become VASPs through a multitude of offerings.

One is to provide currency trading services such as conversion of cryptocurrencies into fiat (i.e. real world) currencies or vice versa, and conversions between different cryptocurrencies, while another is to provide blockchain-enabled payment and settlement services. This can be providing participants on the network with the ability to transfer their digital assets near-real-time with low to zero fee transfers, low-friction cross-border payments and settlements on public blockchains, or crypto settlement capability / liquidity capability to existing payments infrastructure to meet the increasing demand of online purchases using cryptocurrencies.

Lending is also an area where banks can extend their services into the crypto space. However, they’ll likely face fierce competition from crypto service providers who are leveraging existing lending frameworks for crypto but aren’t supervised by a banking regulator, and hence have the upper hand against traditional banks.

Additionally, or as a standalone offering, banks can choose to provide crypto custody services – specifically outlined in the next section.

Crypto custodian

In July 2020, the Office of the Comptroller of the Currency (‘OCC’) issued guidance confirming that national banks may provide cryptocurrency custody services on behalf of customers, including by holding the unique cryptographic keys associated with the cryptocurrency.⁶ These services are fundamental to meet the needs of the various market stakeholders interested in using crypto services and to capture the new business opportunities of a market with ample room for growth.⁷

There’s a broad range of crypto custody models available from fully managed services for institutions to digital wallet services for retail investors or simply storage and protection services. Hence, the offering should be aligned with the bank or financial institution’s overall strategy. Providing crypto custody services is not only an entry point for banks into the crypto ecosystem, but it’s also beneficial for them in the following ways:

Generation of fee income from the stored assets.
Ownership of the crypto banking relationship to attract new clients.
Ability to add adjacent operations and services, including cash management, collateralised lending and leveraged trade execution etc.
Reputation enhancement as a ‘bank of the future’ for both retail and institutional investors who seek to diversify their portfolios and acquire crypto assets.
Linkage with loan business and other lending services to generate additional interest income.

Case study: global bank as crypto custodian

“Growing client demand for digital assets, maturity of advance solutions and improving regulatory clarity present a tremendous opportunity for us to extend our current service offerings to this emerging field,” announced a global bank in early 2021 of its plans to be the first traditional bank to provide an integrated service for digital assets. A year later, the bank has chosen its blockchain technology partner and is getting ready to launch a new custody platform that will allow clients to hold the world’s most popular cryptocurrencies in the bank’s wallet. This service is intended to enable the interoperability of traditional assets and digital.

What are the key considerations at play?

As with any new innovation, technology or way of doing things, there are a number of factors to consider. Below we outline some of the external and internal factors elements we think come into play along your journey towards becoming a crypto bank:

External factors

Regulatory considerations and uncertainty: even though it remains uncertain and piecemeal from various regulators, more regulatory guidance has been given – a prominent example is the SEC requirement for custodians to gross up their balance sheet by taking the crypto assets on balance sheet with a corresponding liability, which will result in a higher capital requirement for these institutions.

Cryptocurrency volatility: extreme volatility causes concerns regarding protection of existing customers, and may present complications such as maintaining customer confidence and regulatory liquidity requirements.

Rapid change: the fast pace at which new technology is being deployed and consumer behaviours/demands are changing etc. creates massive pressure on banks to dive into the deep end with potentially less due diligence.

Security concerns: security risks and technology vulnerabilities aren’t yet fully understood, leading to an unacceptable level of risk for potential fraud or accidental loss.

Internal factors

Business model: the way in which the bank will build or acquire its crypto banking capabilities, aligned with the bank’s strategy.
Infrastructure: specific technical infrastructure is required for the secure storage and handling of crypto assets.
Compliance, governance and controls: governance structures and control frameworks to account for crypto assets and blockchain are needed to ensure regulatory compliance.
Accounting and tax implications: clear accounting and tax treatment of crypto assets should be established.
Risk management: enterprise risk management framework incl. risk appetite statements and limits for crypto banking activities must be in place to effectively manage relevant risks.
Talent capabilities: people and talent with crypto banking knowledge are needed, otherwise skilling-up is crucial.

References

^{1 crypto.com. (19 January 2022). 2021 Crypto Market Sizing Report & 2022 Forecast.

2 Livni, E., & Lipton, E. (5 September 2021). The New York Times. Crypto Banking and Decentralized Finance, Explained.

3 OCC. (22 July 2020). Office of the Comptroller of the Currency.

4 PwC. (2019). The New FATF Rules for Crypto Exchanges and Custodians.

5 PwC. (2021). Crypto Custody.

6 PwC. (2022). Crypto Center.

7 tripleA. (2022). Cryptocurrency across the world.}