The emergence of crypto banking: who is poised for success?

Latest figures put the value of the cryptocurrency market at almost $240bn in 2019, nearly double the 2018 figure of $128bn. Could this mean that the global crypto market is starting to move into the mainstream?

Significantly, the sector is enjoying rapid growth globally, with the UK, Nigeria, Australia, Canada, Mexico and India all experiencing a recent surge in users. Crypto is also starting to attract interest from institutional investors, which see it as possible insurance against the global rise in quantitative easing.

As the size of the market grows, there has been an encouraging response from political decision-makers, central banks and regulators. In the US, the Federal Reserve is talking about creating a crypto dollar linked to the value of its physical counterpart.

In the UK, meanwhile, the Financial Conduct Authority is starting to explore what a cryptocurrency regulatory framework might look like. Similar positive developments are occurring in markets such as France and Germany.

The one area that hasn’t been as quick to respond is the banking sector. Despite the existence of a crypto economy that urgently requires banking support, many of the financial services typically associated with storing and trading wealth are not available. L

In our view there’s a huge opportunity for crypto-friendly banks that move quickly to establish a leadership position. Here, we look at the various runners and riders and assess the key challenges they face:

Incumbent banks

The big banking brands have shown little interest in cryptocurrency to date. In part, this is due to their general aversion to high levels of risk and an institutionalised culture ill suited to digital change and innovation – but there is also a legitimate fear that they will fall foul of financial regulators. 

There are, for example, concerns around money laundering – with criminal networks known to move sums around via cryptocurrencies. There is also the issue of how an incumbent bank would protect its existing customers from the extreme volatility currently associated with cryptocurrency values. 

Alongside the regulatory minefield, there are issues related to tech infrastructure. Right now, most of the high street banks simply don’t have the necessary systems to compete effectively with crypto-first companies (more below). Barclays is one of the few big brands to have explored this area via a partnership with San Francisco-based Coinbase, which made it possible for users to buy cryptocurrencies with sterling and withdraw their funds. But this relationship was quietly dropped in August 2019.

The challenges explain why it tends to be investment banks rather than retail banks that are most adventurous. JP Morgan was the first established banking brand to launch a cryptocurrency – the JPM Coin.

A key point to note is that the JPM Coin’s value is linked directly to the US$, a model referred to as ‘stablecoin’. 

This is distinct from better known cryptocurrencies like Bitcoin, which has a value based on supply and demand, and therefore is more susceptible to volatility. Unlike existing stablecoins, where the cash reserves backing them up are often in question, JPM Coin would be directly linked to money in JP Morgan accounts, and the Coin would mainly serve as a means to transfer amounts between accounts using blockchain. 

Initiatives such as JPM Coin are likely to play a key role in helping to legitimise the idea of cryptocurrencies, as its link to a fiat currency means it is both less volatile than bitcoin and inspires greater confidence than an abstract currency because it is pegged to the checks and balances of a real economy.

Neo banks

Challenger banks have established themselves as the banking industry’s innovators, so are culturally equipped to embrace disruptive technologies. At the same time, the market leaders have built brands that are trusted by large swathes of the population. So in theory they are the perfect bridge between crypto and fiat banking.

The biggest of the neo banks to have sought a competitive edge via crypto is Revolut, which, in 2017, allowed some of its users to complete transactions in currencies such as Bitcoin, Litecoin and Ether. Others to have explored the crypto arena include Germany’s Bitwala, which is allowing users to purchase, hold and earn interest on Bitcoin thanks to a partnership with crypto lending platform Celsius Network.

GAFA (Google, Apple, Facebook, Amazon)

A desire to grow their ecosystem by increasing the services they offer to customers is a key reason for the tech giants to get involved in financial services, and cryptocurrencies are now on their agenda. Apple confirmed its interest in 2019 while Amazon has established blockchain patents that position it well for expansion into crypto.

The fact that the GAFAs are cash rich and have huge user bases would appear to put the tech giants in poll position to win the cryptocurrency prize – but there are obstacles in their way. 

Facebook, for example, experienced a lot of regulatory pushback in 2019 around its Libra currency. Key concerns related to Facebook’s poor record on data privacy and the fact that Libra could become an unregulated financial institution, which with Facebook’s reach and power, could rival some country’s monetary capability. 

Crypto exchanges

It stands to reason that cryptocurrency exchanges are well positioned and strongly motivated to exploit the narrowing gap between crypto and fiat – because they have first-move advantage. Having already built huge cash reserves and crypto-familiar customer bases, it would be relatively straightforward technically for them to add on banking services. 

Undoubtedly they will be subjected to close regulatory scrutiny because of concerns about their role in fuelling the shadow economy. Assuming they can overcome this hurdle, the payback will be greater legitimacy in the banking marketplace. 

Several exchanges, including Celsius, have already introduced basic add-ons such as high interest rates for investments and tax services. Binance, the world’s largest exchange by volume, also recently unveiled the Binance Card, a debit card that it says will be accepted by more than 46 million merchants in 200 regions and territories. 

The bottom line is that the playbook for how to build a digital bank is out there – if crypto exchanges are able to allay regulator concerns.

Crypto-first neo banks

An important subset of this market are second wave challenger banks that have offerings for the crypto ecosystem baked into their business from launch. Examples include Swiss bank SEBA, which acts as a progressive tech bridge between the traditional and crypto worlds. 

Also active is UK-based digital payment platform Wirex which allows customers to buy, sell, exchange and make payments in cryptocurrency. Additionally, they offer a Wirex Visa card, a multi currency card giving users the power to seamlessly spend cryptocurrency anywhere Visa is accepted.

What’s interesting about this subset of companies is the way that the best are prioritising customer experience, adopting the best practices of challenger retail banks. Early indications are that neo banks which concentrate on narrow customer segments or underbanked markets will put themselves in a powerful position. 

This is in contrast to the situation with first wave challenger retail banks which have instead worked hard to establish a position in the mass market.

Interestingly, some of the expertise in this sector comes from the first wave of challengers. 

Mark Hipperson, who was head of technology at Barclays and co-founder of challenger bank Starling, has just launched a new crypto-enabled platform called Ziglu.

There are no two ways about it - we are at a watershed moment for crypto banking with key players lined up to take a lead in shaping its future direction but, so far, without any clarity over who will make the first paradigm changing move. What happens next - especially whether the established banking system can flex and adapt to embrace a more distributed, ledger approach to monetary systems - and how the regulators respond, is key. 

At stake is a landscape where money and the digital systems around it effectively merge, resulting in much faster, more inclusive and more dynamic global monetary and banking systems. L