Why Banks Are More Serious About Crypto Than Ever

We find ourselves in the midst of a new crypto bull market. Unlike the last big bull cycle, this rally isn’t being driven by frantic retail speculators or breathless ICO visions.

Instead, it is being shaped by the deliberate, considered move into the space on the part of institutional investors, corporations, and financial institutions for whom bitcoin, stablecoins, and digital assets of a whole have finally passed muster as not only a legitimate asset class, but one that is unignorable as well.

Over the next few years, every bank and regulated financial institution will have a crypto strategy that is not some small "innovation" initiative, but instead represents a key forward looking strategic interest. Here's why.

They're Finally Allowed To

The last 12 months have seen dramatic shifts in how banks and other regulated financial institutions are empowered to act with digital assets and blockchain infrastructure. Many of these changes have been driven by the nation's top bank regulator, the Office of the Comptroller of the Currency

In July, the OCC published an interpretative letter allowing banks and federal savings associations to custody their customers' crypto assets. Said Acting Comptroller Brian Brooks, "From safe-deposit boxes to virtual vaults, we must ensure banks can meet the financial services needs of their customers today. This opinion clarifies that banks can continue satisfying their customers' needs for safeguarding their most valuable assets, which today for tens of millions of Americans includes cryptocurrency."

In September, the OCC added additional clarity that these same institutions could hold the reserve assets of customers who issue stablecoins. "This opinion provides greater regulatory certainty for banks within the federal banking system to provide those client services in a safe and sound manner."

In late December, the President's Working Group on Financial Markets (which included the Secretary of the Treasury, the Chairman of the Securities and Exchange Commission, and the Chairman of the Commodity Futures Trading Commission) released a statement on their initial assessment of regulatory and supervisory considerations for stablecoins used for retail payments, saying that: "PWG Members recognize that digital payments, including U.S. dollar-backed and other stablecoin arrangements used as payment systems, have the potential to enhance efficiency, increase competition, lower costs, and foster broader financial inclusion."

Perhaps the biggest guidance came in January, however, when the OCC announced that national banks were authorized to participate and engage in public blockchain networks (what they referred to as "independent node verification networks" or INVN) and "use stablecoins to conduct payment activities and other bank-permissible functions." In effect, the guidance elevated public blockchain networks to a similar status as today's predominant payment rails such as SWIFT and ACH.

In short, there has never been more opportunity for banks to engage with the crypto space. The question becomes: what would be their motivation for doing so?

Interested in learning more about this topic? Join Circle's Jeremy Allaire and Visa's Cuy Sheffield for a live discussion on Why Every Bank Will Have a Crypto Strategy on January 28 at 2:00 P.M. Register for free here.

The Time Value of Money and the Problems of the Legacy System

Today's legacy financial system runs on decades-old technological infrastructure with decades-old expectations that no longer befit the speed with which the world moves. There are two categories of problems with this system: time and risk.

In today's internet-powered world, information moves instantaneously, but money does not. Be it a key international trade or a simple corner coffee shop purchase, transactions of all types take days to settle. The time that elapses before settlement is time where capital is tied up and unavailable for other purposes, or alternatively exists as debts that must be accounted for, increasing counterparty risk.

These problems are particularly acute for the most demanding users of the existing system: trading and electronic markets firms. For these firms, capital being tied up in settlement represents lost opportunities to transact, and the more counterparty risk they take on, the more likely something goes wrong.

It's no surprise, then, that these firms are some of the earliest adopters of stablecoins and crypto asset infrastructure. In 2020, the total supply of the USDC stablecoin grew from $500M to more than $4B and was used in hundreds of billions of dollars worth of transactions. While there were an array of use cases driving this demand growth, these fast moving firms were some of the most important users.

Now that the OCC has paved the way, these firms will demand that their banks adopt new infrastructure that moves at the speed of the internet. They will take their massive accounts to the financial institutions best able to integrate with the new infrastructure to fulfill their needs.

What's more, let's not forget that banks themselves are also trading institutions. They are also acutely aware of the time value of money, and care immensely about things that can speed settlement and reduce or eliminate counterparty risk.

Another major dimension to bank adoption of stablecoins is the growing role that crypto and stablecoin yield markets can play in enhancing return on assets on bank balance sheets. Companies today operate in a near-zero interest rate environment - or in the case of many parts of the world outside of America, even with negative interest rates. Crypto and stablecoin yield present an alternative asset class to drive dollar-denominated yield.

This is driving more and more companies to experiment with alternative balance sheet allocations. In 2020, Michael Saylor and MicroStrategy's massive bet on bitcoin as their chief treasury reserve asset caught the attention of press and investors, leading others such as Square to follow. We will likely see more bitcoin corporate treasury allocations this year, but bitcoin isn't the only mechanism for getting exposure to crypto assets markets and the yield that can come from it.

Increasingly, banks and financial institutions have opportunities to tap into high yield stablecoin-denominated accounts that allow them to park value in the form of stablecoins, denominated in the currency they already use and generate returns. We believe that this will be an increasingly important part of the balance sheet toolkit for banks of all sizes in the years to come, in the almost certain environment of near zero interest rates.

Conclusion

Put it all together and you have a world in which the legacy infrastructure slows business down and introduces new risk; where the overarching zero interest rate context makes the core functioning of banks more difficult; but also in which an entirely new alternative has not only gotten up and running but has been granted legitimacy by the most important bank regulator in the land.

Put simply, this is the lead or catch up moment for banks. Those financial institutions that take advantage of the new openness to build better infrastructure will become the preferred partners for some of the world's most dynamic and important users of the financial system, while also seeing benefits in their own operations. Those who wait will find themselves stuck in outdated processes, underwhelming offerings, trying desperately to stay relevant to markets that have moved beyond them.

Interested in learning more about this topic? Join Circle's Jeremy Allaire and Visa's Cuy Sheffield for a live discussion on Why Every Bank Will Have a Crypto Strategy on January 28 at 2:00 P.M. Register for free here.

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