As the former CEO of both a community and regional banking business, I empathize with former peers dealing with this current market turmoil, arguably set in motion by the rapid and spectacular failure of one well-known cryptocurrency firm.
Substantial and unexpected outflows of digital-asset-related deposits at that company's crypto-specialist bank ultimately led to the bank's voluntary liquidation. That resulted in depositor fears spreading beyond crypto to adjacent sectors, in turn creating a mini-crisis of confidence across the regional and community bank sector.
Now bankers and regulators alike are not only reassessing their positions on the bankability of the crypto industry but also on broader questions regarding deposit management including which clients and industries to bank, how much of those clients and industries to bank, with which account structures, supported by what technology and access tools.
In addition, many industry observers are also asking if our much-vaunted personal relationship management model is as effective as we thought it was in keeping deposits "sticky" or if our industry specialization model is now more of a liability than an asset.
I would contend it was the well-executed combination of both these two business models that has helped ensure this "mini-crisis" did not become a full-blown one. We have seen this ably demonstrated by many regional banks in recent earnings calls discussing the stability of their deposit base.
Nonetheless, in the weeks and months ahead new viewpoints, business models, rules and even products will undoubtedly emerge in relation to which customers we should bank and how we should bank them, and I expect many of these to directly impact the crypto sector.
Regardless of which new approaches materialize, two questions will remain central to assessing the bankability of this industry, especially considering the number of recent high-profile bankruptcies and accusations of incompetence and impropriety. The first is our obligation to determine, to the best of our ability, if a new deposit dollar is potentially from an illicit or fraudulent source. The second is our fiduciary and commercial duty to determine if that deposit dollar can be effectively used to support the bank's fundamental mission of providing credit.
Before addressing the question of whether banks will work with crypto firms in the future, I want to draw a distinction between two broad groups within the crypto ecosystem namely, cryptocurrency players and blockchain technology players.
Cryptocurrency players include centralized exchanges, digital-asset custodians, decentralized trading firms and payments facilitators, among others. Some are offshore while some are domestic. Some operate outside the regulatory perimeter while some operate under U.S. regulation, albeit fragmented. And some apply robust anti-money-laundering processes while others do not. They all generally ascribe value to the cryptocurrency itself and assert that it has many of the characteristics of fiat currency such as acceptability, divisibility, and value stability.
Blockchain technology players are only focused on developing and testing cryptocurrency's underlying technology, generally referred to as blockchain, for use beyond crypto in areas such as supply chain and logistics, identity and authentication, asset transfer and payments. Cryptocurrency cannot exist without blockchain technology, hence why the two are often, inaccurately, viewed as synonymous.
This distinction allows us to broaden the question beyond bankability to also incorporate the question of useability of the technology in a banking environment.
I expect to see two approaches when it comes to the bankability of cryptocurrency players. A small number of banks will continue to selectively bank certain firms, especially those with a genuine commitment to compliance and KYC. They will do so utilizing rigorous customer due diligence processes, proactively consulting with their regulator, and ascribing little or no value to those deposit dollars from a reinvestment or lending perspective.
However, the vast majority of banks will remain skeptical of banking many of these firms at scale, until such time as they can satisfactorily answer those two central questions: Can we determine that the funds are not from an illicit or fraudulent source and is this a viable business in a viable industry?
Answering these questions in the positive will require two things to happen. First, we will have to see the crypto industry brought under a clear, federal regulatory structure that helps to identify and remove mismanagement and corruption. We do not have such a structure today and getting there still seems some way off.
Secondly, we will need to be satisfied that cryptocurrencies can create long-term economic value and crypto-related product and service offerings can generate stable and reliable income flows. This is certainly not the case today. Cryptocurrency has entirely failed to consistently demonstrate the critical attributes of fiat currency and the single largest revenue source in the sector remains, overwhelmingly, inherently risky speculative trading and investing.
In terms of the useability of the underlying blockchain technology beyond crypto, it is a subject that generates an unexpectedly passionate and contentious debate. On one hand, there are those that say the next generation of the internet — web 3.0 — will be built on this type of trustless technology and will not require a centralized, single source of trust, such as a bank, to facilitate commerce. As a result, banks will be at risk of being dis-intermediated from large parts of the economic ecosystem, and the payments system in particular.
On the other hand, there are those that say the basic architecture of blockchain technology, in particular its system of distributed ledgers and requirement for participant consensus, renders it structurally incapable of matching today's centralized systems in terms of speed, efficiency, control and scalability. Then there are those, perhaps in the middle, who are seeking to apply some of the aspects of the technology to various banking processes, most notably in cross-border and domestic payments.
The current situation is that we have yet to see widespread use cases, at scale, being effectively deployed in the banking sector, although there are many ongoing and well-funded initiatives. In my view, many of the fundamental design characteristics of blockchain are ill-suited for application within our current regulated banking system.
That said, I applaud those banks with the requisite time and resources, for their willingness to analyze and test this and other technological advancements. It is only in doing so, in a sensible and compliant manner, will we keep our industry resilient and moving forward.
While technology certainly played a role in precipitating our current mini-crisis, I'm confident it can also play a role in resolving it.
