Bankers’ mystification about cryptocurrency as a financial category is … well, mystifying in light of the way banks have adapted to and even advocated for other game-changing technologies in the past.
When banks adopted mainframe computing and automated their recordkeeping functions in the 1960s and 1970s, no one thought the world would end. When people started accessing their cash by ATM, then by telebanking, and later by mobile apps, the sky did not fall. When stock certificates went digital, the system functioned better, not worse.
Yet today the idea of paying a vendor with a stablecoin, or maintaining a payment network by mining Ether tokens, or custodying a customer’s Bitcoin strikes fear into the hearts of bankers. Perhaps it’s the slightly weird crypto language that scares them. And yet, if you get past the jargon, why is custodying Bitcoin any different from a bank perspective than custodying fine wine or art or exotic cars, all of which banks protect on behalf of their customers?
At a high level, of course banks should treat crypto assets the same as they treat other financial assets held by their customers. Banks generally provide one or more of the core services of lending, payment processing and deposit-taking, and various crypto assets serve as technology-enabled means of providing those services.
Stablecoins are payment instruments much like prepaid debit cards or traveler’s checks. Various decentralized finance tokens provide borrowing and lending options for token holders. And staking tokens have features that resemble savings accounts, complete with interest-like features. As part of their overall mission of promoting customers’ financial well-being, banks must find ways of supporting crypto assets. If they do not, banks risk becoming irrelevant to the tens of millions of Americans who already own crypto and the millions more who might in the future.
Our society has a history of innovation and evolution when it comes to money and financial services — from the gold standard to paper money to checks to electronic banking to crypto. Many of us forget that the last two innovations are still fairly new. Cryptocurrencies and blockchain technology are simply another innovation in our society, and they are changing the way people behave and operate.
So, if the question is whether banks should involve themselves with cryptocurrencies, the answer is yes.
Should banks treat crypto assets the same as traditional assets? In truth, it makes little sense to treat all crypto assets the same as each other, let alone the same as their traditional equivalents. Banks handle checking accounts and mortgage loans and derivatives differently, so it follows that banks using stablecoins for payments will treat them differently not only from crypto lending products, but also from their traditional-finance counterparts.
That is because crypto relies on different technology and has different risks and benefits from its various predecessors. For instance, stablecoins are much faster than wire transfers, especially for international payments. But unlike wire transfers, a stablecoin transfer cannot be canceled or charged back to the sender after it has been sent. Thus a different set of risk management issues is in play in order to support the superior speed and cost of the stablecoin transaction.
The same principle applies to custodying Bitcoin: A cryptographic private key cannot be placed in a safe deposit box with the same security as a stock certificate. Thus, a bank seeing to custody Bitcoin will need a more sophisticated technology platform to provide this service.
For the sake of clarity, we should clearly define crypto — otherwise known as digital assets or digital currencies. It’s important to first debunk the false narrative that there is a single asset class for cryptocurrencies. Just as all stocks are securities, but not all securities are stocks, all staking tokens are crypto, but not all crypto are staking tokens. There are more than a thousand cryptocurrencies, and at least dozens of different categories of cryptocurrencies, all of which have distinctive characteristics and potential use cases by design.
At a basic level, some cryptocurrencies represent rewards for maintaining a network. Bitcoin and Ether are examples. Their value correlates with the adoption rates of their respective networks. Other cryptocurrencies represent apps built on top of a given network. For example, Compound is a decentralized finance app that is built on the Ethereum network. This should help explain why some cryptocurrencies are well suited for payments, others for lending, others for hedging against inflation, and so forth.
There are varying and nuanced levels of risk associated with each — as there are for all assets. Universally speaking, a customer bears the risk of price fluctuations, hacking or losing their unique cryptographic access keys, which could result in significant losses of value or losing their digital assets entirely and irreversibly.
As the nascent crypto industry matures and more people get involved and exposed to this risk, there comes an increase in demand for cryptocurrency custody services. So too will more people demand the speed and efficiency of crypto-powered payments. Or the higher yield that some decentralized finance platforms provide relative to savings accounts and money market funds. Banks need to support these services as they do for other assets and by doing so, they can continue to fulfill the financial services function they have historically played in providing payment, loan and deposit services.
However, in order to fulfill these needs appropriately, banks must be provided with the tools and guidance to do so in a safe, regulated way.
There are obviously risks, but the risks are not so different from risks banks have managed for decades. Can crypto assets present money laundering risks? Yes, but so do cash transactions, and sophisticated companies exist to provide transaction monitoring, trade surveillance and forensic analysis of blockchain transactions. Can your crypto wallet be hacked? Yes, but the largest crypto custodians have figured out methods to significantly reduce that risk.
Digital assets may be new, but banks have been dealing with digital instruments for quite some time, evidenced by the fact that we haven’t had paper stock certificates for more than 30 years. In a digitally driven world in which crypto has a $2 trillion market cap, banks must leverage new technology and innovative ways to provide the same services to which their customers have grown accustomed and meet this onslaught of demand.
Given the salient differences, unique features, and risks between cryptocurrencies, one can easily see how there is a danger of a one-size-fits-all regulatory approach.
So the question becomes: What should the framework for these regulations be? To create a safe environment for cryptocurrencies and a networked world to flourish, we need to focus on the real risks like money laundering and terrorism finance and find blockchain native solutions that allow end-users the reward while mitigating the risk.
The future of finance is networked, and banks really have no choice but to evolve with the times if they are to serve the needs of their clients. As we embark on the crypto revolution, we need to focus on both sides of the coin, so to speak — the risks, and the rewards — to create an environment where all Americans can experience the benefits of decentralized finance. It’s no longer a matter of “maybe,” but “must.”
Editor's note: This op-ed is part of a monthly series called "Deposits and Withdrawals" that offers different viewpoints on hot-button topics. A related installment, also on the subject of cryptocurrency,
