The Emerging Role of Crypto in Banking: Risks, Challenges and Opportunities

09.15.2022

Is it time to adopt crypto? Personal banking clients and institutional investors are increasingly expressing interest in this asset class as well as in the distributed ledger technology (DLT) that underlies it — e.g., the blockchain. Indeed, it’s not just startups, investors, fintechs and venture capital funds who have begun to make a sustained commitment to cryptocurrency. It’s also the mainstream, money-center banks and investment banks who are seeing crypto as the future of money.

Cryptocurrencies are a vehicle with great prospects,” explains BCG. “They have the potential to outperform conventional banking products while offering greater efficiency, less bureaucracy, and more transparency.”

How Banks Can Implement Crypto

Simply offering customers the ability to buy or trade crypto isn’t the only way that banks can incorporate crypto into their business. Banks have many possibilities and business use cases for crypto products and related services. Let’s have a look at a few:

Currencies

Banks can help startups bypass the traditional capital markets by providing initial coin offerings (ICOs), where the coin offering becomes the primary vehicle for funding the new enterprise. Banks and investment firms can then help retail customers invest directly in cryptocurrencies by steering them toward these offerings. 

Trading

Banks can also provide currency-trading services, such as for trading between fiat currencies (e.g., U.S. dollars or euros) and Bitcoin and other digital currencies. According to BCG, these coin swaps can be offered through three types of exchanges: central-bank digital currencies (CBDCs) issued from national financial authorities; private blockchain-based currencies from a bank or company; and network-issued currencies, such as Bitcoin or Litecoin, with a public blockchain.

Transactions and Operational Transparency

Banks can also take advantage of DLTs for either front- or back-office operations. They can offer real estate investments in which the blockchain technology makes the transactions more trustworthy through the use of smart-contract offerings, which involve automated timestamps, updates and verification of milestones.

Payments

Another product offering from banks could be to integrate cryptocurrency with established payment or money transfer platforms. When transferring money between countries or currencies, there are usually fees and exchange rates to take into consideration. However, payments and transfers in crypto or digital currencies could eliminate some of these fees, making the transactions more attractive for customers.

How Banks Can Support Crypto While Staying Compliant

To set up an account with a crypto exchange, account holders typically will be asked to go through the expected Know Your Customer (KYC) process — just as they would if they were to open an account at a bank. This is now a standard identity verification process that major exchanges require for anyone who wants to trade crypto.

A strong customer acceptance system with a trusted partner like Instnt can deliver a frictionless, digital customer onboarding experience, ensuring that the right customers are verified and granted access. 

Banks have been implementing KYC for decades, so it should be rather straightforward to extend this procedure to new customers interested in transacting with crypto. Customers interested in creating an account with an exchange without going through the KYC process will be restricted to certain account limits until they verify their identity. This is becoming more and more common, so banks offering crypto products most likely will not meet resistance when onboarding new customers. 

To support crypto while staying compliant, banks and financial services companies can not only mandate the standard KYC process while onboarding prospective customers but also keep a closer watch over the types of crypto transactions these new customers are engaging in. While newer platforms, exchanges and networks might not have the resources to keep close tabs on crypto transactions, banks certainly do. Restricting activities and then alerting authorities can go a long way in mitigating risk to the firm and creating a safer environment for all customers.

Indeed, it is with these identity verification procedures that banks can support crypto while staying compliant. Taking a cue from their clients, banks are moving rapidly in offering crypto products and related services. Large investors may be interested in crypto-based growth assets or in having their banks offer transaction monitoring services based on DLTs. Venture capital funds tend to favor designated crypto funds and other vehicles for raising capital for startup investments, while clients may be looking for rapid-growth investments to diversify their portfolios and increase total returns.

How Crypto Is Related to Self-Sovereign Identity

The self-sovereign identity, also known as decentralized identity, model tries to remove the trust issue that comes with identity management. Self-sovereign identity attempts to give the user full control over their own data, including not only what pieces of identity data are being stored but also who has access to the data.

This concept of decentralized identity is at the heart of blockchain technologies and their promise of data integrity, as users can add or delete identity data and maintain full control over how their identity is used. For some die-hard crypto fans, a decentralized identity is necessary for more transparent transactions.

Banks currently, as a rule, do not offer self-sovereign identity. However, as more customers interested in this data model request it, banks might need to start offering trading or transaction platforms in which customers can sign in using their decentralized identity — whether they transact in crypto or not.

While average banking users might not feel the need to check the blockchain or similar distributed ledger technologies in order to verify how their personal data is being utilized, some customers might. As such, banks will need to consider self-sovereign identity as a feature as they roll out more sophisticated crypto products and related services.

Consult with a digital onboarding and identity verification provider like Instnt to discuss how you can give your customer more control over the management of their digital identity.

What Risks Are Posed to Institutions by Offering Crypto?

As a customer-facing product, crypto performs no differently than other high-risk asset classes, such as penny stocks, junk bonds, futures or commodities. The strongest KYC measures in place can only thwart fraud and prevent bad actors from becoming the firm’s clients; KYC and Anti-Money Laundering (AML) policies don’t measure the customer’s appetite or qualifications for investing in risky products. 

In this regard, banks might need to implement decision-making processes in order to present crypto only to customers who can tolerate the risk of loss. Without these stopgap measures in place, including a digital customer acceptance system like Instnt, delivered at the moment of account sign-up and onboarding, banks face reputational risk. 

However, because the blockchain cannot be hacked, crypto itself cannot be stolen — it’s the wallets, exchanges and platforms that are subject to compromise or theft. As banks have spent decades and billions of dollars upgrading their systems to incorporate the strongest security resources, they have an opportunity to present crypto transactions in a safer environment than that of a startup.

Additional Security

As banks increase the availability of crypto and other types of blockchain-based offerings to their customers, they will need to keep additional security in mind. Crypto will usher in new customer groups, and as trading, payments and other transactions in crypto increase, banks will need to be mindful of identity verification and tracking in order to prevent fraud and protect the firm’s assets.

Instnt Accept™ is the only service that provides indemnification for each good member a bank successfully onboards. In this way, Instnt is liable, not the customer. Similarly, Instnt Accept™ provides performance guarantees for each good customer that is accepted. Because Instnt assumes liability for fraud and provides indemnification up to $100MM, banks, credit unions and other types of financial institutions can experience higher profitability and growth. For more information on Instnt Accept™, start your free demo today.

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About the Author

Instnt Inc. is a public benefit corporation on a mission to bring inclusion and instant account opening experiences for businesses and their customers through proprietary technology, artificial intelligence, open standards and a collaborative effort in the identity governance industry. With Instnt AcceptTM the first fully managed customer acceptance solution with up to $100M in annual fraud loss warranty, businesses can onboard more good customers, grow their top-line revenue, and cut their operational costs without friction or fraud losses in minutes.  Instnt AcceptTM powers various fast-growing financial institutions and credit unions.