Crypto banking: The emergence and potential success of the crypto-friendly banks

For those who have followed the rise of cryptocurrency, it has been a wild ride.

Anonymous, encrypted digital methods of financial transactions have been around since 1983. With the introduction of blockchain technology and the subsequent creation of Bitcoin, cryptocurrency started making headlines and became a buzzword across the globe.

The reaction of governments and banks towards cryptocurrency was largely negative at first. The levels of privacy provided by crypto technology seemed like a criminal’s paradise. Many countries moved quickly to ban or limit new technology.

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There was also a large effort by banks and the media to discredit cryptocurrencies. Howard Marks, one of the wealthiest investors in American and founder of Oaktree Capital Management, claimed that cryptocurrency was a scam. According to him, Bitcoin was “nothing but an unfounded fad (or perhaps even a pyramid scheme) … based on a willingness to ascribe value to something that has little or none beyond what people will pay for it.”

Of course, it makes sense for those who have made their wealth via traditional institutions like central banks to act defensive towards cryptocurrency. In many ways, cryptocurrencies have been proven to be a more convenient and stable way to store long-term wealth. Peer-to-peer lending using cryptocurrency has provided some investors with returns over 22%, far beyond what traditional methods could provide.

The world has come a long way since 2009. Cryptocurrency is starting to gain widespread legitimacy, with use surging in the US, UK, Nigeria, Australia, Canada, Mexico, and India. As such, investors are starting to look at cryptocurrency as an increasingly attractive way to make investments.

Opportunity For Cryptocurrency Banks

Politicians worldwide are grappling with how to regulate an industry that is defined by its lack of ability to be regulated. In this article, we will look at the evolving approach of government and regulatory authorities towards cryptocurrencies, and highlight a real opportunity for crypto-friendly banks.

1 – Cryptocurrencies: Stable or Insecure Investments?

What is it that differentiates cryptocurrency from fiat currency? The main distinction is that fiat currency is regulated, with a controlled supply that is backed by the government. Cryptocurrency is unregulated, meaning that it has the potential for unpredictable fluctuations, reflected by the variable value of Bitcoin.

The part about cryptocurrency being unregulated by governments is what is making it most appealing to investors in 2020. Many investors have concerns about quantitative easing and inflation. These both have been the result of recent economic stimulus practices, increased money printing, and lower interest rates.

A “propped up” economy, prevented from natural market corrections, makes many fear a bursting bubble around the corner. This is incredibly ironic: cryptocurrency was likened to a Ponzi Scheme or a dot-com bubble in its initial stages, whereas now it’s being viewed as a possible solution.

As you might predict, politicians are not so keen on losing their power to regulate finances. Especially in the United States, where surveys show that only 34% of the population have a rudimentary understanding of financial literacy, and an economic system without oversight seems frightening.

2 – Regulated Crypto Banking: An Oxymoron or a Solution?

It would be difficult to enforce banning cryptocurrencies outright. Governments have had to find other ways to stick their fingers in the pie. In 2014, the US declared that while it does not consider cryptocurrency to be legal tender, it is deemed property for tax purposes.

This year, the American government had a different idea. What if they could harness the high levels of security, lower fees, and easier transactions provided by blockchain technology and still monitor it? The US Central Bank’s board of governors announced in February that they would be working to create a nationally recognized Central Bank Digital Currency (CBDC).

Bitcoin’s value recently surged after the US Office of the Comptroller of Currency (OCC) announced that banks can hold a cryptocurrency. However, there are still so many questions regarding the future of crypto regulation.

Will banks be allowed to hold and invest cryptocurrencies as they exist now, or will this new legal permission come with a large number of strings attached? Will Bitcoin and other digital currencies be willing to compromise on the defining aspect of their product: its anonymity and difficulty to trace? Or will the government create its own cryptocurrency, monitored by the Fed and backed by the American dollar? Will this be as secure and low-cost?

It’s clear that governments are aiming towards increased regulation and monitoring of cryptocurrencies. However, this is in complete contradiction to the very essence of the security of blockchain technology. When a single organization gains control of over 51% of bitcoin miners, the potential for fraud dramatically increases (also known as a 51% attack). Blockchain technology is only as secure as its users, and when they get together for illegal purposes the damages can be great. This can be seen in the Japanese Coincheck theft of $532 million and the Silk Road Task Force fraud, during which two high-ranking US government officials stole large amounts of Bitcoins.

The UK has passed similar regulatory measures recently. British cryptocurrency companies must get approval from a regulatory body in order to promote any of their currencies, ostensibly to protect consumers.

This comes almost a year after a widely-touted partnership between central UK bank Barclays and Coinbase quietly fizzled for reasons unknown. To investors, it was a very promising sign to learn that a reputable bank was working to integrate cryptocurrencies. To have the partnership dissolved unexpectedly has made many investors uncertain about the future of cryptocurrencies.

Coinbase was able to find another partnership with the newly founded ClearBank. However, shortly after their partnership, it was announced that, for British Coinbase users, it was illegal to hold digital assets in the form of Zcash. This was due to the fact that Zcash is highly anonymous.

The British tax agency, HM Revenue & Customs, also sent out messages demanding that crypto platforms reveal customers’ names and transaction histories in a bid to claw back unpaid taxes.

3 – Crypto Banking is the Future

Many traditional banks are hesitant to get involved in cryptocurrency until the regulatory landscape is clearer. This makes sense, as we know banks have a high level of accountability and cryptocurrency is known for its unpredictability and anonymity.

It’s clear, however, that it makes sense to do business in cryptocurrency. Whichever bank is able to jump on the chance to provide users with cryptocurrencies will be met with huge success.

It is evident at this point that banks are much more willing to back cryptocurrencies that are tied to fiat currencies. JP Morgan, for example, launched its own cryptocurrency known as Stablecoin, which is directly linked to the US dollar.

There is a clear opportunity for new banks, especially neobanks, to shake up the traditional banking system by offering the technology necessary for cryptocurrency. Many established banks simply do not have the tech infrastructure to provide efficient cryptocurrency transactions.

Adapting to changes in technology has always been difficult for long-established institutions, but it can rarely be avoided. More dynamic industries have been eager to embrace changes in technology with 89% of marketing professionals feeling that they would have more success with better digital skills. In a suit-and-tie boy’s network of the financial sector, cultural shifts and the desire to change are a lot harder to come by.

Although central banks are digging their heels, it seems inevitable that they will have to embrace cryptocurrency at some point. During the advent of the smartphone, some banks were hesitant to roll out online banking due to security concerns. Now, we have seen that online banking has greatly superseded brick-and-mortar banking. It is now a commonplace occurrence to deposit checks by taking a photo or scan receipts using your smartphone.

What is The Future of Cryptocurrency?

We already know that blockchain technology is the best solution for users who want secure and anonymous financial transactions. It is still uncertain how old-fashioned institutions like the government and central banks will adapt to the use of this technology.

On one hand, encouraging the use of cryptocurrencies will erode their power over the economy. On the other hand, if they can use the benefits of this new technology while also retaining a level of control over transactions, they can reap huge rewards.

Like the economic crisis seen in 2008, the economic uncertainties of 2020 are pushing many towards cryptocurrencies. Banks that are willing to embrace some risk getting involved in cryptocurrencies have the possibility of huge rewards.