Jeremy Boot, Senior Product Manager at Temenos, explores the impact of digital assets on the financial industry and how banks must adapt to thrive in the brave new tokenized world
The rapid innovation of blockchain tech has led to an explosion of interest in digital assets. Investor enthusiasm has pushed crypto valuations to dizzying heights. The media is awash with new acronyms DeFi, NFTs, CBDCs.
Cutting through the noise, one thing is clear: distributed ledger technology has opened the door to a future where all our assets, both real-world and digital, could become tokenized and recorded on blockchains, completely redefining how we think about value exchange and ownership.
This begs the question; how will this impact the financial industry and how can banks adapt? Let’s look at some of the opportunities.
The rise of crypto banks
Crypto assets are a hot topic as a new investment asset class, store of value, or hedge against government money and inflation. The ability to buy small amounts makes crypto financially accessible to all and a natural fit for the younger digital-native generation. Attractive risk-return ratios provide new portfolio allocation options for the wealthy at a period of record stock valuations and negative bond yields.
The digitally savvy may like to buy their crypto on exchanges and self-custody in hardware wallets, but this is out of reach for the masses. They would look to trusted institutions to give them access to these new markets, and a wave of offers led by new FinTechs and Challengers is already available.
This is where traditional banks can move in, building on their experience with securities trading to provide an additional integrated offer. Crypto infrastructure providers are evolving enterprise-grade custody and accessibility to markets using standard protocols such as FIX messaging. Banks can leverage their processes for order lifecycle management between front and back office and integrate crypto custody into their core banking systems.
The crucial advantage banks have, is a deep experience of regulatory compliance, such as with customer risk profiling and controls, allowing them to adapt quickly to the incoming regulatory frameworks that are certain to appear.
CBDCs and alternate payment rails
The first Central Bank Digital Currencies are appearing across the globe with many more countries refining their strategy. They seek to facilitate payments, boost their digital economies, and protect against the adoption of alternatives. Central Banks have no interest in managing the end customer directly and do not want to risk disintermediating banks. For these reasons, the standardised approach evolving for retail CBDCs is the two-tier model where traditional institutions remain the interface to the customer.
The emergence of CBDCs represents an opportunity for banks to gain ground on competitors by quickly integrating CBDC accounts into their offerings. By leveraging infrastructure partners at the back to link to the CDBC network and providing mobile apps on the front, they can offer a frictionless experience to their customers. One that facilitates exchange from current accounts to CBDC wallets and with an integrated payments experience.
Alternate payment rails – for example, Stablecoins issued on Ethereum or Lightning payments network on the Bitcoin blockchain – are also key areas to monitor adoption trends and potential for integration.
Open banking, new possibilities
Open banking facilitates financial product distribution, allowing institutions to broaden their ecosystems of products adding value to their customers. Digital assets open the door to additional products that could be included.
For example, on SmartContract blockchains we have seen the emergence of DeFi (Decentralised Finance) protocols. Many indeed have dubious levels of decentralisation in their current form, and the ultra-high yields on offer to liquidity providers scream Ponzi. Nevertheless, DeFi offers an exciting glimpse of new automated, non-custodial, and decentralized lending and borrowing models. Aave, one of the pioneers of the DeFi space, recently launched a first permissioned and KYC’d protocol opening the door to regulated financial institutions to tap into this tech, potentially offering new products to their clients to gain passive income in return for providing liquidity with their spare deposits.
For crypto investors holding native assets of proof-of-stake blockchains, staking would be a natural add-on service a bank could provide to their customers. Staking is the process of delegating assets to help secure the network. In return for locking up their tokens the user receives staking rewards. As on-chain economies develop and grow securing networks will become increasingly important. Asset staking could become a new form of standardised capital income generation, alongside bond coupons and stock dividends.
Everything tokenised
NFTs (non-fungible tokens) have grabbed the headlines. Though the assets today are primarily digital – CryptoPunk JPEGs and the like – NFTs can also be used for real-world assets. Everything from stocks, collectibles, real estate and more could be tokenized, revolutionizing value ownership and exchange. The underlying blockchain provides a means to exchange value with other participants without having to rely on a centralized party.
Tokenisation opens the door to fractional ownership of assets such as art and real estate, lowering barriers to entry, and bringing in new liquidity to these markets by opening to the masses.
Beyond government CBDCs, non-profit organisations, sports clubs, corporations could issue tokens providing new ways to engage with their communities, encourage participation and loyalty, and distribute value to their network. New creator economies might emerge for digital works of art, metaverse artefacts and objects, non-propriety gaming assets.
Aside the low-value gaming or social tokens, we will need safe places to keep our valuable tokens. This will be essential for security, taxation, inheritance planning and the like.
Enter banks – banks of the future will not only hold our money but become the trusted guardians of the holistic value of our lives.
Banks as trusted guardians
The digital asset landscape is evolving fast. Most people will look to their trusted financial institutions to help them manage their new digital financial lives.
Banks can leverage their large customer base and deep regulatory expertise to provide new digital asset services that are trusted, secure, accessible, and compliant.
The good news is that there are infrastructure providers emerging that banks can leverage on their journey. In this way, banks can become primary players in the brave new tokenised world.
