Road to Success

Year in year out, people continue to wonder how long the crypto hype is going to continue. The volatility of the market and the crashes it has faced keep leading some to believe that the digital currency’s time has come to an end, but without fail, it always pops back up again. But why?

This month at The Fintech Times we’re going to be looking at what makes digital currencies, most notably cryptocurrencies, so popular, while also uncovering the emerging alternatives to cryptos and why the digital future looks so intriguing.

We kickstart the month by looking at some of the most popular blockchain initiatives in different sectors, with banking being the first to come under the microscope.

We hear from Dmitry Gooshchin, Gilbert Verdian, Gregory Pepin, Henry Liu, and Omid Malekan about some of the latest ways in which blockchain technology is being integrated into the banking world.

Smart contracts

Dmitry Gooshchin, COO and co-founder of EndoTech, an information technology company that focuses on artificial intelligence and machine learning, identifies how smart contracts can be used in the banking ecosystem, though how ultimately blockchain integration is still in its early stages:

“One of the most popular blockchain initiatives we’re seeing within banks is smart contracts. Smart contracts use blockchain technology to generate and implement the terms of an automated agreement between two or more parties, streamlining many traditional business transactions. When the terms of a specific clause within the smart contract are met, the outcome is automatically executed, without needless legal oversight, saving costs and time.

“For example, when a customer purchases a greater scope of x product, the vendor will be paid automatically.

“Moreover, because a smart contract can be tethered to IoT devices, it can ensure the incorporation and execution of ‘back-up’ clauses between two parties, such as penalties for failing to meet quality standards. If a delivery of frozen stock rises beyond an agreed temperature, a smart contract can detect this and will execute an agreed form of remuneration.

“Because each contract is tethered to the signatory’s digital ID with a time-stamp, it also makes forgery and under-hand revisions to the contract impossible, adding an extra layer of security to the agreement and enhancing trust between two parties – especially if they are doing business for the first time.

“In 2020, Barclays published an article about the value of smart contracts and the likelihood of future implementation. Their recent acquisition of Copper, combined with their current testing of smart contract use-cases could certainly be seen as a sign of their intentions, along with other mainstream banks, to incorporate this type of blockchain technology into their offerings.

“It must be said, however, that the adoption of blockchain technology within traditional finance is still fairly speculative in comparison to crypto, where we are seeing innovation at an exponential rate.”

Tokenisation and CBDCs

Gilbert Verdian, founder and CEO, Quant analyses the impact tokenisation and CBDCs could have on the banking system:

“This year, we’ve seen many tier-one banks rapidly accelerate their blockchain and distributed ledger technology (DLT) strategies. The strongest trend is within capital markets, as financial institutions like custody banks actively tokenise assets like funds, equities, bonds, credit, mortgages and real estate. BNY Mellon, State Street and Northern Trust have taken steps forward in this area.

“Institutional demand from asset and fund managers and retail consumers is behind the shift towards asset tokenisation. The benefits are substantial: tokenisation can transform securities, idle physical assets and other instruments into new digital assets. These can then be fractionalised to transact seamlessly across borders, providing a better way to trade with improvements to reporting, transaction speed and settlement.

“The enabling factor is maturing regulation in Europe, Asia-Pac and the US, which will provide the framework for more financial institutions to move to implementation stage.

“Another initiative we see is the institutional adoption of DLTs. Retail use cases and DeFi applications have proved to institutions that new value and markets can be created. Now, we’re seeing the implementation of DeFi solutions by regulated entities to serve their institutional clients.

“Another trend is the evolution of central bank digital currencies (CBDCs) and commercial stablecoins as a new form of money. As of July 2022, 105 countries and 19 of the G20 are exploring CBDCs. China is actively piloting a CBDC, with 261 million people – a fifth of the country’s population – having downloaded its digital yuan wallet. Commercial stablecoins, backed by bank deposits, are also on the rise.

“JPM‘s Onyx stablecoin for repos is processing billions per day; Circle‘s USDC, with a market cap of $43billion, is another with active payments use. We’re involved in a project with LACChain, a pan-regional blockchain infrastructure in Latin America, to enable domestic and cross-border stablecoin payments and banking functionality.

“The adoption of tokenised money will be guided by maturing regulations and harmonised international standards, such as ISO TC307.

“It will be a world where cash and private money will co-exist along with secure, interoperable CBDCs and commercial stablecoins that offer significant benefits to consumers — privacy, financial inclusion and programmability — meeting the needs of today’s digital society.

“The convergence of tokenised assets settled with tokenised money is the holy grail the industry is racing towards. Tokenised assets create new forms of value. And the risks of these transactions can be greatly reduced by using central bank-backed money for real-time settlement, mitigating counterparty risks and simplifying regulatory reporting.”

A new banking system

Gregory Pepin, CEO of Io.FINNET, the API driven financial platform looking to bypass the traditional supply chains and labour pools of the financial industry and make financial service organisations’ innovations accessible to anyone, discusses how digital banks are moving on from the old banking system and simply digitising them, and moving on to the next iteration of banking:

“The banking system we are currently relying on was built in the 70s. In most cases, digital banks are simply marketing facades for old banks, with different designs and interfaces. Instead, they cause high costs, heavy processes, complex onboarding systems, and a lack of real ownership.

“However, the global financial sector is now claiming a transformation due to technological progress, price-sensitive yet highly demanding high-net-worth individuals (HNWI), the emergence of a new class of customers (the so-called mass affluent), the rise of fintech and regtech, and the increase in compliance costs and transparency expectations.

“As we move into a more regulatory-friendly framework for emerging technologies, such as blockchain, more and more banks have started to integrate them.

“There are banks using blockchain technology to streamline the process of settling cross-border payments, which saves on costs and time. JP Morgan, one of the largest financial institutions in the world, for example, developed the Onyx, a digital solution enabling instant transfer and clearing of multi-bank, multi-currency assets on a permissioned distributed ledger. Recently, Swift has been testing out a new platform called GPI (Global Payments Innovation), which uses blockchain technology to track payments in real-time and detect suspicious activities immediately. Other banking organisations are also studying blockchain as a form of digital identity for their customers.

“The emergence of the blockchain is a turning point in the history of innovation. It offers us the opportunity to create an alternative financial system, where breakthrough financial innovations are not slowed down by institutional forces but enabled and accessible by everyone.

“Fintechs will continue disrupting the old monopolies and mindsets that constitute today’s financial industry. We can achieve greater financial integration without sacrificing financial independence or ethical finance by concentrating on the nature of the clients of each financial service provider and constructing the appropriate market infrastructure for their unique realities. “

Regulating crypto

Henry Liu, CEO at BTSE, the crypto exchange, identifies three ways in which the blockchain industry is impacting the banking world:

“First, we forecast that governments and legislators around the world will tighten their regulation of crypto companies, but this could pave the way for more traditional financial institutions to begin offering crypto services and/or partnering with crypto companies. For example, the UK is on its way to recognising crypto in the same manner as other financial assets via the proposed Financial Services and Markets Bill. Meanwhile, Europe is looking to enforce its Markets in Crypto-Assets regulation memo (MiCA) by end-2023 or 2024.

“Second, the current culture of anonymity within crypto will be greatly challenged as more countries consider implementing CBDCs. Such anonymity can facilitate crime and terrorism financing and undermines KYC and AML protections. As regulators generally aim to protect and guide the market in order to reduce threats to their financial system, such anonymity often provokes reactions.

“Third, we’re seeing competition ramp up among centralised exchanges. We expect more mergers and acquisitions soon in the industry as the advancing technologies and new regulations have raised the bar to operate as a DeFi protocol, NFT marketplace, or exchange. Today’s leading exchanges could be looking to expand into new market segments and offer varied solutions to become crypto-banking hybrid institutions.”

Banks are building products and services to drive crypto services

Omid Malekan, adjunct professor at Columbia Business School and author of Re-Architecting-Trust: The Curse of History and the Crypto Cure for Money, Markets and Platforms analyses the impact crypto has had on the space:

“When Bitcoin first appeared on the radar of the banking industry, the response was to coop the technology. Thus began the ‘blockchain, not Bitcoin’ era on Wall Street, where major institutions tried to deploy private networks to improve existing markets.

“Experiments were designed (and press releases were issued) espousing the benefits of the technology, while ignoring its most successful application. Years later, the industry had achieved little with its private networks, while public networks like Bitcoin and Ethereum took off.

“Growing adoption of applications like stablecoins and decentralised finance—all built on the public networks—eventually forced the industry’s hand.

“Today, banks are building products and services that will drive even more activity away from the siloed financial systems of old to the newer, crypto-centric ones. This symbiosis frustrates the decentralisation originalists who wanted crypto to replace banking but is a necessary condition of mass adoption.

“The best example of this phenomenon is digital asset custody. Individuals and corporations have always sought the help of trusted (and regulated) institutions to protect their assets. Blockchain technology allows anyone to custody their own assets via a cryptographic key, but most users chose not to due the complexity and heighted risk. Banks around the world are rushing to roll out crypto custody, and BNY Mellon, one of the world’s biggest custody banks, recently went live with its solution.

“Other banks are working on so-called ‘on and off ramps.’ Crypto needs greater connectivity to the traditional financial system to scale (think: buying a coin or NFT with a credit card) and surveys show most people prefer to get exposure through familiar service providers such as their bank.

“Then there are ancillary services, like holding the cash reserve for digital assets backed by fiat currency called stablecoins. There is already $150billion worth of such products on various blockchains, and a significant portion of their reserves is deposited with banks.

“The next few years are likely to see greater convergence between the banking industry and crypto. The banks that innovate and join the revolution will grow and make more money, while the ones that don’t will fade away.”