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Why Banks are Valuable to Crypto
8 days ago

Bitcoin was invented to enable people to bank themselves, so they could avoid the delays and costs of needing to route payments via a trusted third party, such as a bank. Excluding small-value payments, Bitcoin is an excellent solution for real-time gross settlement where speed, security and low cost is required.

Since the invention of bitcoin, an entire ecosystem has flourished in the cryptocurrency (crypto) industry, much of it financial in nature. Some of the most successful businesses in crypto, such as Coinbase, mimic their traditional finance (TradFi) counterparts and are expected to become the crypto equivalent of financial supermarkets.

Traditionally, crypto companies have eschewed financial regulation, claiming crypto is too innovative, and unprecedented to be subject to decades-old laws. Meanwhile, regulators, most obviously the SEC in the US, have enforced relatively ancient laws without providing regulatory guidance and made it essentially impossible for crypto companies to actually “come in and register”.

As a consequence, multiple crypto companies have been fined, sued, or forced out of the US, fleeing to jurisdictions with more clear regulations (see BlockFi, Coinbase, Nexo examples). In some cases, regulatory actions fomented market fear driving ‘bank runs’ which ultimately crashed the entire credit market within crypto, killing product offerings (see Abra, Gemini), and putting multiple companies out of business (see BlockFi, Celsius, 3 Arrows).

Regulations, as imperfect as they may be and as awkwardly as they may be enforced, were created for good reason. Typically, that is to protect the consumer — and, perhaps they are used to protect the establishment. Also, regulations hardly ever get repealed, usually regulators just add more regulations, garnering more control.

Crypto will not be an exception.

The bigger crypto gets (more people taking risks with it, more companies earning more money in it), the more regulations will be expanded and enforced. This is already well underway. In addition to the above examples, we are now seeing US regulators (again, its the SEC) enforcing actions against DeFi solutions (see Tornado Cash, and UniSwap). Regulators have already indicated that stablecoins should be issued by banks; and they given guidance as to how insured banks should account for crypto custodial assets.

Ultimately, there will be a merger of crypto and TradFi. We see this in the Banking as a Service sector where most of the US banks that bank Fintechs are receiving consent orders from regulators, forcing banks to take greater ownership of the products (and consequently reduce the number of fintechs they support). We see traditional finance powerhouses launching crypto partnerships and products (see the various Bitcoin ETFs and Blackrock’s BUIDL offering). The Blackrock BUIDL offering is interesting because it necessitate four companies to partner to pull it off in a compliant way. A bank could do it alone, or with perhaps one technology partner, if the bank wasn’t too preoccupied with managing commercial real estate risks, or fully satisfied to earn long term risk free returns buying treasuries.

Capital always flow to returns and returns correlate with risk. Crypto is risky and represents oversized returns. Capital is flowing to crypto. However, regulatory risk remains an existential threat to many, if not most, of the businesses active in the crypto sector. Its logical for crypto exchanges to aspire to become financial supermarkets like their TradFi forefathers; Schwab and Fidelity offer dozens of branded products to solidify client relationships and drive retention. It follows that exchanges would offer regulated financial products like Yield (earn interest on your deposited funds), Borrow (borrow cash against your crypto portfolio), yielding stablecoins (ie. crypto equivalent of money market account), and add tokenized real-world assets (ie. securities) to their platforms. The problem remains though, that they can’t just “go in and register” so they need to partner with a bank that is already licensed to offer such products.

Long term, those partnerships will morph into mergers, as regulators eventually get comfortable with a crypto-native company buying and being a bank. In the meantime, the crypto companies and the banks that partner will win more share and retain more clients than those that don’t.