Benefits may emerge as skepticism wanes
Although recent banking collapses and regulatory scrutiny have led to skepticism about cryptocurrency, banks with an eye on innovation continue to explore uses for blockchain, digital assets and web3 solutions internally and in customer-facing products and processes.
Banking leaders are exploring the ability of these technologies to deliver valuable services to customers and also use them in their own processes.
“We’re seeing the larger banks adopt blockchain for cross-border settlement,” said Grant Thornton Principal & Forensic Technology National Practice Leader Johnny Lee. “Tokenization of real-world assets and back-office settlement functionality likewise represent extremely promising use cases for blockchain over time.”
The immediate prospects of cryptocurrency in particular for the banking industry are tenuous, as the regulatory environment continues to be uncertain. Recent SEC lawsuits against market participants show that the Commission is eager to classify many cryptocurrencies (with the notable exception of Bitcoin) as securities, which would require market participants that deal in crypto assets other than Bitcoin to register with the SEC.
Banking regulators also threw cold water on cryptocurrency in the industry with a statement in January highlighting the risks that crypto assets pose to banking organizations. Legislation that may regulate cryptocurrency in the United States, meanwhile, is in its infancy in Congress. But despite these regulatory hurdles and the recent failures of a number of cryptocurrency exchanges, crypto lenders and other market participants, banking leaders continue to see promise in decentralized finance platforms that can use blockchain technologies to support fiat lending and investing and facilitate asset exchanges. We have seen an accelerated adoption of these technologies in particular by banks in Europe, from institutional to retail offerings.
Leaders of financial institutions of all sizes are working to determine the role that these technologies will play for them now and in the future. Grant Thornton professionals say banking leaders that follow the right steps have an opportunity to make the most out of blockchain, digital assets and web3 opportunities in banking, capitalizing on the opportunities while managing the risks.
Understand and embrace the possibilities
Whether or not banks are ready to plunge into these opportunities, they need to understand them. Training their people on the basics of blockchain and cryptocurrency and the potential future use cases can be a useful first step.
“Even if they’re not jumping in right away, they should prepare for adoption,” said Grant Thornton National Leader for blockchain, digital assets and web3 industry Markus Veith. “They should have their people ready to handle it from a variety of aspects.”
Embracing the possibilities starts with getting a bank’s house in order, so to speak. Many banks have siloed processes that have created such complexity that their data is not coming together in a meaningful way.
To be better positioned to take advantage of these opportunities, banks may need to transform their strategy, operations and risk management to enable identification of opportunities and threats on a proactive basis and replace unsustainable, reactive processes.
Banks often have pockets or islands or silos of information that cannot be acted upon easily. This is a systemic problem that needs to be corrected to make the most of these opportunities.
Get it right on the front end
Proper planning for web3 projects can significantly increase your success. The creation of a web3 product can be compared to the construction of a building. The process starts with determining the use cases, considering all the important functionality and the appropriate dependencies as well as the regulatory aspects and implications.
A bank can prepare by building a 360-degree model that includes all the opportunities, threats and risks. Leadership can discuss in very simple terms: What do we want to do, and where can the wind blow? Risks also can be reduced by anticipating what regulators may or may not take an interest in.
Banks can increase their likelihood of success by bringing an engineering mindset to the process so they carefully map out the road ahead.
If you build a journey map and see that you may run into traffic through certain areas, you have a choice: Do you continue with the original route, or do you take an alternate route around the traffic? If you haven’t thought about that ahead of time, that traffic is going to surprise you and slow you down.
Questions to ask may include:
- Where do you want to be in three to five years with this strategy and product?
- What is your growth trajectory?
- What obstacles could stand in the way of that growth trajectory?
- What about this product might customers not like?
- What elements of this product might raise regulatory objections now or later in the life cycle?
- What specific aspects of data will you need to manage?
- How are you going to embed know-your-customer risk management into the process?
Manage the risk
Many cryptocurrency failures have resulted from failure to manage risk effectively.
The Mt. Gox cryptocurrency exchange was brought down by a cybersecurity breach in 2011, according to charges recently unsealed by the U.S. Department of Justice. The FTX crypto asset trading platform allegedly collapsed when customer funds were diverted inappropriately to another privately held crypto hedge fund, according to charges filed last year by the SEC.
“If you’re not contemplating risk when you’re adopting, developing or integrating new technology, you’re inheriting risk.”
“If you’re not contemplating risk when you’re adopting, developing or integrating new technology, you’re inheriting risk,” Lee said. “The Mt. Gox hack — and virtually every other crypto-security issue that followed it — represent somewhat elementary departures from security principles and risk management considerations.”
Lee sees a parallel between the web3 and generative artificial intelligence industries as they develop customer-facing products and services. He said long-lived efforts to make AI development transparent and accountable have been undermined by companies that are placing speed to market and profit motives ahead of risk management considerations.
“Generally speaking, the same philosophy animates digital assets,” he said. “I don’t think it always will, but it certainly does today. Perhaps the key takeaway here is that ‘move fast and break things’ is a terrible risk management strategy.”
Banking leaders also need to monitor regulatory risk as they contemplate web3 projects. Although the lack of government interference makes web3 platforms attractive to some investors, Veith said the lost trust in cryptocurrency after the FTX collapse made it clear that a strong, sensible regulatory system is necessary for this budding industry.
“They’re handling billions of dollars of customer assets,” Veith said. “Initially, everybody wants independence from the legacy financial system and its limitations for peer-to-peer transactions. Then, when something fails and users lose money, they ask why the government isn’t protecting their assets.”
Consider the customer point of view
Any customer-focused product is dependent on the sentiment of its potential customers, and in the current market there are strong feelings against cryptocurrency after a series of exchange collapses last year.
To overcome that fear, banks may need to present web3 products to consumers in a way that makes them comfortable. These products can be bolted on to an existing product, or perhaps piloted in a way that customers warm up to them.
Banks also may be able to follow the example of some large asset management firms that presented cryptocurrency opportunities primarily to high net worth investors who are willing to take risks.
Be ready for the benefits
The European Union’s recently adopted rules on markets in cryptoassets (MiCA) provide a regulatory framework that’s designed to protect investors and facilitate compliance by service providers, and it may pave the way for expansion of digital assets in Europe.
Continued regulatory uncertainty and recent actions by regulators have accelerated the exodus of crypto native companies from the U.S.
“Someday, when the U.S. regulatory environment is more settled, hopefully there will be a return to the U.S. for responsible, compliance-oriented companies,” Lee said.
Banks that prepare for that day and explore the potential for use cases now may give themselves a competitive advantage in the years to come.
Contacts:
Graham Tasman
Principal, Banking Industry Leader
Graham leads the Banking Industry for Grant Thornton, bringing the breadth of our firm’s services to our clients and delivering world-class business transformation capabilities that elevate our clients’ strategic agendas around digital disruption, finance, risk, and sustainability in a demanding regulatory environment.
Philadelphia, Pennsylvania
Industries
- Asset management
- Banking
Service Experience
- Advisory
- Commercial and growth
- Risk advisory
Markus Veith
National Leader, Blockchain, digital assets and Web3 solutions
Partner in charge of the Northeast Financial Institutions Practice
Markus leads Grant Thornton’s Digital Asset Practice and is the Partner-in-charge of the Northeast Financial Institutions Practice and an SEC and IFRS specialist. Markus has over 20 years of experience in the financial services industry and in public accounting.
New York, New York
Industries
- Construction & real estate
- Asset management
- Banking
- Private equity
Service Experience
- Strategic federal tax
- Tax
- Advisory
- Audit & Assurance
- Restructuring and turnaround
- Valuation
- Employee Benefit Plan Audits
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