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What’s Next for the Crypto Finance Industry?

By Mark Jacobsen

Once a payment means for shady black-market transactions, crypto is now moving into the mainstream and may soon merge with the traditional finance space.

The move of traditional finance houses into the crypto space has been afoot for several years now, a trend that will no doubt continue to gather steam. A newer development, though, is the transition in the other direction: for 2022 may go down in the annals of history as the crypto finance industry’s breakout year into the traditional space.

With its dizzying rise, crypto has emerged to become a regular part of asset allocation conversations, a popular culture mainstay, and an increasingly important topic within political spheres.

It is precisely this hype that has brought the sphere of crypto assets a step closer towards mainstream adoption.

Crypto assets are currently a US$2.3 trillion market. While that is a large number in some ways, global stock markets alone contain more than US$71 trillion in assets. The key to the enthusiasm is crypto assets’ hyper-accelerated growth, as the total market capitalisation has tripled over the past year, according to Bloomberg’s figures.

This phenomenal growth rate and the massive headroom for further expansion are forcing traditional financial institutions to embrace the crypto wave. On the other side of the bitcoin, it only seems a natural step for the crypto finance industry – cash rich, but product homogenous – to expand into the traditional sphere.

The move towards offering traditional products as one-stop shop for all financial services is gaining momentum: this year and beyond, we expect more applications for licensing for fund management, brokerage and custody, and greater M&A activity between crypto firms and traditional banks.

Pressure from traditional finance

Cryptocurrencies and the underlying blockchain technology are becoming a powerful force in the global economy, affecting everything from cross-border retail payments to interbank transfers.

Similarly, the adoption growth of crypto finance is unmistakeable. Last November, blockchain company ConsenSys announced that more than 21 million people (a 38-fold increase from 2020) were using its MetaMask cryptocurrency wallet, which allows users to interact with the Ethereum network and decentralised applications known as Dapps. The Dapps power such functions as crypto-based lending, borrowing, swapping, and pooling, using a variety of smart contract and protocols.

With cryptocurrency giving people a new method of investing and transacting, banks and financial institutions are being forced to contend with its meteoric ascent in fears of becoming outdated and redundant. They are grabbing for a piece of the booming industry, with 13 of the world’s largest banks pushing roughly US$3 billion in funding so far into blockchain companies, according to analytics company Blockdata.

At the same time, banks are considering adopting cryptocurrency as a legitimate asset class. Asset managers are offering crypto products and providing cryptocurrency-related services. Payments providers like Mastercard, Visa, Paypal and Square are invested heavily into the space, with larger financial institutions like BNY Mellon, Standard Chartered and Citibank also throwing their hats in the ring. In 2019, a unit of JPMorgan called Onyx introduced JPM Coin, a digital currency backed by the dollar that runs on Quorum, an internal technology that mimics the structure of blockchain.

Mirroring the traditional financial system

Critically, the core functions of the capital markets system – including depositing, lending, borrowing, investing, and trading – are currently being replicated in this crypto finance economy, represented by not only centralised full-service crypto finance houses such as Coinbase and Gemini, but also decentralised exchanges such as Uniswap for asset trading and Synthetix for derivatives trading.

In the secured lending business, crypto lending platforms like BlockFi and Celsius provide the same services as traditional broker-dealers active in repo and securities lending. “Crypto banks” such as Signature Bank serve to provide unsecured lending akin to commercial banks and non-bank lenders. In place of investment funds in traditional finance, large crypto funds such as Grayscale and Galaxy provide a full suite of asset management services for investors.

In other words, almost every existing traditional financial service has now been mirrored by a crypto pseudo-equivalent. With these similarities in services, it seems inevitable that the two systems will merge. As banks and financial institutions jostle into crypto sphere, pressure mounts for the converse to take place. To this end, crypto finance seems well poised to do so.

“Traditional” financial institutions in the end?

Crypto finance has reached a key turning point. With the development of trading, lending and investing platforms, the time value of money is now fully reflected in the sphere. The next logical step in this maturity transformation would now be to compete for traditional finance funds. A crucial move in this direction would be the offering of traditional products.

To date most, if not all, of the activity in the sphere of crypto finance has concentrated on the use of natively digital assets aimed at retail investors, represented by a plethora of blockchain-based tokens and “stablecoins” – digital assets pegged with various degrees of reliability to a fiat currency. This has kept the crypto economy a largely encapsulated system, with users only being able to participate with digital currency.

However, proponents are increasingly looking at incorporating traditional asset classes such as real estate, IP rights, equity, debt, and fiat currencies. The process of “tokenisation” – the digitalisation of real-world assets, is an important first step in this direction. Tokenisation creates a critical bridge between real-world assets and their trading, storage and distribution in the digital sphere.

In this competition for funds, and as cryptocurrency companies become more a part of the sphere of traditional financial services, the possibility of becoming a bank, broker-dealer, or licensed fund manager become increasingly a requirement. In fact, Swiss Financial Market Supervisory Authority (FINMA) awarded banking and securities dealer licenses to two cryptocurrency banks (Sygnum and SEBA) in 2019, a significant milestone towards the institutionalisation of the digital asset economy. More recently, Coinbase and payments firm Ivy Koin reportedly met with FDIC officials about possibilities to obtain banking licenses.

Since cryptocurrency business models are already modelled on deposit taking, exchange, remittance, merchant payment processing, personal and business value storage, ATMs, and even escrow and lending, it makes good business sense for these services to be integrated under a single umbrella for customers.

Whether this can eventually be achieved hinges critically on crypto service providers tackling regulatory concerns and obtaining licenses. While this move may prove problematic for some players – cleaning up past transgressions can be long and arduous and often requires divorcing the business from its founders – other players are aggressively moving to become more regulated through the acquisition of licenses and previously licensed businesses. Ultimately, if the crypto industry adopts some of the standards of the regulated world, and the regulated world adopts some of the innovations of crypto, that exchange could be a very good thing for everyone.

The question still remains, as traditional financial market players step up to adopt crypto finance in a bid to stay relevant, can the crypto sphere itself break through this critical turning point to eventually provide a one-stop shop for financial services? With little being new under the sun, the incorporation of the key players in this new industry into the mainstream asset cases seems a foregone conclusion.

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