From Bitcoin to NFTs, why institutions are adopting crypto

From Bitcoin to NFTs, why institutions are adopting crypto

Opinion

Alternative Lending

Digital Banking

Savings and Investment

Cryptocurrencies are increasingly becoming an accepted part of the financial landscape with institutions now realising they must adopt them, writes Ivan Soto-Wright

Image source: Photo by Oleg Magni from Pexels

The global perception of cryptocurrency has shifted dramatically in recent years — once being seen as a fringe investment class, they are now known for having a multitude of use cases including in low-cost remittances, peer-to-peer lending, and high interest savings accounts.

With cryptocurrencies increasingly becoming an accepted part of the financial landscape, institutions are realising they must adopt this young asset-class, or risk losing relevance. Broadly speaking, I believe the reason for increased adoption amongst businesses can be split into the following three camps.

Surge in consumer popularity and understanding

Until very recently, only those with a strong understanding of the underlying technology felt comfortable participating in crypto in any meaningful way. However, as functionality and awareness has grown, so too has adoption and, in many instances, value.

This came to a climax last year, when — against the backdrop of macroeconomic uncertainty — Bitcoin’s explosive rise in price drew an enormous amount of attention from the press and public, making the year something of an inflection point in terms of global interest.

The recent surge in consumer interest can also be credited to prominent public figures endorsing cryptocurrencies, as well as firms such as Mastercard, Tesla and JP Morgan, all of whom have signalled strong interest in the space. Last month, Mastercard announced that it will “start supporting select cryptocurrencies” and create “more opportunities for shoppers and merchants…to transact in an entirely new form of payment.”

Around the same time, Tesla also announced that it will soon accept Bitcoin as payment (shortly after adding $1.5bn worth of BTC to its treasury). Naturally, these were widely viewed as endorsements for the idea that this emerging asset class will play a major part in disrupting the traditional financial system.

This heightened awareness has led to a surge in interest which, in turn, has put pressure on businesses to offer services allowing their users access to crypto.

Say if a consumer is looking for a new bank account – all other things being equal, are they going to choose the option that offers crypto exposure, or the one without? While not everyone will immediately want to explore the crypto space, we’re increasingly seeing that products and services that incorporate crypto are more attractive to consumers.

A focus on security and speed

One of the major benefits of blockchain technology is its ability to enforce systemic transparency, making it very difficult for fraud to go undetected. The open and decentralised nature of public blockchains means that transactions are tracked from start to finish, network-wide, removing any doubt around the provenance of funds, as well as removing the need for an intermediary. Additionally, chargebacks are technically impossible, as all transactions are final and immutable.

A key pain point for businesses operating within the traditional financial system is that money transfers typically take hours or days, are labour-intensive, and expensive. Blockchain technology can cut transaction times from days to seconds, and fees from dollars or even hundreds of dollars to fractions of a cent

For businesses in the financial services space, speed and safety are both paramount — yet they don’t often go hand-in-hand. For an industry that largely relies on outdated, slow and clunky legacy systems, the infrastructure that MoonPay and others offer can be a game-changer. Speed and costs can be lowered without compromises in security, all to the benefit of their users.

Access to emerging markets and trends

Given most cryptocurrencies are hosted on decentralised ledgers, users don’t need a traditional bank account to be able to access or engage with them — access is open. Many perhaps don’t see this as an important differentiation point in more developed economies like the U.K or U.S. where banking access is prevalent, but the reality is that an estimated 1.7 billion people are classed as ‘unbanked’ worldwide and don’t have the opportunities that we are so fortunate to have.

Crypto is fundamentally open and accessible, and as it becomes more mainstream, businesses can begin to offer much-needed services to markets that have previously been out of reach.

But crypto is more than just a way for businesses to enter new markets it also allows them to future-proof their offerings and increases agility in catering to emerging consumer trends. Recently, a number of entirely new types of marketplaces have emerged – a prime example being NFTs.

NFTs (non-fungible tokens) act as a digital certificate of ownership for any digital asset, such as a Tweet, piece of artwork, or an album, and have very quickly become something resembling a mainstream financial product. Businesses are already starting to cater to this surge in interest in the NFT space.

Taco Bell, for example, just had tremendous success with its ‘NFTacoBell’ collection of taco gifs, with prices reaching more than $3,600 per gif.In the art space, the first digital-only art auction by Christie’s sold its first digital piece of artwork for £50m — people are seeing real value in these digital products. Businesses that have been quick to integrate crypto offerings into their platforms have seen significant surges in revenue, while those that have been slower to adopt may, to some degree, be falling behind.

We’re on the precipice of a new financial age where crypto is a central pillar.

Businesses, large and small, have already started to embrace this new technology, engage with new markets, serve the needs of changing consumer mindsets and ultimately become more profitable. As is always the way, those who are slow on the uptake risk missing out in the long term.

Crypto CFD challenges: Liquidity, counterparty risk, regulation

Crypto CFD challenges: Liquidity, counterparty risk, regulation

“Deliverable crypto is a different matter. When crypto exchanges start being regulated and offering reliable connectivity, brokers still have to make sure that their aggregation software is able to handle cryptos and their infrastructure can ensure timely delivery. Moreover, counterparty risk remains much higher than with a regular forex LP”, said Ms. Zakharova.

Providing liquidity is no easy function to achieve. It requires a combination of capital, technology, and established institutional relationships for successful delivery.

When it comes to crypto CFDs, it means bringing an emergent asset class to the world of contracts for difference products. The challenge became feasible in 2017 as the crypto ecosystem matured to the point even CME Group launched the first Bitcoin futures contract.

FinanceFeeds spoke to Natalia Zakharova, Head of Business Development at FXOpen, a global company that has regulatory licenses in Australia, in the UK, and European jurisdictions, to ascertain her view on the challenges of crypto CFD liquidity aggregation and delivery.

“If we speak about crypto CFDs, I don’t see why liquidity aggregation should be any different than forex. It might have been an issue back in 2017 when crypto CFDs were new, liquidity was thin and demand was huge. These days there is a choice of reputable LPs offering consistent pricing and execution.

“Deliverable crypto is a different matter. When crypto exchanges start being regulated and offering reliable connectivity, brokers still have to make sure that their aggregation software is able to handle cryptos and their infrastructure can ensure timely delivery. Moreover, counterparty risk remains much higher than with a regular forex LP”, said Ms. Zakharova.

Indeed, a number of established prime brokers have launched their crypto CFD offerings, including CMC Markets Connect, Advanced Markets, and B2Broker.

These companies have developed unique products, minding the spread competitiveness, minimal slippage, leverage, and most importantly, market depth with an ever-expanding crypto CFD liquidity pool as the institutional players join the party.

A solid crypto prime CFD solution that ensures the deepest liquidity pool will should aggregate cryptocurrency exchanges and brokers, non-bank liquidity providers, OTC orders of institutional clients, hedge funds, and client-broker orders.

In regard to counterparty risk mentioned by Ms. Zakharova, the irony is that Bitcoin was created with the intent of eliminating counterparty risk with its decentralized and open blockchains.

But when Bitcoin users hand their Bitcoin over to a custodian such as a cryptocurrency exchange, counterparty risk is reintroduced into the system. News that established names such as Goldman Sachs are preparing their crypto custody services are likely to inspire greater confidence in the leveling of the playing field.

Will Crypto CFDs be around for long?

While the industry quickly adapts to the digital asset class, so are the financial watchdogs across the globe, namely the top jurisdictions for CFD trading.

The UK Financial Conduct Authority has imposed a ban on crypto CFD products for retail traders. The ban announcement was issued on 6 October 2020 and retail brokers started to enforce the new restriction on 6 January 2021. The total ban will take effect on 25 March 2021.

“The FCA considers these products to be ill-suited for retail consumers due to the harm they pose. These products cannot be reliably valued by retail consumers because of the:

inherent nature of the underlying assets, which means they have no reliable basis for valuation

prevalence of market abuse and financial crime in the secondary market (eg cyber theft)

extreme volatility in cryptoasset price movements

inadequate understanding of cryptoassets by retail consumers

lack of legitimate investment need for retail consumers to invest in these products

These features mean retail consumers might suffer harm from sudden and unexpected losses if they invest in these products.”

The regulator stated that retail consumers are estimated to save around £53m from the ban on these products.

FXOpen was one of the first FX and CFD brokerages to offer crypto trading pairs, with currently more than 40 cryptocurrency markets in its offering, including Ripple (XRP) which is currently ‘fighting for its life’ amid the SEC vs Ripple lawsuit we have been covering. The SEC claims XRP is a security that was sold in coin offerings. Ripple responded that it never held an ICO. Wherever the case may take us, it is likely to establish a meaningful precedent.

FXOpen announced the closure of all crypto CFD positions for UK retail clients by January 5. Professional clients are exempt from the ban in the UK and FXOpen maintains its crypto CFD offering for customers across the globe.

In the aftermath of the UK ban on crypto CFDs, the trading industry eyes other regulators alike to get a clearer view of what is ahead.

Although the UK is now out of the European Union, ESMA may regard the FCA’s move as an example for its future policy. Australia did draw inspiration from Europe for its restrictions on CFD products coming into effect later this month.

Crypto regulation offers India an opportunity that must be seized

The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, is under review and likely to be tabled in Parliament shortly. The contours of the bill are not public yet. However, market commentary suggests that it will permit the issuance of a central bank digital currency (CBDC) and the use of blockchain and distributed ledger technology that underlies a cryptocurrency. As for private digital currencies, recent comments by finance minister Nirmala Sitharaman indicate that rather than an absolute ban, there may be experimentation, exploration and encouragement of the emergent technology behind these.

Given the rapidly-evolving crypto developments, policymakers and regulators appear to have taken an opportunity to proactively embrace a promising technology. Global use cases are growing, as cryptos go mainstream with widespread applications. Applications of blockchain include its use in ‘regtech’ for regulators to capture and store data, in automated risk management, and for the facilitation of regulatory reporting as well as supervisory processes. Central banks around the world, from the European Central Bank to China’s and Turkey’s, are in the process of issuing CBDCs. This could be done in India, too. A recent Reserve Bank of India (RBI) report on currency and finance for 2020-21 rightfully recognizes the potential of CBDCs for financial inclusion and improving aggregate demand in emerging markets, as also for enhancing the speed of monetary policy transmission. RBI did indicate that a CBDC is a “mixed blessing", as it would risk disintermediation of the banking system.

In this context, any policy, legislative or regulatory approach to private cryptocurrencies must embody the principles or proportionality and proactiveness. When RBI banned crypto purchases through Indian banking channels, the Supreme Court struck it down, stating that while RBI was empowered to regulate cryptocurrencies, such power must be exercised with proportionality, backed by adequate empirical evidence. According to the Basel Committee, among others, the proportionality principle stems from the need to ensure that any state intervention—in the form of rules, sanctions and oversight—is aimed sharply at the achievement of a desired policy objective. A regulatory strategy for cryptos must not be excessive, but oriented towards mitigating the specific risks they present. There are several risks associated with cryptocurrencies, including their lack of backing by a tangible asset. It means they may have no intrinsic value from a traditional perspective, but a virtual market value. Their price discovery is in uncharted territory, which heightens the risk of market manipulation and has implications for consumer protection. They also raise concerns of information asymmetry, hacking vulnerability and fire sales, and thus of potential threats to systemic stability. Some of these risks are unique to cryptos, while others attend other financial products too, but each must be addressed through sound regulation.

RBI governor Shaktikanta Das’s recent statements must therefore be heeded, particularly on consumer protection and financial stability. A report of the Financial Action Task Force (FATF) underlined crypto anonymity and layering as intensifying the risks of money laundering, but the FATF also provides risk-based guidance to mitigate such risks through a combination of traditional and non-traditional methods, including customer identification, verification and transaction-monitoring prerequisites. We need a well-conceived regulatory framework that facilitates transparency, and the responsible democratization of market participants could guard against digital invasion and coercive behaviour. Pre-emptive regulation can monitor and prevent such undesirable outcomes.

A virtual ban without a market-linked regulatory architecture, however, may lead to unintended consequences and prove counterproductive. Research demonstrates that outright bans tend to push an activity underground, which allows for abuse. Further, bans are almost impossible to implement in a digital world where regulatory islands cannot exist. Given cross-border flows, what is needed instead is a multilateral platform for regulation, even as countries protect their own jurisdictions. The absence of this will result in circumvention and cross-border arbitrage.

Cryptocurrencies also present opportunities that the government and regulators must catalyse. There is adequate empirical research on how decentralized, peer-to-peer finance through blockchain-based cryptos can make financial services more accessible, cost effective, efficient and interoperable. The FATF had as far back as 2014 highlighted the potential for financial inclusion through appropriately-regulated virtual currencies. India could use them to deepen its financial markets.

Letting RBI issued a CBDC while limiting or restricting private cryptos is well intentioned from the perspective of monetary sovereignty—the exclusive power of the state over legal tender. Multilateral agencies like the International Monetary Fund (IMF) have indicated that private and public money can coexist, and in complementary rather than contradictory roles. According to the IMF, just as we value innovation and diversity in all spheres, we must do so in the monetary system as well, though without compromising stability.

Public-policy objectives, from consumer protection to systemic safety, can be addressed through micro and macro prudential regulation of private digital tokens, with an eye kept on market conduct, data privacy and operational resilience.

As a matter of good regulatory governance, any legislative or regulatory prescription should be participative. Private cryptos can be tested in a controlled environment, such as a regulatory sandbox or RBI’s Innovation Hub. This would allow the experimentation mentioned by Sitharaman, not only for market participants, but for regulators as well. This will allow policymakers to examine and monitor crypto applications and provide an iterative learning process through which more robust regulations could evolve.

In conclusion, the proportionate, proactive, participative and process-driven regulation of cryptocurrencies will aid the success of Digital India. The regulation and acceptance of cryptos can be done in two stages. A CBDC can mark the start of India’s journey into the world of digital currencies, but must not be an end in itself. Private cryptos may well be sustainable under regulation and could also help the government and central bank meet key policy objectives. Today, India has a chance to be a global leader in framing the regulatory architecture for a new digital world. The democratized and appropriately-regulated use of cryptocurrencies is an opportunity that the country must seize.

These are the authors’ personal views.

Sunil Mehta and L. Viswanathanare, respectively, chairman, Yes Bank and CMD, SPM Capital Advisers; and partner, Cyril Amarchand Mangaldas

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