Digital money is the future. Opportunities and risks of crypto banking.
Crypto currencies are enjoying huge popularity, but what does the growing trend towards digital money mean for financial institutions? On the 8th Credit Suisse Cash Day, experts discussed the challenges posed by crypto banking in Switzerland.
Digital money is on the rise.
The money of the future is digital. While the use of cash is becoming less relevant, cashless payment methods – driven by e-commerce and mobile transactions – have continued to gain ground during the COVID-19 pandemic.
Leading the way among these exciting new media of exchange are digital assets such as cryptocurrencies (e.g. Bitcoin, Ripple, and Ethereum). In addition they include stablecoins, the market value of which is linked to one or more fiat currencies. Furthermore, central banks are exploring and discussing digital versions of their fiat currencies – or central bank digital currencies (CBDCs). Thanks to shared distributed ledger technology (DLT), digital assets can be transferred worldwide without the involvement of a commercial bank.
"Digital assets are not only used as a means of payment but also serve as an alternative asset class," explains Burkhard Varnholt, CIO of Credit Suisse. In light of these two key functions, it's important for financial institutions to engage with crypto banking in Switzerland in order to avoid risks and exploit new opportunities.
What risks do financial institutions in Switzerland face in relation to crypto banking?
Thomas Weisshaar: Digital assets are highly volatile. In addition, there's a risk of them attracting criminal activity – and indeed sanctions are a possibility in some circumstances. Nor should we ignore the vast amount of energy consumed by the blockchain system. That means cryptocurrencies are inconsistent with ESG* sustainability and cannot be incorporated into sustainable investment strategies. In addition, there's still no set of generally applicable regulations and nor is there full transparency.
Dr. Sébastien Kraenzlin: For the traditional business, the danger posed by digital assets lies in the inefficiency of the current payments system. Fact is, payment transactions are the single biggest reason for interaction between a bank and its customers. Since the transfer of digital assets for cross-border transactions takes just a few minutes and there are no high fees involved, the process seems to be a straightforward alternative. Established financial institutions need to be aware of this challenge and seek to improve existing market infrastructures.
* The abbreviation ESG stands for Environmental (E), Social (S) and Governance (G).
Of all digital assets, cryptocurrencies are the means of payment most often associated with illegal transactions and criminal activities. Won't such activities get a further boost from crypto banking?
Daniel Diemers: I wouldn't put it quite like that. The blockchain constitutes an unchanged account – meaning transactions using digital currencies can be traced back more easily than if they had taken place using a fiat currency, for example. In addition, there are now numerous regulations designed to protect investors and safeguard market integrity. In Switzerland, for example, there's also a DLT Act.
Urs Bernegger: Criminals will also find it increasingly difficult to get rid of the bitcoins they've accumulated. Where digital assets were used to make payments in relation to illegal transactions, it's no longer possible to use them to open an account with a bank. That's because the bank not only obtains the personal contact details of the person involved but can also view their wallet.
What opportunities does crypto banking offer for financial institutions?
Mathias Studach: Access to virtual currencies is still highly complex and involves various risks. Many investors don't know how to invest in digital assets. If we manage to simplify the purchase of digital assets as well as the trading process for clients, this will create an exciting opportunity to tap into a new alternative asset class.
Urs Bernegger: The tokenization of assets and other means of financing likewise presents a great opportunity. Fact is, a token is divisible, cheaper, and easier to trade. This would make it much easier to transfer money between individual banks. I'm convinced central banks will start to use digital currencies as a clearing tool in the near future.
How will digital currencies and tokenized assets change the banking model of the future?
Urs Bernegger: Cryptocurrencies have shown that it's possible to transfer digital assets easily and quickly via the DLT system. Digital assets are therefore likely to continue growing in importance. This has already been recognized by central banks and the Swiss government. Financial institutions therefore need to learn how to use distributed ledger technology to manage assets correctly via the blockchain.
Dr. Sébastien Kraenzlin: Financial institutions could change their role and become a bridge between the "new world" surrounding the DLT infrastructure and today's world. This would ensure the banks continue to play a central role, for example in relation to payment solutions and regulatory aspects.
How will financial institutions succeed in bringing the two worlds together?
Dr. Daniel Diemers: Various factors need to be considered, and banks need to be active on several levels at the same time. First off, they need a targeted strategy if they are to become established in the digital assets space. A large number of technical adjustments – including an upgrading of legal risk compliance – are also required. It will also take a cultural shift within the bank itself – that means tackling and dispelling any worries and concerns about digital money. As bank customers come to expect digital assets in the form of crypto currencies, tokens, and other assets in the future, financial institutions will have little choice but to embrace this change.