Numbers go up! You only live once.
That’s two crypto memes to describe how the crypto industry celebrated PayPal’s announcement that, from 2021 onwards, it will enable its 345 million customers worldwide to buy and sell bitcoin and other currencies from their accounts.
Shortly thereafter, crypto euphoria hit new heights when Southeast Asia’s largest bank, DBS, announced plans to launch a full-fledged crypto exchange. The announcement was later removed by the bank, but the crypto community had found enough reasons already to take bitcoin from $10,000 to $14,000 in two weeks.
DBS’ announcement was certainly more surprising for everyone because it referred to the service as a crypto exchange. Unlike Revolut’s crypto trading app that allows Revolut to trade principal for their customers and offset the risk on crypto exchanges making a margin in the process, DBS’ announcement referred to an exchange rather than an app or a feature. Since I witnessed firsthand a different high street banks’ unwillingness to give Coinbase a bank account in 2017, the news (albeit retracted) was as emotional as it gets in a professional sense.
Good for bitcoin?
Commentators on both the pro-coin and no-coin side were skeptical of PayPal’s baby steps. Believers are disappointed that PayPal’s customers can move crypto only inside PayPal’s network (you can’t withdraw or deposit your bitcoin). Skeptics are unsure if PayPal’s crypto integration gave anything truly new to the customers’ payments experience. Some acknowledged that a giant like PayPal could only ever take baby steps and allowing crypto withdrawals from the PayPal network was always going to be too risky from an AML standpoint.
Two fintech commentators, however, got to the crux of the matter, noting that Bitcoin is good for PayPal. First the FT's Simon Taylor pointed out how bitcoin had increased customer engagement for Square’s Cash App, and then Ron Shevlin, writing in Forbes, highlighted that the need to compete with Cash App likely pushed PayPal to adopt bitcoin.
See also: Noelle Acheson - Why the PayPal Rally Isn’t What It Seems
I celebrated the PayPal announcement. too, although for a different reason. The real value of the PayPal announcement isn’t that people will be able to buy and sell crypto. People can buy and sell crypto already on peer-to-peer platforms like Paxful and the numerous global and local crypto exchanges around the world. It’s that a small percentage of PayPal’s 345 million customers will be motivated to learn about crypto, and a large percentage of PayPal’s competitors will be motivated to see the industry in a wholly different light. In combination, these two factors will bring in tens of billions of dollars in retail assets into crypto over the next two years, turning minnows into tunas and tunas into whales.
Now that we know what’s coming, shouldn't we all quit our COVID-era jobs and retire?
No, and here’s why. Where banks go, regulation follows. Outside the U.S., regulators have had a relatively laissez-faire approach to the crypto industry. China and India, which have banned bitcoin or virtual currencies at different points in time, have not enforced such bans in practice. Even the U.S. has been flexible in the interpretation of what are securities and in consumer protection regulation. This is for two reasons. First, most regulators have seen crypto as a fringe pursuit of the nerds. Second, regulators felt comfortable the fiat banking system is not exposed to risks arising from the crypto ecosystem.
Until 2018, regulators discouraged banks from working with crypto businesses. Crypto exchanges adopted stablecoins like tether in 2016-2017 and then broke through the regulatory “fiat-crypto barrier” in 2019 by partnering with small or medium-sized payments companies lacking banking licenses. Today, major exchanges like Coinbase, Kraken, Blockchain.com and Binance have three or four banking partners in major jurisdictions with new fiat-to-crypto payment channels coming online every week. Indeed, banks serve payments that serve crypto but rarely serve crypto directly.
Where regulators draw the line
This is why the DBS announcement is much more significant than the PayPal announcement. We don’t know from the announcement that DBS will hold crypto on its balance sheet. But if the bank is operating an exchange, this is likely to be the case.
Unlike PayPal, which offers mainly payments and small consumer loans, DBS is a bank that takes insured deposits from customers and makes large loans to both individuals and institutional customers. While both are systemically important in different ways, after the 2009 debacle of Lehman Brothers deposit taking and institutional lending activities require compliance with a far more stringent set of prudential rules.
In plain English, this is no longer about anti-money laundering compliance or token-friendly interpretations of securities laws alone. It is about a vast array of risk management requirements and controls that crypto firms do not have to deal with currently. For example, banks have to hold capital and implement a wide array of technology-, cyber- and data-related controls that cost money, personal hours, audits and processes, which mean lower profits and slower changes. Swiss crypto banks, which were the first to hold crypto on their balance sheets, are required to do everything that banks do and crypto firms just don’t.
Let’s make this simple again. Where banks go, regulators follow and bring the entire mountain of compliance and risk management requirements with them. So when banks start offering crypto services, not only will banks be asked to apply all of the banking regulations to crypto, crypto firms will also increasingly be asked to apply banking regulations.
Seasoned bankers like Caitlin Long understand this dynamic and have worked very hard to both influence regulators and bring banks to crypto firms like Kraken. Two of the large crypto firms for which I have consulted have sought to acquire banks and have been held off only by the sheer cost and effort of complying with banking regulations.
Now that cat has left the bag and there’s only one way this story ends. Over the next five years, most crypto firms will become banks and banks will become crypto firms. There is not going to be a fiat industry and a crypto industry. There will be only one banking, payments and capital markets industry that serves both fiat and crypto.
What this means for crypto
Four things: First, for consumers it means less risk and better standards of asset protection and consumer protection. When KuCoin got hacked, there was no major regulatory response. But if KuCoin was a U.K. bank and had got hacked, we’d have had an army of auditors looking at every paper inside the bank and announcing a major fine and a new set of controls.
Second, it means much lower profitability in crypto and fewer, higher-quality assets. Today, a developer can launch a borrowing and lending service with no know-your-customer compliance, no capital, no risk management and no personal liability. Such a token gets listed promptly on exchanges and, if it goes to zero in two weeks and customers are REKT, there’s no action from the regulators. Once banking rules apply, such an enterprise will be promptly shut down. Essentially the cost of launching new services, i.e. innovation, will go up by 100x slower. More expensive innovation is what we pay as a society for consumer protection and lower systemic risk.
See also: PayPal archives
Third, the overnight returns and venture cycles in crypto will get aligned with the long eight-year venture cycle in the rest of fintech. Harvest Finance, which was recently manipulated out of $24 million in customer funds, was quite fond of describing how its deposits grew much faster than Monzo. What the Harvest Finance team clearly doesn’t understand is the cost of simply launching Monzo is approximately $50 million to $100 million, whereas the cost of launching Harvest Finance is two guys living on ramen noodles in a garage. Further, Monzo is not allowed to lose $24 million in customer deposits and get away with a mere apology on Twitter. In the U.K., Monzo executives can actually be sanctioned and penalized for that sort of failure under the U.K. “senior manager” regime.
Fourth, if everyone is a bank and there are far fewer assets to trade at much higher cost, everyone except bank execs will make a lot less money, and those who lose today will lose a lot less. There will be far fewer exchange hacks, rug pulls, cottage industry scams and other such reminders of the pre-1934 Wall Street.
Is the crypto party over now?
No, in fact it’s just about to get much bigger but less entertaining. Banks won. Crypto believers might feel they have occupied Wall Street, and we might indeed have for some time, but the converse is now becoming true. Banks will increasingly occupy Crypto Street instead. If the announcement by the Securities & Futures Commission of Hong Kong on Tuesday is any indication, the era of crypto firms operating without licenses, registrations and the full weight of compliance and risk controls ends in a few years. Crypto firms like Coinbase, Kraken and Binance, which seem to be taking active steps to get ahead of this convergence and obtain payments and banking licenses, will win big and those that don’t will find it rather difficult to survive as independent businesses beyond 2025.
You live only once! Become a bank.