This year, crypto adoption in mainstream fintech has accelerated sharply. PayPal (PYPL), Revolut and Square (SQ) made much discussed moves. Recently, AllianceBernstein, a highly respected independent research house, published a report stating it has “changed their mind about the role of bitcoin in asset allocation.” And Rick Rieder, BlackRock’s chief investment officer, went on record on CNBC the other day to say that “bitcoin could replace gold.”
The crypto industry is prone to announcements about future announcements. In 2016, these announcements used to be “blockchain” proofs of concepts that were never intended to see the light of day. And in 2020, these could just turn out to involve banks paying lip service to crypto to look innovative and avant garde.
But, while crypto believers like me have a tendency to selectively hang on to the positive parts of these announcements, institutional endorsements of crypto are not insignificant. At a minimum, it’s clear that most major investment banks are now covering bitcoin for their clients and a large number of corporate and retail banks are furiously exploring how they can take advantage of the commercial opportunity presented by this level of retail and institutional interest in crypto.
On a recent Citi Digi Money client podcast, Citibank Research’s Ronit Ghose asked me if crypto is finally going mainstream and if it’s time for banks to adopt crypto. While I don’t have access to the original recording or transcript, I have tried to summarize my analysis here.
The future of money
The fundamental question regulators and banks need to ask is not whether bitcoin will go to $50K or $500K or whether the U.S. dollar will crash next week. It’s "what will payments and investments look like in the future?" How will consumers experience "money" and how will such a system of money and finance be governed and supervised?
As my good friend David Birch has highlighted in his brilliant book, “The Currency Cold War,” the future of money will be built not with cards, SWIFT messages and interchange fees, but with programmable tokens, networked services and intelligent wallets.
To state his case in my own examples: If my son wants to pay for digital goods on his Xbox, my wallet will automatically use Fortnite V-Bucks. If I am paying for groceries, the mobile wallet will automatically select Tesco reward points accumulating tokens. A JPMorgan equity token will automatically send me the dividend as Britcoin (GBP) on schedule and DalioCoin held in my neighbors’ trust fund will automatically be locked until an edtech oracle attests that their privileged child has safely landed at Harvard, at which point the token will start releasing FedCoin for his or her socials and boat rides, no questions asked.
This synthesis of crypto and the mainstream financial system towards this future of money is what we all must keep our eyes on. That is the big picture.
To get there, banks have a steep learning curve to climb and crypto and DeFi provides precisely that learning curve today. Banks that jump atop the crypto train will find untold prosperity in the digital frontier, and banks that fear of the unfamiliar will be lost forever in the wilderness. Resistance is futile and the time for doing nothing with crypto was two years ago, not today.
Let’s dive further into how the world of money is changing today and what it means for banks.
Crypto has found real world utility
Critics still say that crypto has no utility other than speculation. I don’t know if bulls**t is a printable word, but that is indeed what that criticism is. There are at last four distinct use cases we can identify in the real world.
First, if we look at economies like Nigeria where central banks are unable to provide sufficient dollar liquidity to small and medium businesses, such trade is often facilitated by bitcoin. In effect, bitcoin has partially displaced the U.S. dollar as the currency of foreign trade and unless there’s digital dollar liquidity made available without the current tyranny of geopolitical sanctions, the digital yuan will likely do so completely in the future. This thesis deserves an entire article of its own and I will take the subject on in the near future.
Second, in countries like Argentina or Lebanon, where there is no social security net and the domestic currency is highly unstable, bitcoin has provided a “digital money mattress” for hundreds of thousands of consumers. This is a real, humanitarian use case that can be difficult for Western Europeans or Americans to relate to.
The third use case is exchange of value among internet-based communities or what I call “Burning Man Money.” Historically we have built money for a world that’s geographically divided but that's not the word we live in anymore. Around two billion people live in internet-based communities that require internet-based money to exchange value. Often these digital natives interact with their internet friends on the other side of the planet much more often than they interact with their next-door neighbors. Gamers understand this use case better than anyone and the rest of us are increasingly beginning to.
The fourth and most important use case is decentralized, internet-based finance. Measured even by a blunt metric like TVL (total value of crypto assets deposited), DeFi is now a $15 billion economy growing rapidly month on month. This is the main reason banks need to integrate crypto – to learn and prepare for rapid disruption. DeFi is integral to the future of money in that DeFi replaces fire-walled financial services that use fire-walled money with networked financial services that use networked internet money. Those who understand the internet understand what this means.
Regulators have shifted
When it comes to regulation, we are not in 2019 anymore. The education and advocacy work we did as a community between 2015 and 2019 has helped regulators see both the inevitability and the economic benefits of internet based money and finance.
I categorize regulators in three overlapping buckets. First, there are regulators that tend to offer a knee-jerk reaction to crypto and say, "This is not money we understand, this is not money to be controlled, so we have to shut it all down.” These regulators actually try to enforce draconian regulations with little nuance or discretion.
The second and most common bucket is the regulators who are afraid of the uncertainty created by technology led disruption, but they recognize that there is a genuine consumer need for decentralised internet-based money. For example, regulators in Nigeria, India and China have made strict pronouncements to protect consumers from scammers like PlusToken and OneCoin while rarely enforcing the rules against businesses built on decentralized assets like bitcoin or ethereum.
The third bucket is forward-thinking regulators who understand that crypto innovation is a source of competitive advantage for the financial system they are supervising. Literally every regulatory body I have interacted with over the years has at least one or two forward-looking visionaries like the Securities and Exchange Commission’s Hester Peirce or the Office of the Comptroller of the Currency’s Brian Brooks, who have been engaging proactively with the industry to create a safe environment for crypto innovation to deliver consumer benefit.
Regulators are competing for innovation
Unlike the neolithic payments systems of the U.S., the European Union and India have shown that instant and free domestic payment systems like SEPA and UPI can be made to work well with existing technologies and frameworks. However, point-of-sale experiences remain firmly stuck in plastic and interchange fees and cross border payments remain a profound embarrassment for the entire global financial system.
In Europe, we have tried to solve these problems by creating a rule, committee or think tank. Initiatives such as the EU-wide Payments System Directive 2 have been delayed or thwarted by legacy institutions often on account of somewhat valid cybersecurity and fraud related concerns.
In the middle of all this analysis-paralysis, there’s stiff competition for innovation. While the West tries to regulate, the East continues to innovate. On their own, bitcoin and cryptocurrencies may not have been enough of a wake-up call for Western regulators. But China’s central bank digital currency, i.e., the DCEP (or Digital Currency and Electronic Payments) system has forced the issue on digital money. U.S. and European regulators recognize that if the future of money is Chinese, then China will be the power that dominates trade and military power.
China’s DCEP is a particularly interesting case because earlier this year U.S. sanctions practically debilitated Huawei. As a result, China recognizes it can no longer rely on an international system of money controlled by the U.S. or a domestic system of money controlled by Tencent and Ant Financial. Where does that leave a political system where the government is supposed to control everything? If it doesn't control the money, it doesn't control the payments, it does not have access to transactions. China’s DCEP is not an experiment; it’s imperative.
Now that the China fintech FOMO trumps crypto FUD, regulators are taking a very different approach to crypto. The regulators are saying, "Look, if this thing is going to happen anyways, then we might as well bring it into a banking framework and regulation as opposed to saying, let's keep this crypto thing out into an unregulated sector of money." This is why the Bank of England’s Deputy Governor Jon Cunliffe recently pronounced that “it is not the job of the regulators to protect banks against digital currencies.” He will ultimately prove to be the first of the many to say central bankers that out loud.
No one’s money
So whose money will we use as a settlement currency in a bipolar, or even multipolar, world? China’s money or America’s money? Odds are that we will need money that’s controlled by neither. That money is crypto.
Bitcoin was originally built to serve as peer-to-peer electronic cash, but bitcoin is not cash because it's not fungible. Further, bitcoin needs layer 2 solutions to process large-scale, internet-based payments. Banks and payments companies can help solve this challenge. If I want to move my bitcoin or pivot in a closed loop system where my bitcoin addresses are in two addresses within the same entity database, like PayPal, that you don't necessarily need to move money across a blockchain, you can settle on a blockchain on a deferred basis. This way, Bitcoin or Ethereum can enable a cross-border, global settlement layer that allows cross-border transactions using digital assets that no sovereign state or private company controls. This trustless settlement layer is a necessity of a bipolar world where the U.S. dollar is no longer acceptable to other powers, e.g., China, as the only settlement currency.
Crypto is the gateway
Fortunately, in the West, we still have free-ish markets where consumers and entrepreneurs do not wait for rule-making to make the world a better place. Crypto is changing as well. Crypto started with this vision of no credit, no debt. Some bitcoin maximalists naively believed that everyone was going to live off of bearer assets, but credit is fundamental to society and money. So crypto exchanges and firms like BlockFi ended up creating lending experiences that are not so different from the experience of fiat money-based services we receive from intermediaries today but they are a start.
Like the rest of fintech, DeFi is not new finance. It’s a preview of the future of finance as the future of money is realized. Unlike fintechs who have been busy launching wooden and metal cards, the once ignored crypto fringe has moved rapidly towards programmable money tokens. More recently, intelligent agents like Yearn Finance, Aave and Nexus Mutual have started building financial intelligence, banking functions and complex claims directly into such tokens. At the same time, wallet providers like Coinbase, Metamask and Argent have started to enable access to sophisticated functionality provided by DeFi services. In a few years when the technology has evolved further and risk frameworks governing these decentralized protocols have matured, the 100x better experiences provided by DeFi will make it impossible for legacy systems to compete for consumer engagement or share of wallet.
That is the future of money and it's happening right here, right now. Forced by customer demand for crypto, this is the future of money towards which Square's Cash App, PayPal and Revolut have already taken the first step. If banks want to take their eyes off of this Napster movement, they will go exactly where Columbia Records and Blockbuster video went eventually – into profound irrelevance. Resistance is futile but it’s a choice, not destiny.
Where should banks start?
The key for banks is experiential learning. They should start immediately by licensing technology and services from crypto custodians and offering digital wallets that provide integrated access to crypto and fiat money. This is something that Revolut has done particularly well using partnerships with custodians and exchanges. It's not hard for banks to copy quite quickly subject to regulatory permissions and compliance approvals which can take time. This is like providing a locker for digital gold in the same way that banks provide lockers for jewelry and property papers today, just that these are going digital, starting with digital gold, i.e., bitcoin.
The second step is to partner with crypto and DeFi startups, even if it’s in a learning or sandbox environment and experiment with programmable, digital money and wallets. What does this experience of self custody, or consumer controlled assets look and feel like? How do peer to peer, mutualized, permissionless, internet-based services work? What possibilities for automation, efficiency and transparency do such decentralized financial services present? This is an important learning exercise for DeFi innovators as well.
The third step is to move from proprietary walled garden solutions to permissionless blockchain solutions. Permissioned ledgers were a good step for banks to experiment with shared operating models built on shared data and shared logic. That ship of “less closed but not fully open solutions” has now sailed. Now it’s time to take all that learning into an open, internet environment.
Overall, to survive, banks have to go beyond superficial mobile apps and design payments and banking experiences for a far more internet savvy consumer who is ramping on to networked services that use programmable money. This is why integrating cryptocurrencies into banking apps and services is critical. A really good time for banks to start was last year. The next best time is today.
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