Cryptocurrencies are enjoying a boost in mainstream popularity and acceptance. Once spurned by serious investors as too unstable to trust, or even as inherently worthless, crypto is finding favour with governments and financial institutions as they seek to explore a world of payments and transactions outside of the traditional banking system. 

There are a number of drivers behind this turnaround from pariah status to legitimacy. For one, crypto in general and leading currency Bitcoin in particular have had a good pandemic. As economies locked down in early 2020, predictions that Bitcoin’s time had arrived as a safe investment haven looked ill-founded as its value crashed alongside that of other assets and markets. Then it bounced back, much faster than regular currencies, and has remained fairly stable, shedding much of its reputation for volatility along the way. 

Along with this phase of steady success has come greater awareness of the virtues of crypto outside of the clique of risk takers and serial early adopters that have been its main backers to date. Regular citizens are starting to buy into it, especially in developing regions where traditional banking is often not available or not trusted, places like Africa, Asia and South America. Central banks from Brazil to South Africa are acknowledging its viability. 

Regulators for their part have moved on from treating it with the greatest possible suspicion to trying to bring it within their jurisdiction in some way. An example of this is the European Commission which has adopted a Digital Finance Package by way of refining its legislative stance on crypto-assets and digital resilience. The FCA is talking about something similar. Tighter rules may be on the way for something that was always intended to be beyond regulatory reach, but that may simply be the precursor to even wider acceptance.

One thing is for certain: as the gulf between crypto’s proponents and detractors narrows, and as its popularity extends into new areas, traditional financial institutions have questions to mull over. Do they continue to maintain the position that crypto is a threat to the traditional bank sector and to the status quo of capital markets? Or do they find a way to embrace it and to profit from it, leveraging their unique strengths along the way?  

Let’s start with the question of why banks might be interested in embracing crypto. If crypto had a buoyant time during COVID, banks did not. While they may have enjoyed a post COVID M&A boom with record revenues, this is not considered sustainable looking forward.. Capital ratios are down and threats to solvency are higher than at any time since 2008. Some are saying COVID’s impact will in fact outweigh the disastrous impact of that epochal crash in the long term. Interest rates remain subdued. Growth is slow. The future is not especially rosy, and new ideas are needed.

It is partly in response to this worrying scenario that banks are pushing aggressively ahead with the digital transformation of their processes and structures. A positive stance on crypto should be seen as very much in keeping with this drive, leveraging some of the gains already made in areas like digital resilience, blockchain and GRID and the deployment of AI, ML and advanced analytics to improve the customer journey and beat back the threat of money laundering. 

The huge investment that banks have already made in digital technologies and capabilities gives them the ideal set of capabilities to extend into new markets and product areas previously deemed too risky and unmanageable to track. Crypto is one such market. The trick is to find a way to engage in this new market whilst sustaining the competitive advantage they enjoy over disruptive digital rivals in areas like security, compliance, risk analysis, scale, experience and reputation.

Digital twinning, something that many banks have already explored as a way to road test innovative ideas, looks like a great tool for exploring the opportunity presented by crypto without adding to existing risk profiles. Using a digital twin of their business could give institutions the ability to demonstrate to central banks and regulators how they and their clients would potentially lose or gain in multiple crypto scenarios. The virtues of tether crypto, for example, could be showcased to show how volatility can be controlled. Banks could safely create and then try out a set of crypto products, presenting them as so-called Institutional DeFi, in other words blockchain-based financial products tailored for institutions that are governed by strict compliance rules.

Digital twinning lets them ring fence their market exposure, while at the same time letting them demonstrate how their traditional strengths could be of value in a new digital world. They have proven knowledge of KYC, as well as expertise and experience in dealing with AML and fraud. In fact, traditional banks could argue they are better placed than anybody to develop and deliver safe and effective crypto solutions. 

There has never been a better time for banks to explore this exciting opportunity - ideally in partnership with another party able to bring experience of analytics, digital twinning, blockchain, algo trading and a track record of innovation in financial services to the party. Better to make the move now ahead of rivals than to wait until they are left behind in the wake of other people’s crypto success.