By Alex Batlin is Founder & CEO of Trustology
Last month, US officials gave the go-ahead for all nationally chartered banks in the US to provide custody services for cryptocurrencies, previously reserved for specialist firms. Now national banks will be able to hold digital assets for their clients, as well as hold onto the unique cryptographic keys for a cryptocurrency wallet. So what does this mean for both crypto and traditional investors? How does this now impact the business models of entrenched institutions — a beneficial revenue stream or too costly? And what can specialized crypto custodians offer that banks can’t? Alex Batlin, CEO of Trustology, explores.
The green light for bank-based crypto custody came in an interpretive letter from The Office of the Comptroller of the Currency (OCC) in July. In a significant milestone for the crypto industry, the OCC stated that federally regulated banks could start providing banking services to cryptocurrency startups, as well as custody of private keys. However, banks have a long way to go until they can meet the standards required of the cryptocurrency industry. Crypto, after all, is an entirely different ball game to traditional fiat custody.
Getting Accustomed to Custody
No two cryptocurrencies are created equally. The ecosystem contains a diverse range of tokens and coins with different use cases, features, and characteristics. Not only can you tokenize existing asset classes like securities, but there is also a whole new set of asset classes such as virtual currencies that banks’ compliance teams will need to grapple with. Add to that the fact that crypto assets are typically cross-border with a mix of regulated and unregulated participants, and it only heightens the complexity. And then there is settlement risk which currently poses a significant hurdle for market participants. This is where banks hold an advantage. They can adapt existing clearing and settlement processes to crypto assets — especially when it comes to trading hours.
What could be problematic for traditional banks, however, are traditional asset servicing functions which are turned upside down in crypto markets. Much of the crypto sector’s operational procedures are automated via smart contracts posing a new challenge to banks alongside that of key management, transaction signing, and operating blockchain infrastructure, such as nodes.
And then there’s the matter of business models. The entire value proposition for digital assets differs drastically from fiat. The crypto sector’s favoring of disintermediation means that many traditional revenue streams, such as charging interest on fiat loans and fees for services provided, may no longer be viable in the new regime and ecosystem. If the success of crypto continues, then these old revenue streams may disappear entirely. This is especially being evidenced today with quantitative easing and fiat devaluation.
A major hurdle, however, is that digital asset technology goes slightly beyond what traditional banks are accustomed to with fiat custody. Key pair management, encryption, and cybersecurity controls are just some of the fundamental safeguarding measures expected of crypto custody that banks are accustomed to — but blockchain is a game-changer when it comes to the way the data is recorded, with many complex nuances that banks will need to readjust to in order to successfully transition.
When faced with new opportunities like crypto and blockchain, banks are left with a few options — namely build, partner or buy. Either they build infrastructure in house from scratch, acquire it, or integrate with an already established crypto custodian and make use of their infrastructure. The latter is the most likely route, simply because it’s the most cost-effective and requires the least amount of lead time. Build options tend to require long lead times for entrenched banks.
Integration also allows banks to harness the years of experience of existing crypto custodians, as well as the safeguards and controls they allow. Given the acceleration of the sector and a projected market cap of $3.6 trillion by 2028, it’s a highly competitive market segment. This being the case, partnering to combine custodial technology already in operation with the existing systems and processes of banks, may be the ideal scenario for first movers.
Taking Custody of Crypto
Akin to cryptocurrencies, not all crypto custody is born equal either.
There are several different methods of securing private keys. The leading distinction between crypto custodians is the choice between cold wallet storage and hot wallet storage. Cold wallets provide more physical security, as they’re held offline, but often render a slow rate of transfer. A hot wallet, meanwhile, provides almost instantaneous access but has greater propensity for cyber attacks due to internet connectivity.
And then there’s the choice between different security technologies, such as simply storing private keys in an offline vault, i.e. cold storage, or more sophisticated solutions, such as hardware security modules (HSM), multi-party computation (MPC) or smart contract-based wallets. Each of these technologies comes with its own set of pros and cons and is at a different stage of maturity.
Cold storage was initially used by many exchanges and custodian wallet providers as it was the only option that could be insured, but its reliance on physical access to private keys for every transaction made it too slow and too expensive as high-frequency margin trading replaced long-only strategies. Also, the use of omnibus versus segregated account structures — forced by the high cost of physically managing keys — led to a lack of transparency as owners could not independently audit their balance and so reintroduced accounting reconciliation costs and balance sheet ambiguity.
Smart contract wallets support multisig, but only by using smart contract code, which means they are limited to specific blockchains, e.g. Ethereum. They also don’t support KYC/AML due to privacy issues, e.g. exposure of private data on the blockchain. For institutional investors and funds looking to stay compliant or scale, this wouldn’t be the ideal solution. In principle, one could build a smart contract wallet utilizing an oracle network, but this exposes even more data on the blockchain, such as whether the account is custodied or not.
HSMs, as their name suggests, differ from MPC in that they involve physical hardware devices. Perhaps the most ubiquitous of all custody solutions, HSMs create and store the private key within secure element chips to isolate and protect from attack vectors, such as man-in-the-middle attacks. While extremely shielded, HSMs do have some inherent latency issues due to their need to connect devices when transacting. This is exactly the same technology used by SWIFT networks and banks for several decades now.
Some firms choose to evade the individual pitfalls of these methods and consolidate both hot and cold wallet characteristics with HSM or MPC. By employing an amalgam of front-end software combined with end-to-end hardware security, custodians can provide a fully automated process that both lessens third-party risk and reduces transfer delays. Combined with multi-sig and other controls such as whitelists, biometric verification, and insurance, some custodians go the extra mile to ensure that not only are private keys secured but that users have the utmost control.
Custodians are even starting to dip their toes into the decentralized finance (DeFi) sector. The division has blossomed into a $7 billion industry in the past few years — with most of that value captured in the past few months of 2020 alone.
Now, with interest burgeoning, custodians are starting to offer users secure access to the sector, supporting investors across the entire spectrum of activity — be it within safekeeping assets, transacting on-chain, on-exchanges, facilitating settlement, or when using DeFi protocols across blockchain ecosystems.
Entry to DeFi enables brokers access to the sector’s liquidity, lending, and borrowing capabilities. And banks would be remiss if they didn’t follow suit.
Though, once again, the existing technology of established custodians will play a major role here. Expertise beyond managing keys and transactions is required to support a wide variety of financial protocols for a large spectrum of crypto assets inclusive of the DeFi sector, which is where custodians hold an advantage. At present, custodying private keys across separate blockchains is a logistical nightmare. Some custodians offer multi-chain support, overcoming the issue via re-signing technology, which enables fluid transactions between multiple DeFi ecosystems.
With the technology and regulatory obligations in place, the impacts of bank-based digital asset custody on the crypto sector are likely to be vast and wholly positive. One major blessing for the nascent space comes in the form of legitimacy via regulation. As traditional institutions ready to enter the market, we can expect a significant uptick in regulatory development. We have already witnessed this via a raft of new regulations, such as 5MLD, which has freed up opportunities for German financial institutions in offering crypto services. And now, with affirmation from the US SEC, American banks are looking to follow suit.
Consequently, as regulation matures, the more risk-averse banks, reticent to enter at the beginning, will join the fray. As a knock-on effect, traditional buy-side companies, such as hedge funds, endowments, and family offices, will likely feel comfortable enough to allocate a percentage of their assets to crypto and even test the waters of DeFi themselves.
As crypto custody becomes a reality for US banks, eyes will undoubtedly be set on the South Korean institutions already in the process of unrolling crypto-asset custody. Kookmin Bank (KB), one of South Korea’s largest commercial banks, unveiled plans for a digital asset custody subsidiary, dubbed KBDAC. Their nearest rivals, Nonghyup Bank (NH), has also announced it will launch custody services for institutional investors, following a new legislation amendment introduced in March 2020.
However, as KBDAC inches closer to launch, South Korea’s new stringent anti-money laundering laws threaten to hinder operations as the costs of compliance leans against profitability. This issue could resonate in the States as well, particularly impacting small and medium enterprises looking to hop on the custody train.
In any case, for effective custody to be pulled off, banks, both big and small, will need an established tech-focused custodian to ensure safe entry — especially if the goal is to maintain both safeguarding and control, as it should be.
How open banking can drive innovation and growth in a post-COVID world
By Billel Ridelle, CEO at Sweep
Times are pretty tough for businesses right now. For SMEs in particular, a global financial and health crisis of the sort we’re currently witnessing represents a truly existential risk. Yet there is hope of a brighter future. Digital transformation is already helping organisations in countless sectors, with everything from building supply chain resilience to rolling out potentially life-saving contact-tracing schemes. Yet it’s not just delivering transformative benefits in grand projects like this.
Thanks to open banking rules, a new wave of fintech innovation is sweeping the globe, offering business leaders a new launchpad for success. Even something as simple as corporate expenses can be transformed by the power of open data — to help firms cut costs, reduce fraud risk and become more productive.
Opening up data to innovation
It’s easy to get bogged down in the technical details of open banking, and the slew of new acronyms it has ushered in: Third Party Providers (TPPs), Account Information Service Providers (AISPs), Payment Initiation Service Providers (PISPs), and Application Programming Interfaces (APIs). Yet at the heart of the open banking revolution is a simple concept: the idea that forcing banks to open up their customers’ financial data will create more competition, and fresh opportunities for market entrants to create innovative new services.
This was at the heart of the UK government’s world-leading strategy when it was introduced back in 2016. A revised EU payment services directive (PSD2) gave it legal teeth, mandating that all payment account providers in the region provide third-party access for customers that want it. The push is also about reducing banking fees and enhancing financial inclusion, of course, but it’s in competition and innovation that the benefits really shine for businesses.
Access to real-time financial data via open APIs has already resulted in a range of new services which are helping businesses ride out the current economic storm. Whether it’s capabilities that can help freelancers prove loss of income to receive targeted loans, or services designed to streamline business processes to reduce costs and fraud — examples of innovation are endless.
What’s more, it’s already global. Aside from the PSD2, open banking rules are taking shape in Australia, New Zealand, Japan, Singapore, Hong Kong, Mexico and elsewhere. According to frequently cited Gartner predictions, regulators in around half of the G20 countries will create an open banking API regime over the coming year.
In the UK alone this is set to create a £7.2 billion revenue opportunity by 2022, with 71% of SMBs and 64% of adults expected to adopt it by then, according to PwC.
Making expenses pay
Corporate expenses and travel management might not be an area one immediately associates with high levels of innovation. But here too, open banking is having a profound impact. By combining automation, in-app approvals, integration with corporate policy and secure open banking APIs, companies like Sweep are offering new ways to solve old problems.
Part of the legacy challenge relates to productivity. Managing corporate travel costs and expenses was cited last year as the biggest concern of the UK’s small and mid-sized firms. Separate research claimed that SMBs are estimated to lose over £8.7 billion annually due to the time it takes employees and managers to complete these menial tasks. By automatically integrating real-time corporate bank account information into an easy-to-use app, we can save up to 15 hours a month on data input and travel administration per employee. That’s all time they could be spending on growing the business.
Another key area of concern is fraud. According to some estimates, fraudulent expenses claims could be costing UK firms £1.9 billion each year. In the US, the figure could be approaching $3 billion annually. Whether it’s the result of submitting expense claims for personal purchases, claiming for additional mileage on work trips, or over-claiming for other items, it all adds up. What’s more, fraud tends to spike particularly during times of recession, when normally diligent employees look for ways to supplement their income.
In this use case too, there are benefits to be had from open banking-powered solutions. Traditional manual processes offer too many gaps that can be exploited by fraudsters. Submitting paper receipts to finance departments — which must then input the information into spreadsheets or accounting software — is slow, error-prone and lacks accountability. However, with modern digital systems, transactions are automatically fed through from bank account to expense management platform. Here they are seamlessly checked according to policy and automatically approved, rejected or flagged for further investigation.
The future’s open
Thanks to the power of open banking, innovative fintech use cases like this are transforming operational challenges into opportunities to cut costs and fraud risks, improve employee productivity and become more strategic. With real-time data fed through from corporate bank accounts, finance directors can better understand spending patterns, react with greater agility and gain the insight they need to run their businesses more efficiently.
So what of the future? The good news is that open banking is only just getting started. As more sophisticated machine learning algorithms are developed, it has the potential for even greater disruption by empowering SMEs with predictive analytics and forecasting tools, or more accurate fraud checks, for example. Those in Europe may benefit most as PSD2 allows businesses to use tools that work seamlessly and securely across markets, without requiring any duplication of work.
In fact, open banking is not just good for individual SMEs, it’s important for Europe as a whole if we are ever to nurture successful digital unicorns to compete with those coming out of the US and China.
Open banking been described in the past as a quiet revolution. With the right buy-in from business and the continued innovation of digital platforms, it may soon become a full-throated roar.
Banks take note: Customers want to pay with points
By Len Covello, Chief Technology Officer of Engage People
‘Pay with Points’ – that is, integrating the ability to pay with loyalty reward points directly into the online check-out process – is a trend that is growing exponentially with big-name brands like Amazon, PayPal and American Express leading the way.
The past few months have posed an unprecedented challenge in the loyalty space, especially with the pandemic’s impact on travel. The unforeseen impacts across the board have caused institutions with premier incentive credit cards to feel increased pressure to retain their loyalty members. As such, exploring innovative ways to create a personalized loyalty experience for customers is at the forefront now more than ever.
Offering the flexibility to pay with points is certainly one option that can help transform financial institutions’ (FIs) loyalty programs. With the evolution of consumer preferences – like relying on other forms of payment outside of credit and the move towards contactless payments – viewing points as currency naturally ties into the “new ways” in which American consumers bank, pay and shop.
Personalization is a win-win for banks and loyalty program members
As the world continues to evolve in light of the pandemic, consumer habits like mobile banking and shopping online for groceries are likely to carry over long-term. As a result, consumers will expect their loyalty programs to provide new incentives to fit their ever-changing needs. By offering loyalty program members the ability to pay with points for the items they want or need during the online check-out process, FIs are creating a more personalized shopping experience. This can help increase member retention, especially compared to dated loyalty programs that offer limited options for point redemption.
As we’ve learned with iPhones, tap to pay and other technologies that reduce friction, once consumers begin using a new and convenient digital service, there’s little desire to go back to the old way of doing things. By incorporating pay with points into loyalty programs sooner rather than later, FIs will be setting themselves apart in terms of meeting their member’s needs with modern payment offerings.
Outside of providing a personalized experience to loyalty program members, pay with points as a program perk also has specific benefits when it comes to a bank’s bottom line. Currently, there are billions of dollars in liabilities in the form of unused points sitting on banks balance sheets. This is in part due to loyalty program members inability to spend their points how they want. By allowing a more personal and flexible way to spend points, banks can reduce those liabilities while creating a more engaging experience for their members.
Meeting consumer demand is easier than you think
Incorporating the infrastructure to power new digital capabilities is more often than not a cause for concern: how expensive will it be? What does down time look like? How long will it take to get up and running?
Luckily for banks, the process is actually quite simple – and inexpensive. With a lightweight integration of a few APIs, banks can tap into a pool of retailers to make their merchandise available for purchase with points by loyalty program members in no time. And as the retail network expands, there’s no need for additional IT work to add new brands into the fold. Ultimately, API integrations upfront create a frictionless and scalable solution for FIs and a preferred shopping experience for members. And based on market feedback, the personalized experience that results from giving customers the option to spend points as easily as they would cash or card, far exceeds any initial inconveniences that may arise.
According to our recent Customer Loyalty Survey, 75% of customers are more likely to spend loyalty reward points to make a purchase over other payment methods. The findings also indicated that 72% of customers are actively engaged in loyalty programs because of the available redemption options.
Long-term loyalty is not just about acquisition or promotional material, but rather the experience of redemption and viewing loyalty points through a fresh lens. Customers today are well-versed in what’s available to them online. The more redemption options offered to the consumer, the more appealing the FI becomes.
Loyalty point redemption in action
In April of 2020, when the world was mostly in lockdown, we looked at how a select group of approximately 3,000 consumers spent their loyalty reward points, comparing April 2020 to April 2019. Key findings suggest that, if given the opportunity, consumers will spend their loyalty points to buy what they want or need based on their specific circumstances. For example:
- Significant increases in the purchase of outdoor items like BBQs and smokers (+3401%), fire pits and heaters (+2644%) and pool and patio accessories (+1297%) suggested people were making the most of the spaces around them.
- Consumers were focusing on their personal health and well-being with the increase in points spent on fitness accessories (+1664%), bike accessories (+1453%) and fitness trackers (+536%).
- Finally, the increase in purchases of hand-held power tools (+3076%), smart control lighting (+1750%), stick vacuums (+1096%) and specialty small appliances (+531%) suggests consumers took advantage of the opportunity to check projects off their at-home to-do lists.
We’re keeping a close eye on how loyalty point purchases evolve as more retailers and FIs get on board with viewing points as a true form of currency, especially in a post-pandemic world. Which items will rise to the top in the coming months and years as the payments ecosystem evolves? Will flight purchases or experience-based purchases regain popularity?
What’s next in the loyalty payments space?
As consumers continue to look for alternative payment methods, offering the flexibility to pay with points is the perfect opportunity for FIs looking to reinvent their loyalty programs. Engage People has always viewed loyalty points as a fiat currency, creating innovative technology that allows for easy integration that satisfies loyalty program members’ needs.
In the future, there’s a real opportunity to incorporate loyalty reward points into everyday life – extending beyond the online shopping experience. Imagine a world where you can pay for coffee, your bills, monthly subscription services like Netflix or make charitable donations with loyalty points just as you would with a credit card or cash. The future involves a mindset shift by consumers, financial institutions and the entire payments ecosystem, and that shift is viewing loyalty points as a true form of currency. Like reaching for cash, a debit or credit card, loyalty points can easily become a payment option of choice for consumers. FIs that are at the forefront of this trend now have the most to gain long term.
The Importance of Liquidity Solutions
By Justin Silsbury, Lead – Product Manager at Infosys Finacle
Economic uncertainty and business complexity have made a deep impact on corporate treasury management in recent years. With regulations getting tougher, funding becoming elusive, and profits shrinking fast, the way liquidity is managed is making a real difference to companies’ survival. As corporate treasurers around the world struggle with the challenges of liquidity management, they are turning to their banks for support; it is imperative that the industry respond with digital solutions that enable clients to manage money efficiently at low cost.
Why corporates need liquidity solutions
Corporate banking customers need a liquidity structure that maximises security, liquidity and yield. Even today, treasurers in multinational corporations lack visibility into their companies’ overall cash position across countries and currencies. Delivering returns on excess cash, although important, is not a priority for them, but making sure the money is safe and available when needed, is. Therefore, a liquidity solution should be able to consolidate a company’s cash position across all its accounts around the world, provide a unified view in real-time, as well as offer timely suggestions on maximising utilisation and yield. It should automate all these functions as far as possible to reduce both manual overheads and the risk of moving money manually on a daily basis.
Broadly, liquidity solutions are of three types – cash concentration solutions that automatically move money around the world; interest optimization solutions that reward customers based on their aggregated balances without the need to move any money; and investment sweeps that move all the consolidated funds to a money market fund or other short-term investment to earn extra returns.
And why banks should provide them
There are several reasons why banks should invest in a sound liquidity solution. The most important one is that without it, a bank can never become a customer’s principal financial institution. A large corporation will have many banking providers, each one trying to increase share of wallet; in this situation, a high involvement product such as a liquidity solution is particularly effective for building stickiness and strengthening a bank’s position vis-à-vis others. An illustration may be useful here: say a food retail chain banks with Santander in the U.K., and other banks across Europe. If the retailer chooses to consolidate its cash daily into its U.K. account using Santander’s liquidity management solution, where the excess cash can then be swept into an investment vehicle overnight, over time, Santander can cross-sell other products to the client to increase revenue and stickiness.
Technology does it
Corporate banking has historically lagged retail banking in technology adoption. It is high time that banks remedied this by digitizing their corporate solutions. Specifically, they can leverage a variety of digital technologies to provide clients instant access to liquidity, global visibility into the overall cash position, and efficient working capital management. With robotic process automation and machine learning, they can simplify and automate processes to cut cost and lead-time. Blockchain enables banks to offer fast, secure, cross-border transactions, while open APIs ease collaboration and co-innovation with Fintechs, customers and developers.
Banks need to deliver frictionless, personalized, “retail banking-like” experiences over customer-centric corporate banking channels. Instead of channel silos – one for liquidity, another for payments and so on – customers will see data from all their accounts in one place, from where they can manage liquidity, forecast cash flows, secure trade finance etc. On their part, banks can use 360-degree customer insight to issue not just timely alerts but also contextual recommendations. For instance, being able to alert a customer that a large payment is due the following week, but also suggesting the best options for arranging those funds.
Apart from improving the customer journey, a real move in corporate banking is towards cloud adoption. Many banks have started the cloud journey, but many still have some distance to cover before they are fully cloud-enabled; mainly, they are migrating monolithic, on-premise workloads to the cloud. Early adopters, such as JP Morgan Chase, HSBC and Citibank, are setting the pace by developing their own capabilities as well as procuring certain components from Fintech partners to plug into their overall solution.
One size doesn’t fit all
In the past, corporate banking solutions were largely meant for big companies, but today they are relevant to enterprises of all sizes. Internet and mobile have enabled even small local firms to scale far and wide, creating a need for solutions to manage their money across borders. Therefore, banks need to make sure their liquidity solution can accommodate the different needs of different clients. Only a flexible, componentised solution can do that.
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