By Alexandre Lemarchand, Vice President, global sales, Ledger.
The new financial paradigm – digital asset adoption – has arrived. This time, unlike the days of the dot.com boom, banks cannot afford to fall behind and miss ripe capital generating opportunities for their clients. It took many “Big Bang” types of events for the financial industry to cautiously warm up to digital assets. The financial crisis in 2008 – and the decade that ensued – saw the big banks lose the trust of customers that, until that point, had no other choice but to utilize their services. Since that time, banks have been in the spotlight for all that went wrong, and it took many years to repair that damage – and some mistrust still exists.
Looking at where we are presently, it is easy to see, on a worldwide scale, the level of sweeping changes that have taken place both economically and politically, which have affected the financial services industry. A dichotomy exists between the “old world” and the “new world”, and both seek to gain autonomy. Countries such as India, China and nations throughout both Africa and South America are demanding a monetary democratization take place, while countries throughout western Europe and the U.S. endeavor to stay ahead of the curve. Understanding this shift is the most essential part of accepting where the world is today and why digital currencies are poised for their most important act to date.
Knowing the industry’s history and where we are today, it is apparent that no bank wants to lose control of the newest class of assets – ones that are quickly becoming more mainstream – and they certainly don’t want to be left behind as the future of finance unfolds. Therefore, traditional custodian banks need to become a part of the new system. And the future of digital assets lies in the fact that currency is experiencing a fundamental revolution, and those assets need to be regulated. We know nothing will happen in an unregulated world as there has to be an inherent trust.
As digital assets gain popularity as a form of currency, traditional banks are rethinking how they can manage, secure, and interact with these assets. Along with the concern that customers have expressed toward banks, those same customers have also grown tired of shelling out exorbitant fees for slow transactions and limited services, all the while having very little control of how their money is being held and protected. To gain customer trust, banks need to demonstrate their support for digital assets and that they have a way to keep them safe.
Banks do recognize that securing digital assets is not done the same way as gold or paper money would be secured; hence, the fact that a new crop of operational risks have arisen from this new paradigm. Next generation assets call for next level custody, which can only work if customers feel this class of assets are receiving the same level of security that would be given to traditional fiat money. Crypto is an asset that regularly circumvents hackers, with very few actors having the wherewithal to fully understand and tackle the nuances of the industry.
Moreover, something to think about is the fact that the custodians of today will not have the same clients tomorrow now that big companies, such as Square and Microstrategy, which are outside of finance are buying mainstream crypto, including Bitcoin, Ethereum, Ripple, etc. This is where the real future of finance truly comes into play. One thing that is clear is that digitized assets do not make custody less needed; if anything, these assets need more custody and security solutions because of new operational risks. So, what are banks, who traditionally have been custodians and maintain security on premise to do going forward? The linchpin lies with third party technology providers.
While building bespoke technologies has worked for banks to fill voids in the short-term, especially related to custody of assets, long-term solutions will reside with third-party custody solutions offered through trusted and well-known actors specializing in technology for institutional needs. Banks delivering another layer of technology is beneficial; it is not; however, the endgame for a true digital transformation to take place and thrive.
As the cryptocurrency world starts to become more regulated, technology-based custody solutions will continue finding themselves playing an extremely important role – and they are ready for their time in the spotlight. The reason for this is that digital assets will need to have a stamp of approval through regulations, which will impact custody and the lasting need for it. Furthermore, the future of custody will need to be blockchain agnostic for banks to justify employing outsourced solutions.
In the past, banks created their own bubble through these in-house solutions. And for a time, they were working. But disruption eventually happened. This time, they have a chance to get ahead of and join the disruption with an activist asset class that is set to become conventional over the coming years. Banks realize that digital assets require a further level of innovation that they themselves may not have the resources to provide custody services, especially as various cryptocurrencies come into play. For this very reason, third party technology providers will become a vital part of the ecosystem. The newer generation of banking customers sees the system as one that is running in place instead of moving forward. Speed of service as mentioned earlier, is also a big factor in the future of banking and finance. We can look at neo-banks as a model example for employing novel ways of thinking and showcasing belief in pioneering products.
With that, there is investment underway at traditional banks regarding their support for major blockchains and cryptocurrencies. Our belief is that integration and interoperability will be important customer factors. Third-party technology providers will not only be used for security by custodian banks. Through these partnerships and integrations, new services such as clearing, settlement and prime brokerage will also be offered by these actors, cementing their place in the ecosystem. The way things were done in the past no longer applies; this is the time to reimagine standards and create news ones.
There is a network effect that will take place for very siloed types of companies—think of major bank holding companies, as an example. In the very open centralized world, the key thing to anticipate is direct connection and the ability to move to and from various points rapidly. All of this must happen while having the highest level of security and lowest possible constraints to meet those expanded customer expectations.
The network effect and being interconnected is a vision that we believe in and one that we can get behind. The future of custody is simply process flow, master security and master key and meeting all the regulatory requirements, while being as flexible as possible to easily integrate key blockchains and additional services to add value for customers. Financial and non-financial and persons will require custody solutions. This strategy will bring forth companies that are outside of straight finance, including conglomerate types that may require custodianship solutions as it is costly to build and maintain and not everyone can do that.
The network effect and the buildout of these solutions are well underway. Compliance and regulation for the so-called tech providers is happening now. It is only a matter of time before we see larger rollouts. Investments in security and customer trust will be made to have solutions ready for what’s to come in the new year and beyond for institutional custodians, asset managers, exchanges, brokers and, of course, banks.