Flight to Safety with Quality: Why crypto winter has opened up opportunities for traditional banks
The post-FTX era presents significant and still untapped opportunities for traditional banks. With crypto investors now seeking regulated entities they can trust, banks are - now more than ever - perfectly positioned to capitalise on this change in customer needs. In response, some have already started actively exploring the space. By adopting crypto as a new asset class, banks have begun defending their assets under management, diversifying their product offering, and attracting the next generation of crypto-native clients.
- The crypto market is experiencing a flight to safety, as customers turn to trusted parties that offer secure and regulated crypto services
- Non-regulated players are driving crypto innovations, while regulated players are leveraging them into more robust products
- Investors and bank clients continue to be drawn to crypto as a new asset class, and to various sectors within the crypto asset ecosystem
Bitcoin was famously launched in 2009 as a project to create decentralised money without the need for banks. Five years later Ethereum emerged as an open-source protocol upon which to build a full-scale, decentralised financial system – also without banks.
While still small compared to TradFi, Bitcoin, Ethereum and the cryptocurrency and decentralised finance (DeFi) industries they have spawned have made significant inroads. At its peak, the overall crypto market cap was close to USD three trillion. In 2021, the Ethereum Mainnet settled over USD 11 trillion in value, more than Visa.
What’s in it for banks?
After the scandals and market crashes of last year, it can be tempting to believe that those peaks will not be reached again. For reasons we go into below, we think the opposite may be the case. The crypto economy is likely to rebound and remain a challenge to banks.
The good news is that the nature of that challenge is an opportunity for early adopters to capture market share and expand and diversify their product offerings to attract a new generation of clients.
Previously, most investors accessed the crypto economy via centralised, often unregulated crypto exchanges. These provided easy-to-use on- and off-ramps to crypto and DeFi, often at attractive rates.
Today, we are witnessing a flight to safety, with many investors moving funds into trusted, regulated crypto entities. Investors want to feel safe and get all the upside, even if these entities are pricier (more below). For traditional banks, getting into this space now could be a chance to win some of this existing business and gain new business when the crypto economy returns to growth.
The first step is to understand the current crypto economy market dynamics. Here’s what banks need to know.
The crypto economy will continue to draw investors and bank clients. For traditional banks concerned about client retention in the face of the rise of the crypto asset economy, it is important to understand what is drawing clients away. Factors include:
- Higher returns and diversified asset allocation. Many consumers still see cryptocurrencies and DeFi as an alternative source for higher returns than what they can get through traditional products. And not without reason, Bitcoin became the best-performing asset of the decade with returns of 10x more than the Nasdaq 100. Holding Bitcoin has provided more returns than real estate, stocks, and gold combined.
- New investment opportunities. Digital assets represent new opportunities previously unavailable to many investors, whether in the form new asset classes, like cryptocurrencies or digital collectibles; or new investment opportunities, like yield farming. Blockchain-based tokenization can also make previously unbankable, uninvestable assets like fine art available to retail investors, often through fractional ownership.
- Lower fees and more control. Many investors are drawn by the generally lower fees to be had in crypto and DeFi for many types of transactions, as well as the independence and control over their own assets the crypto economy offers – something many see as a safeguard against financial fraud.
- The crypto ethos. Last but not least, increasing numbers of individuals (mostly next generation) are being drawn to the crypto/DeFi ethos. They like the idea of decentralisation and a censorship-resistant blockchain infrastructure, seeing in it a means to protect themselves against what many still perceive as a traditional financial system that does not treat them fairly.
There is a good argument that crypto and DeFi markets will recover and grow again. There is no doubt that cryptocurrency markets are highly volatile. Until now, every market crash has been followed by a rebound at higher levels. History seems to be repeating itself, with both cryptocurrency markets and DeFi (as measured by total value locked or TVL) more or less stable over the past six months. As has happened before, they have stabilised at significantly higher levels than in the past. Yes, crypto lost two-thirds of its value in 2022, but it is still up 400 percent compared to the beginning of 2020. DeFi TVL has steadied at a volume three times higher than the beginning of 2020.
We can expect that the crypto and DeFi infrastructure will continue to grow and mature. Many casual observers have interpreted the Terra/Luna and FTX debacles as failures of crypto and DeFi. In reality, they were old school financial frauds of the kind DeFi is trying to make obsolete. True DeFi has proven itself quite resilient to these shocks, and we can expect the already vibrant crypto and DeFi infrastructure ecosystem to continue to grow and mature. Many large mainstream players, like Goldman Sachs and MasterCard, seem to agree. Institutions like JPMorgan and the Monetary Authority of Singapore recently used Aave and Uniswap to trial foreign exchange and government bond transactions on a public blockchain, while Société Générale-Forge used MakerDAO to refinance covered bonds, with Sygnum Bank acting as the exchange agent. That being said, these institutions are proving how they can leverage DeFi rails to bridge the gap between the traditional and crypto markets.
Capitalising on the flight to safety with quality
As mentioned above, one of the most interesting developments in crypto and DeFi markets in the second half of 2022 was a flight to safety among those investors who remained in the markets. We have seen this very strongly in our business, where we saw close to USD one billion of inflows during the fourth quarter of last year.
The reason seems clear. While the crypto economy remains attractive to many, they have for understandable reasons lost trust in the large, centralised new entrants (like FTX) they had used before. The preference today for those looking for a gateway to crypto is with trusted, regulated entities. This may seem contradictory to the decentralisation ethos, but as we have posited elsewhere, the future is not either/or but rather hybrid, a mix of the best of traditional and trustless systems.
From retaining current clients and defending assets under management (AuM), to increasing share of wallet among existing clients interested in crypto, to diversifying their product offering, to acquiring new customers and – crucially – preparing for the next generation of crypto and digital asset-native clients, there are many ways banks can profit from being involved in the crypto economy.
About the Author
Authored by Sygnum