As governance on digital asset markets reaches equivalence with conventional finance, the banking sector is increasing its involvement in the space.
While much has been said about the potential for blockchain to rearchitect the financial industry, legacy bank infrastructure has continually marginalized the roll out of blockchain projects. However, some positive indicators of accelerated adoption with the digital world have been gaining pace.
The rapid advances in industry standards over the past year have hastened digital assets and their integration with conventional financial markets, beckoning a significant increase in usage. One recent indicator of converging digital and conventional finance markets was the news that JPMorgan opened up its banking services to U.S.-based crypto exchanges Coinbase and Gemini.
The primary catalyst to JPMorgan’s ingress into banking services for digital assets is likely attributable to the comprehensive regulations that digital exchanges are now operating under. Industry players have worked collaboratively and closely with regulators to address salient challenges, to define standards, and to establish protective frameworks for digital asset investors. These stringent governance protocols, regulations and standards, minimize operational risk and ensure system safeguards, thus building trust in the way digital assets are handled.
The implementation of the FATF ‘Travel Rule’, which has recently led to the creation of data sharing apparatus for exchanges — enabling them to ensure that trades across their platforms are in compliance with anti-money laundering (AML) best practices — has been an important milestone in this regard. It represents the digital asset industry’s inevitable shift towards comprehensive regulatory oversight, by holding digital asset exchanges to the same standards as their counterparts in the banking sector.
Many next-generation exchanges have adopted robust reporting frameworks to operate in accordance with recognized industry accreditations, with security qualifications for data privacy and expansive middle office controls for Know Your Client (KYC) and AML policies. They have been designed from the outset with advanced security protocols for client assurance such as necessitating two-factor authenticated logins, segregated duties, policies against asset co-mingling, as well as transparent fee structures, independent auditing, and the optionality of a variety of custodial partners. This embrace of ‘ultra-compliance’ among these emerging market leaders offers assurance which allows both investors and banking partners to engage in the digital asset space with confidence.
In addition to a comparative operational infrastructure, JPMorgan is also experimenting with its own digital currency — the ‘JPM Coin’. This coin is anticipated to be pegged to the U.S. dollar and used for interbank settlements with explicit backing that would be held in accounts at JPMorgan. Wells Fargo has also announced that it will introduce its own fiat-backed stablecoin to support near real-time money movement and cut out costly and bottle-necking settlement intermediaries.
Developments such as these exemplify digital assets’ growing interconnectivity with conventional markets and legitimize the digital form of value transfer. Banks now recognize that their current payment architectures are in many ways antiquated and that blockchain can enable substantially more efficient payment networks, supporting a high velocity of transactions with automated reconciliation, and data security data. Indeed, Gartner estimates that by 2022, at least 25% of cross-border payments involving U.S. banks will use stablecoins traversed across blockchains. As an increasing number of banking leaders are gravitating towards digital asset solutions and engagement with technology, virtual asset players, the silos between blockchain initiatives are slowly breaking down.
While the banking sectors entrance into digital assets has largely comprised of piecemeal approaches, a larger momentum is growing. The Central Bank of Argentina (BCRA) is testing a new blockchain-powered clearing system which is intended to be rolled out with major commercial banks including Santander and BBVA. The idea of retail digital fiat currency is also gaining traction, in part to COVID-19 pandemic igniting deliberations on the topic. Many representatives involved in the build out of stimulus bills have acknowledged the relevance of digital solutions as an alternative to welfare checks. China is in the midst of piloting a “digital yuan” project across several cities and the Central Bank of Mauritius has indicated that an announcement on its central bank digital currency plans is imminent.
Up until this year, regulatory uncertainty has acted as a major deterrent to the banking sector’s engagement with digital exchanges. However, as banks delve into their own digital asset projects, these exchanges have started to be held to the same levels of stringency for compliance (i.e. AML, counter terrorist financing, and KYC) as banks, foreign exchanges, and securities exchanges. Designed at the beginning to operate under stringent governance, best practices, and standards, next generation exchanges exemplify the convergence of the digital assets and traditional finance worlds. These platforms now offer functionality that is commonplace in conventional investment infrastructure such as price ladders, portfolio margining, and robust treasury management, on par with traditional investment houses. As such, concerns around trust, counterparty risks, and investor protection are rapidly receding and opening the digital asset world up to heightened connectivity with mainstream banking.
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 The FATF Travel Rule is an update to the existing Financial Action Task Force (FATF) Recommendation 16, an anti-money laundering directive intended to address concerns around cross-border and domestic wire transfers. (link)