Andy Flury is founder and CEO of Wyden, a company that provides institutional trading technology for digital assets.
Over the past nine months, bitcoin has seen an increase of around 50 percent. Blackrock, the world’s largest asset manager, has filed for a btc ETF. And Germany’s largest credit institution, Deutsche Bank, is currently in the process of approving a cryptocurrency custody license. Added to this is MiCA and, therefore, greater regulatory certainty for institutional investors. All of this leads to institutional adoption being at a significant threshold, making the decision about the right infrastructure even more important.
However, things looked quite different in the cryptocurrency market last year. In the crypto winter of 2022, Terra-Luna and Celsius stumbled, Three Arrows Capital was ordered into liquidation, major players such as Gemini, Genesis and Grayscale fought legal battles with the SEC, and in November FTX had to initiate insolvency proceedings and the cryptocurrency Market valuations took a big hit.
Furthermore, in early 2023, the insolvencies of US banks (Signature, Silvergate, and Silicon Valley Bank) had profound effects on cryptocurrency trading, established procedures, and the related venture capital market. This made it clear that the rules of traditional finance, economics, and governance did indeed apply to the cryptocurrency market.
A look back reveals many weaknesses in this market that are currently being addressed. A look ahead shows that institutional adoption of the new asset class is at an important threshold. Even more so as the EU’s MiCA regime will come into effect in less than a year, offering European banks a significant market advantage, especially now that the United States is lagging behind due to its upcoming presidential election.
Minimizing counterparty risk as a key issue for banks
Like traditional assets, cryptocurrency trading includes various functions such as custody or brokerage. These are strictly separated from each other in the TradFi sector as part of strict risk management policies. However, at FTX & Co, this governance principle was ignored, leading to a cascading negative impact and eventual downfall. Therefore, banks must ensure that internal governance guidelines are in place and adhered to when connecting to crypto exchanges and other service providers.
As banks plot their digital asset strategy, they face a market plagued by fragmentation with hundreds of centralized and decentralized crypto exchanges, OTC desks and brokers. To ensure a best execution policy for itself and its clients, something that MiCA also requires, among other things, a bank must connect multiple trading venues to its own platform. These can have large variations in price and liquidity, which can be exploited opportunistically through intelligent order routing to obtain the best average price by spreading a single order across multiple locations.
Diversification is also advisable in the context of risk management. The collapse of a singular trading venue could mean a catastrophic loss of assets. Connecting multiple trading counterparties increases a bank’s complexity and liquidity costs, but significantly reduces default risk. Rigorous investigation of commercial counterparties is necessary as part of the due diligence process to clarify liability issues up front. In this case, for example, it should be determined who is responsible if a downstream trading platform used by a trading counterparty has payment difficulties.
After Silvergate and Signature, the importance of smart cash management
The recent collapse of US banks Signature and Silvergate casts a long shadow that affects not only their clientele but also the broader cryptocurrency trading ecosystem. These banks had facilitated instant USD transfers to crypto exchanges, thereby minimizing the assets held in these locations. However, current cash management alternatives appear to be in their infancy.
While stablecoins struggle with volatility and transaction delays, SEPA offers instant liquidity in euros. However, its transactional boundaries and limited market reach pose challenges for institutional trading. And FedNow, the instant payment service launched by the Federal Reserve, has yet to be established to achieve the desired network effects. Off-exchange settlement solutions through providers such as Copper ClearLoop or Fireblocks are the most likely to provide an effective means of efficient cash management, allowing funds to be instantly transferred to exchange accounts before a trade is placed.
In addition to a centrally managed liquidity pool, liquidity management automation is a useful component of intelligent cash management. Individual functions such as pre-funding, rebalancing or payment settlement are automated. Another modality is dynamic cash management: in this way, money parked on crypto exchanges can be increased during trading hours and reduced or withdrawn completely outside of trading hours.
Business lifecycle orchestration and seamless integration
The technical implementation of cryptocurrency trading requires a bank to connect additional systems to its core banking infrastructure. A custodian suitable for institutional-level trading secures the private keys that enable custody of clients’ assets. Additionally, a trade order execution system is needed that can access various crypto exchanges.
Finally, a solution is needed to orchestrate all the functions described above, as well as to integrate other functions such as liquidity or risk management. He Wyden The platform is currently the only one that offers such a range of functions. In their digital asset strategy, banks must be attentive to their unique needs, risk profiles and customer demographics.
Banks as established and trusted access points
Established financial institutions have clear incentives to promote their digital asset strategies. From a bank’s point of view, among the four current business cases (cryptocurrencies, nft, DeFi and tokenization), only cryptocurrencies have consistently demonstrated clear market demand and assured revenue potential for institutions. From a retailer or investor perspective, a regulated bank’s digital asset offering presents an elegant solution: uniting the need for security and convenience.
A bank regulated as a “trustee” of cryptocurrencies guarantees custody of clients’ wallets. Additionally, access to digital and crypto assets is greatly simplified as the bank acts as a one-stop shop for all asset classes, from traditional to digital. Wealth advisors can provide comprehensive risk management education and assist with portfolio diversification. Expanding the bank’s own offering, for example through betting, increases customer convenience, provides the bank with valuable data and more contact points and at the same time makes it a central and reliable partner.
If banks manage to learn from the mistakes of the past crypto winter, nothing will stop institutional cryptocurrency trading from coming of age. The technological prerequisites of a professional and integrated business ecosystem are there. The task now is to implement them in all areas of the banking sector, even more so as MiCA will add greater regulatory certainty for financial institutions.
Considering the evolving landscape, it is evident that beyond infrastructure, regulation is critical to an institution’s digital asset strategy. This will inevitably lead to diverse regulatory regimes in different regions, which will significantly influence its attractiveness. Consequently, for European banks in particular, it is imperative to not only develop internal knowledge and infrastructure but also stay abreast of these regulatory changes.
This is a guest post by Andy Flury.. The opinions expressed are entirely their own and do not necessarily reflect those of btc Inc or bitcoin Magazine.
