Let’s start with what blockchain is, a decentralized ledger technology that guarantees the authenticity of data without the need of a third party steward. The technology has a wide array of applications from payments, to smart contracts, a store of value, and more. While many of us understand what blockchain is, figuring out how to apply it profitably is more challenging and nuanced.
In this article we’ll cover two main topics:
- Revenue generating activities for cryptocurrency in financial services
- Major compliance and risk management considerations for crypto services
Applications for Cryptocurrency:
Offering crypto related services can be not only profitable, but strategically beneficial. By offering accessibility, financial institutions can potentially reduce deposit outflow and increase opportunity for a more diverse customer or member base.
In fact, while many community institutions and even larger FIs have struggled with aging customers and members, crypto offerings offer potential diversity as it’s used more frequently among younger adults; with 31% of people ages 18 to 29 having participated compared to only 8% of people aged 50-64[1]. Couple this with the fact that a survey by Visa found that 18 percent of respondents were likely or very likely to switch banks based on crypto services and you have strong potential for a broader market reach.
Custodial Services:
As a financial institution (FI), financial technology company, or institution affiliate custodial services can be one of the easier ways to enter the cryptocurrency space. Customers or members look to their institution’s as a trusted steward of their assets, and custodying a key or asset may give that individual more comfort. Custody revenue usually won’t exceed 1 percent of the underlying asset, with higher fees associated with specialty services.
Custodial services can be more or less technically demanding depending on how you choose to implement them. By developing the capacity within the institution you will need to take on more technically savvy staff and map out development. Alternatively, many firms are partnering with a blockchain native firm to assist with the service, reducing in house expertise needs but elevating the importance of third party risk management.
Lending:
Lending has two distinct opportunities, (1) traditional lending to industry participants or industry supporters or (2) lending on cryptocurrency as the underlying asset collateralizing the loan.
The revenue opportunity here varies based on the type of lending. Traditional commercial real estate, equipment financing, accounts receivable / inventory financing will all have standard market rates, with a potential premium for the industry. Overcollateralized margin lending will typically have a higher rate than say a similar arrangement with a dollar or equity backing, given volatility in crypto markets.
Deposit Account Offering:
Offering account access and/or payment processing can be another source of revenue. Depending on the type of account fees can be as high as $2500 per month. Additionally, payment processing for a crypto affiliated vendor can typically yield up to 3-4%.
Higher fees for deposit account offerings are typically for those account holders which may qualify as a money transmitter per FinCEN’s regulatory definition (more on this as we move to compliance).
Linked Deposit Access:
A more complex opportunity on the horizon will be some sort of throughput to decentralized finance (DeFi) networks. DeFi yield opportunity for customers and members is typically much better than traditional financial services rates, and as a result has grown dramatically in popularity. Financial institutions that are reviewing deposit outflow activity have found meaningful transitions out of FI accounts and into blockchain related holdings.
Compliance and Risk Management Considerations:
Money Transmission and FinCEN:
A major compliance consideration is whether or not the entity you may be banking qualifies as a money transmitter. Money transmitters are considered money service businesses (MSBs), companies with this designation must register with FinCEN, implement an effective, risk-based anti-money laundering program, and comply with recordkeeping, reporting, and transaction monitoring requirements applicable to money transmitters.
There are three distinct types of customers as defined by FinCEN for maintaining a compliant cryptocurrency banking program. Using these categories your institution can develop policies and procedures to identify if a customer is a money transmitter and therefore subject to FinCEN’s licensing and procedural requirements.
(1) Exchangers are typically an MSB and are “Engaged as a business in the exchange of virtual currency for real currency, funds, or other virtual currency.” (2) Administrators are also are typically an MSB and are “Engaged as a business in issuing (putting into circulation) a virtual currency, and who has the authority to redeem (withdraw from circulation) such virtual currency.” Lastly, (3) users are typically not an MSB and are person(s) that obtain(s) virtual currency to purchase goods or services.
Regulatory Approval:
The Office of the Comptroller of the Currency (OCC) now requires non objection for federally regulated institutions to engage with cryptocurrency services. While the OCC has previously affirmed federally regulated financial institutions ability to provide custody services, certain deposit activity, and engage with a distributed ledger. Interpretive letter 1179 introduced a new hurdle for written non objection from the institution’s supervisory office. The OCC wants to validate that the institution has the capacity to conduct the activity in a safe and sound manner, so if you are a federally regulated bank when submitting a request to participate outline the following information:
- The type of activity you wish to engage
- Risk management systems and controls
- Risk measurement systems
- Any other consideration (policy limits, concentration considerations, technical expertise, etc..)
Risk Management:
Last but not least, risk management. Regardless of your maturity level this article is a good point to start assessing what you currently have the capacity for and what you want to have the capacity for. What industries can you serve, what services align with your risk appetite, and what controls may need to be developed. By at least starting a road map to understand adoption requirements your firm is positioned for success regardless of the trajectory of cryptocurrency and blockchain.
[1]Morning Consult Poll, Harris Poll, NORC University of Chicago, Forbes
