With all the pressing challenges community banks face, should they also devote brain space to cryptocurrencies?
Shuki Licht, chief innovation officer at Finastra, makes his case for why community banks should be focused on crypto now.
A few takeaways from the conversation:
The main reason he cites for crypto is that more Americans are taking an interest in crypto, and this likely includes community bank customers.
His standard advice for community banks is to “think big, start small and eventually scale up,” with a starting point of getting educated about crypto.
The lack of a comprehensive regulatory framework presents an opportunity for community banks to try to influence on how the rules are crafted.
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Below is a full transcript of my interview with Shuki Licht.
Shuki, why should community banks, with all of the other things that they have coming at them right now… all of the existential threats they face, all the difficulties achieving scale, changing technology and trying to keep up with the new imperatives created by the pandemic, all of these things that community banks have on their plate… why should they be focused on crypto now?
There are three reasons for my opinion that community banks need to be focused on crypto right now. The first one is a huge amount of demand by the consumers –as you’re aware, more than 20% of U.S. consumers are on crypto. More than 70 million consumers are using some kind of cryptocurrency, so there’s big demand from the consumer side to use this kind of technology. The second one is the digital revolution that’s happening, especially because the pandemic and the COVID situation that leads to people to use more and more and do what we call retail investments or retail trading. And the third one, the technology is here. We talked a lot in the last years about blockchain and what we can be done with that. I think what we see in the last almost year or two years, we see applied cryptocurrency investment. And the banks want to be on this side of technology, new revenue streams and to support the demand of their consumer.
There are already so many players out there offering ways to get crypto exposure, and this includes various fintechs and brokerages, neo banks and others as well. Community banks aren’t exactly known for being at the front edge of technology, so what do they bring to the table for customers crypto-wise that these other market players don’t already offer?
One thing that I found during my career about the community banks and about the consumer is about the loyalty and about the very deep relationship with their consumers. And on the other side, a customer of community banks see the banks as a trust, that someone that is trusting and loyal to them. And we see more requests from consumers that are looking to use or to invest in crypto with the trust of the banks – to make the banks help them to decide, first, if to get into this field, and second one, also to help them with the potential of what areas that they recommend them to invest in cryptocurrency.
I don’t have to tell you about volatility within the crypto market. As we’re speaking in early March, Bitcoin is off 25%-30% since its November peak, and that’s included a lot of gyrating in January and February as well. Community bankers tend to be a conservative bunch who run conservative institutions. Crypto is a lot of things, but one thing that isn’t is conservative, so how should banks be thinking about the extreme mood swings within crypto?
I think I will use three words for that is education, education, education, and I think I see that from personal level. I see it for my friends and I see that also what I’m reading in the market and what we are hearing for the community customer and customers that are not for community is they have lack of understanding of volatility, the high volatility, the risk and rewards when investing in cryptocurrency, and how much liquidity or how much cash they need to put in this investment. And I think the banks will come with more packages of education to support their consumer, but not just how to get access to these types of investment but also what are the risks and what are the areas that they need to take into consideration. I think this will be a strong story by the banks, I think, especially these days that the regulations are not yet in the front or try to support any story here. I think that guidelines and best practice and education that will come from the banks will really, really help to the end consumer to understand the risk. The banks cannot pretend that their consumer may not fall into the trap of the high volatility, but for sure they can educate them and understand the risk around it.
It makes sense that there should be some education on this. But once a bank starts offering guidance and advice about crypto exposure, tax implications, and things like that, then they own the outcome to some degree, don’t they? This strikes me as kind of a risk. The bank wants to educate and protect their customers, but then if things with crypto get really volatile, to the downside especially, then these customers are looking at the bank and saying, “Hey, what did you do to me here?”
We can take a look at that in three strings, OK? The first one is, the solution that we recommend for our banks to use or to embed it in the digital experience came from fintechs, and the obligation and the custody and everything is done by the fintech itself and the banks have less risk on their side. The second one is limitation. We are talking about digital applications. We’re getting more and more banks that are asking us how can we limit and how we can configure the system to make sure the customer cannot go to X amount of dollars for investment, or vice versa, cannot go or invest more than X percentage of this cash and et cetera. So this is another area that we see more of the banks are trying to make sure that they are protecting their consumer. And the third one is, when we talk about cryptocurrency investment, is the types of the tokens that we are recommending to go first. We are supporting very few to try to reduce this kind of volatility and also from the end consumer not to make him into a bad situation where there is no liquidity to let him later on move it or transfer it to fiat (currency).
On the regulatory side, an alphabet soup of federal oversight agencies are looking closely at crypto right now. The uncertainty about possible new rules and things like handling KYC and anti-money laundering is, for the most part, keeping banks on the sidelines. So what would you say to a community banker who is just itching to get going with crypto so far as the regulatory risk outlook goes?
Because all this ecosystem now is involved and built, I think it’s a great opportunity for community banks to impact and influence how these regulations will come out. I know there’s a lot of requests from them to come with their experience and their understanding how to go forward with it. You mentioned KYC, you mentioned other process for AML, et cetera. This must be part of the story because otherwise the banks don’t want to put themselves into any kind of risk. And I think that there’s high potential for all the partners to collaborate together. Fintechs or providers like us and others, of course, we will come to the table and, of course, the banks themselves. So I see this as opportunity now because this is what happens in the market.
Crypto is a class of currency assets, of course, but unlike the dollar or an ounce of gold, crypto is also advanced technology. So which of these dual identities, currency or technology, do you think is more important for community banks to be focused on right now and also maybe think about the longer term as well?
I will talk from my experience. In the last years, we tried to use the blockchain technology for the sake of the technology itself. And I think that all of us failed because we’ve been very focused on the technology and less about the use cases. I think once the cryptocurrency went to investment use cases, we will see more decentralized finance for peer-to-peer payments, et cetera. The question is what will be the technology that will be involved, especially if it will be a public network, or will we see hybrid network or full private network? I think the use cases and the value for the end consumer will be much more important. And I’m very happy to see that, by the way, especially in terms around DeFi, that we see more and more tangible use cases, that the technology is less important. We are just starting to use the technology for things that more matter from a use-case perspective.
We hear about the value of the blockchain for banks in the coming years. Some people go so far as to predict that it will revolutionize the industry. How do you see the blockchain being integrated into banking, and what do you think community banks could be or should be doing now to prepare for a future that includes blockchain?
I think all the concepts of DLT, distributed ledger, this will be revolution that’s coming very, very quickly. I can talk about from the end consumer. I’m a consumer and I can go to one of four compounds, or I can go to any exchange today or any lending platform, et cetera. I can earn APY of 3% to 5% to 7% on my money, compared to what I can get in the bank – a saving account that is less than 0.5% APY. So the promise here, it’s huge, huge, huge for the consumer regarding the potential of what he can get from his money. From the perspective of the potential of the technology, smart contracts have changed the entire game. The idea that you can replace entire workflows and guidelines that exist today in the banks with a code that you can execute – this leads you to a very nice story because you can get a loan or you can borrow money, or you can supply money to this pool of money in a short of milliseconds instead to wait two weeks to go through a workflow at a bank. On the other side, because everything is written by algorithms, there’s much more protection of your liquidity, much more balance between the collateral that you need to put inside. You have a full transparency of what’s going on in real time. The cost is much lower, the potential of revenue is much higher, and the profits are higher. So I really, really believe that we’ll see more and more solutions that come outside from that. If I’m trying to predict what will happen in 10 years from now, most of the financial instruments that we see today that exists in the bank will be replaced by (decentralized finance). The question is who is going to control these DeFis? I’m pretty sure the banks will own that later on in the game, but right now this is the revolution that they see.
You’ve mentioned DeFi a number of times in our conversation so far — decentralized finance. DeFi is often described as banking without banks, with the blockchain as a technological foundation, if you will. What are some of the key impacts that banks, and in particular community banks, will feel from DeFi, and how soon do you think they will start feeling those impacts?
I see the disruption across all the business units of the bank, OK, and let’s go one by one. Let’s start with lending and trade finance. For that, you have the peer-to-peer lending companies that you can supply loans, and on the other side you can borrow loans. So this is one place that’s already been replaced by smart contracts. And I think that once the bank will start to take that into the organization, this will replace things that we are doing today in the banks. If I double click on the lending and trade finance using DeFi, we can do crazy things like flash loans. I can borrow money that doesn’t belong to me, and after that I can go and invest in some stablecoin. I can exchange it with other coins and I can return the money that I loan back to the pool, and everything I can do it in one transaction. This is what we call a flash loan. So I can do all this process with zero investment from my side. So this is a big revolution. We talked about the lending and trade finance. Let’s go to the next level, the capital markets. For the capital markets, the things that are much more complex lending and investment, we see that this day it has been replaced by DeFi capability. Let’s go to the payments. We are talking very heavily now about the metaverse, how people are going to exchange stuff in the virtual world. Things around DeFi will be one of the engines for payments in the metaverse. So you see more and more in every business unit, you see a disruption for the bank. Where the banks are sitting, in this case, I think that we are in the early stage, meaning that it’s mostly controlled today by fintechs that try to build their own ecosystems. I think that, in the next generation, we will start to see banks that are coming with their own solution. And some of them will be built into the core of the bank, so I think this will come soon.
Let’s finish up, Shuki, by bringing things back around to crypto. There are now more than 10,000 different cryptocurrencies in circulation. And on top of that, we have talk about central bank digital currencies. In the Federal Reserve’s case, that would be a crypto version of the dollar. If a community bank wanted to facilitate crypto for their clients, how do they first sort through such a crowded field of competitors, or maybe the answer for them is just to come out with their own community bank coin?
I always believe in “Think big, start small, and scale fast after that.” So think big. Yes, they need to educate themselves about all the trends to understand what’s going on. I’m excited about it that every week you can learn new stuff. So I think first they need to educate themselves, to think big and to start to think about strategies. The second one, to start small. My recommendation is just to start with a crypto wallet, to embed it into their digital experience and start to let their own consumers to start to consume this cryptocurrency wallet, to see how it works, to start to learn and educate themselves about what are the advantages, what are the disadvantages, et cetera. Then they can go to the next level and start to design their own decentralized finance. And again, for decentralized finance, they don’t need to replace the entire ecosystem or the entire financial instrument. They can select one or two, or areas that they believe they can generate for them more revenue. Maybe it can be peer-to-peer lending, so to collaborate with one of the peer-to-peer lending ecosystems that already exists outside. It’s a good earning and value for their own consumer, but it’s also a good profit and revenue generation for them, so to take some of the DeFi, separate it to small pieces and just piece by piece. For your question for central bank digital currency, I’m pretty sure this will come because, at the end of the day, once we are talking about peer-to-peer payments or alternative rails to payments, some of the CBDC will start to take control and be the central hub for these kind of payments and reduce a lot of complexity that existed today in the traditional payments. This is maybe another place that community banks need to start to take a look at it.
Reducing some of the complexity and, in doing so, creating some clarity about the future of crypto in banking I think would be welcome across the industry. Shuki Licht, chief innovation officer at Finastra, many thanks again for spending some time with us on the BAI Banking Strategies podcast.
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