Banks as digital asset custodians?

Competition and Markets Authority (CME) considers the UK retail and SME banking market to be anti-competitive

Basically, most startups and SMEs open an account with same bank as their personal account. The crux of the problem is, according to the CME, not that more banks are needed, but that people need to be able to easily switch to other providers. CME considers that customers “fear that switching their current account to a new bank will be complicated, time-consuming and risky”.

In terms of statistics, the CME says that “50% of start-ups looking for a SME account choose the bank with which they have a personal current account, over 90% stay with their BCA [Business Current Accounts] when the initial free banking period comes to an end, and around 90% then go to their BCA provider when they are looking for business loans”. The solution is better access to data (through the Midata project) and price comparison sites.

But most likely the real change in retail banking will come with PSD2 in 2018. According to Finextra, retail banking is set to lose 43% of retail payments revenue. Under this new EU directive, payment service providers will have read and write access to banking APIs. This will mean a service such as Transferwise will write a payment via API from a person’s local account to Transferwise rather than a manual transfer process. This will likely cause a seismic shift in retail banking because any payment company will have all the main functions of a bank without the hassle of custodianship.

So where to next?

Digital assets are the future.  

The reason people use banks is because they have a sense of security. If the bank fails the government will bail them out. 

That perception may change as banks have to bail-in (i.e. take customer deposits before asking money from the government). 

That said, banking security is overall robust and that is something the banking industry should be proud about.

In my opinion, the retail bank of the future is a custodian of digital assets. Barclays just gave up its precious metals vault to a Chinese bank. I would use some of that cash to create a digital asset vault. I have clients that come to me (although I am a lawyer) and want to buy large amounts of bitcoin. I ask where do they want to store it. Then they appear slightly baffled because they realise that digital assets actually involve physical delivery just like gold. Lose your private keys for your bitcoin wallet, and they are gone forever. So a bank would be the perfect candidate to provide a virtual vault for digital assets.

New bonds are being issued on the blockchain. Am I going to hold on to the blockchain bond or pass it to someone that knows how to hold stuff safely? 

I think, as you move up the value chain, there comes a point where you need a custodian because too much is at stake. 

Also, an insurance underwriter is more likely to write cyberinsurance for a bank handling digital assets than a startup.

Now there is an obvious regulatory barrier. The EBA discourages banks from holding and transacting with digital assets such as bitcoin. 

That doesn’t mean you can’t create a subsidiary to provide that as a service. More so, acting as a custodian of digital assets is not a regulated activity in the UK (well at least for virtual commodities such as bitcoin or Ether). 

It goes further. I have an important smart contract that I have entered into; could be the sale of my car or it could be an Over the Counter forward contract for a large amount of currency. I want my bank to hold my private keys, because I don’t trust myself to keep them safe. 

Basically, people need to delegate risk and human psychology is such that even if the blockchain is trustless we still need to trust ourselves to look after our own cryptographic keys. 

So there may be light at the end of the tunnel for banking in providing digital asset custodianship and private key management. 

Also, customers want more choice. They don’t want a GBP account when it starts tanking after Brexit. They want a hedge. A few currency accounts by default and maybe they want to buy some bitcoin too from the bank. To be quite honest only uninformed customers will use a bank for forex. It is difficult to compete with Transferwise; why would any business pay £20 to a bank to send £100 to Hong Kong and wait three days?

Either the bank needs to cut costs dramatically on payments/forex or start to offer more innovative solutions. I want to pay a supplier in Vietnam or China. If I use SWIFT, it will take forever i.e. more than 10 mins. If I go on Uphold.com, put some pounds in then send pounds to the supplier, they then convert the funds to bitcoin and withdraw immediately. This is the future. Without optionality in payments, banks will never meet the growing needs of SMEs. The world is globalised and SMEs participate in that world economy. 

As said, the bank’s biggest asset is the perception of operational security. If I lose my bank card, there is a procedure to get me a new one. If I lose all my account details, there is a procedure to find out who I am. If I start buying stuff online from different IP addresses, my bank flags it as fraud, I call them up at any time, and they unblock the card. This is all about operational security. 

But operational security is only the start of a service it is certainly not the end.

I appreciate that banks have set up accelerators and innovation hubs and are investing in the startups that will ultimately compete with the banks. This is a survival instinct being engaged. The key is not only to protect yourself from becoming irrelevant kind of like Blockbusters investing in Netflix, but to leverage your own solid customer base and operational security to surprise the market with your own solutions. 

If I was a bank today, I would have set up a subsidiary to build a custodian solution for digital assets. Innovative solution for an innovation hungry market.