The banking and crypto markets may be more symbiotic than you think

bychykhin - stock.adobe.com

The promise of crypto is to democratize financial services that are otherwise captured by brick-and-mortar banking or classes of products that require money to make money. The promise of blockchains is a third generation of the internet, what can be referred to as Web3, which enables people to read, write and own digitally scarce content and assets. Crypto proponents would argue that this amounts to nothing short of an anti-establishment revolution allowing people to opt out of the traditional political economy and opt in to technology-powered economic self-sovereignty. As the market losses and enforcement actions of the last two years have shown, the durable parts of crypto (no more monolithic than banking) may be more evolutionary in financial services than revolutionary. This is a good thing for markets and the players who wish to disrupt financial services with novel technologies.

Taking a long view on evolutionary innovations in banking is telling. For example, far from a world of always-on financial services, banks have had to undergo profound business model innovations that both extended their reach, while lowering the cost of being a bank — a segment of the economy that enjoys a necessary public backstop, thus imposing conservative prudential and risk management standards. As the economy shifted over the last 100 years, consumers demanded access to their money beyond 9-to-5 banking hours — with a number of bank holidays in between. Arguably the blend of labor laws, efficiency and cost reductions of moving from a human teller to the automated teller machine, which was invented in the late 1960s, is an example of evolution rather than revolution.

As ATMs proliferated, the ability of banks to meet their increasingly dynamic customers where they were — whether at a gas station, traveling overseas or at odd hours of the day — the ATM represented a breakthrough. The breakthrough is in evolving the physics of banking and money, while still abiding by a rules-based economy. The next extension of this model saw the rise of e-commerce force banks to face a potential adapt-or-die moment, as growth of internet-scale economic activity triggered a wave of fraud metastasizing into today's virulent version of cybercrime. Banks and financial services firms faced a stark choice: Absorb fraud risks giving customers a zero-liability proposition, or miss a permanent transition in the economy to an internet-borne services sector and the rise of globalization.

Evolution, not revolution, followed, and while the number of banks in the U.S. began to decline from more than 14,000 in the 1930s to around 4,100 today, banking did not die, it evolved. This evolution required the approximation of an always-on, more open banking environment powered by the internet as a part of the technology foundation that would not only power the economy, but would also power banking. Insidiously, not all banks, even the survivors, can keep up with the digital transformation and cybersecurity arms race, and the failure of any one bank erodes confidence in banking. Today, it is not only normal in banking to have internet-based account access, the ability to execute wires, move money across accounts, check balances or request a loan, among other integrated services, it is the basis of survival.

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Despite many banks keeping pace with evolution in internet banking, much of the core of banking remains unchanged. Even at the most well-endowed technology-powered bank, executing a wire transfer is still analogous to the era of fixed-line telephony. The longer a call traveled over fixed infrastructure, the higher the costs. In banking, the faster a customer needs a payment, in no small measure because speed in today's banking system requires people and overhead, the higher the cost. These activities are further encumbered by technologies that are either antiquated or proprietary, which conspires to produce a veritable walled garden in financial services. This walled garden exacts the highest costs from the people who can afford it the least, for even basic financial services. As an example of legacy technology debt, the ACH, Swift and other interbank payment networks were first born in the 1970s. As an example of proprietary, most of these networks and even their public alternatives such as FedNow, which was launched with a pilot group in July 2023, are still proposing closed value transfer networks.

It would stand to reason that the advent of mobile-enabled digital wallets and open blockchain ledgers would be seen as revolutionary and potentially anathema to the safety and soundness of banking. But, as 2022 taught us, perhaps crypto and banking are not pitted in a fierce death match, but rather present as symbiotic a business upgrade as the internet and the ATM did in the past, and as mobile banking does now. In fact, crypto may need banks more than banks need crypto — yet, for the world to make material advancements in where banking and financial services currently fall short, discouraging responsible technology innovation, especially in areas that can clearly extend the perimeter of the formal economy, would be shortsighted not only for banks and their regulators, but for the economy writ large.

Emerging technologies can often be scary and untenable, especially for a sector that by design and regulatory fiat has to be risk averse. The migration from owned server farms to cloud computing was also terrifying. Today, however, cloud computing and all the attendant technological jargon has faded to the background and banks, businesses, markets and consumers are better off. The same transition is underway with blockchain-based financial services, as a wave of institutional adoption gains speed. Just like the checkered early days of the internet or the continually checkered scorecard on Wall Street, to normalize and manage novel technology risks requires banks and nonbanks to innovate, partner and compete. Indeed, looking at the technology and vendor capture most U.S. banks labor under, the advent of open-source systems should be welcome, even if the first waves of development of the so-called internet of value have left a lot to be expected.