After hitting close to US$65,000 apiece just a couple months ago, Bitcoin is in the doghouse again, losing more than 50% of its value in June alone. Facing both governmental and corporate pressures with the banning of cryptocurrency trading in mainland China and billionaire Elon Musk withdrawing support, the cryptocurrency has continued to be highly volatile over the past several months.
The growing interest in cryptocurrencies such as Bitcoin, Ethereum and XRP by both institutional and retail investors has sparked concern within the banking community, which is expected to be increasingly exposed to such digital assets in the future as demand picks up.
Already, financial institutions such as DBS, Northern Trust and Standard Chartered are looking into custodian services for digital assets. DBS late last year announced that it would work with cryptographic keys that control digital assets on behalf of clients. Northern Trust has partnered with Standard Chartered to launch Zodia, a cryptocurrency custodian for institutional investors.
Acknowledging the popularity and growing acceptance of cryptocurrencies, the Basel Committee on Banking Supervision (BCBS), the global standard-setter for the regulation of banks, has proposed a framework for banks to follow. Under the BCBS proposal, there would be a differentiation in the prudential treatment of crypto assets into three main different groups.
These are tokenized traditional assets which are based on real assets such as artwork, stablecoins which are cryptocurrencies pegged to a stable asset such as gold, and cryptocurrencies such as Bitcoin. Under the proposed arrangement, volatile cryptocurrencies that have no stabilization mechanism would attract a much higher risk-weight for banks.
“Banks’ exposure to crypto assets remains small, according to the BCBS. However, the rapid development of the asset class and the fast growth of cryptocurrencies that are not stabilized increases material risks for banks with cryptocurrency exposure,” Fitch Ratings explains in a commentary. “The extreme price volatility of some of these assets and an unproven track record of liquidity will make it challenging to hedge positions when providing derivative instruments to institutional clients or when manufacturing investment products that reference crypto assets. Allowing less sophisticated retail and private customers access to this asset class also entails substantial reputation and legal risk.”
While banks’ exposure to these assets is currently small, the increasing popularity of cryptocurrencies is something banks need to consider if they hope to capture the opportunistic trends of the future.