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Traditional financial institutions continue to demonstrate use cases for digital asset support, along with DeFi capabilities, despite current market conditions.

The cryptocurrency sector is the Wild Wild West in comparison to traditional finance, yet a number of banks are showing interest in digital assets and decentralized finance (DeFi). This year in particular has been notable for banks exploring digital assets. 

Most recently, JPMorgan demonstrated how DeFi can be used to improve cross-border transactions. This came shortly after BNY Mellon — America’s oldest bank — announced the launch of its Digital Asset Custody Platform, which allows select institutional clients to hold and transfer Bitcoin (BTC) and Ether (ETH).

The Clearing House, a United States banking association and payments company, stated on Nov. 3 that banks “should be no less able to engage in digital-asset-related activities than nonbanks.”

Banks aware of potential

While banks continue to show interest in digital assets, BNY Mellon’s 2022 Survey of Global Institutional Clients highlights increasing demand from institutions seeking access to digital assets through reputable custodians. According to the survey, almost all of the 271 institutional investors (91%) are interested in investing in tokenized assets. The survey also found that most of these investors are using more than one custodian, with 35% conducting business with traditional incumbent players.

The heightened demand from institutions seeking access to digital assets is one of the reasons why banks are showing interest in cryptocurrency and DeFi offerings.

Bobby Zagotta, CEO of Bitstamp USA — a cryptocurrency exchange founded in 2011 — told Cointelegraph that Bitstamp has received many inbound requests recently for their Bitstamp-as-a-Service offering, which allows fintechs and traditional financial institutions to give clients access to cryptocurrency.

“Last year, fintechs were asking Bitstamp about services to support cryptocurrency. This year, fintechs have been discussing the downsides of not offering clients access to digital assets. Banks are waking up to the fact that there is client demand to buy and sell crypto, and if people can’t do this with their banks they will go somewhere else,” he said.

Zagotta added that banks currently not looking to implement digital asset offerings will lose market share: “Banks are realizing that they could be creating a customer retention problem if they don’t come to market with crypto offerings.”

To Zagotta’s point, BNY Mellon’s survey found that 65% of institutions are currently engaging with digital-native platforms rather than traditional financial players. However, BNY Mellon’s findings also indicate that 63% of surveyors would accept longer settlement times in order to transact with a highly rated traditional institution.

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Moreover, some industry experts believe that large banks can advance their operations by implementing crypto and DeFi solutions. Colin Butler, global head of institutional capital at Ethereum layer-2 network Polygon, told Cointelegraph that while the pilot trade conducted by JPMorgan and the Monetary Authority of Singapore was a milestone toward the adoption of decentralized solutions, it also demonstrates that these entities are testing to see if DeFi frameworks are beneficial.

“If the answer is ‘yes,’ then it would allow them to significantly increase the efficiency of their operations,” he said.

Butler elaborated that Polygon’s proof-of-stake blockchain ensured that the cross-border transaction conducted between JPMorgan, the Monetary Authority of Singapore, and other banking entities was fast, secure, and as cost-efficient as possible. He said:

“All of these elements are extremely important when it comes to DeFi adoption. The inherent efficiency of blockchain-based solutions is what gives DeFi an advantage over traditional financial systems that have been built over the past decades. While they’re still ‘working,’ these frameworks are very rigid. The latest advancements in DeFi can help make the whole process of transacting significantly more efficient and convenient.”

Echoing Butler, Seamus Donoghue, chief growth officer at METACO — a digital asset custody provider for major financial institutions — told Cointelegraph that he believes all financial assets will eventually be represented on distributed ledgers. As such, Donoghue mentioned that there is an imperative to redesign the financial market infrastructure. 

“This is the reason why virtually all tier-1 banks are now investing in building new infrastructure: not for the currently bearish crypto market, but for the much larger vision of how every asset will be represented and how value will be created and exchanged, globally,” he said.

Donoghue added that banks will eventually become the bridge for institutions seeking exposure to digital assets and DeFi. He explained that this is due to the fact that traditional financial institutions have consumer trust, large balance sheets and a network of market participants creating liquidity, along with a customer base with unmet needs.

However, traditional financial institutions remain concerned about regulations. Mathias Schütz, head of client and tech solutions at SEBA Bank — a Swiss-based digital asset bank — told Cointelegraph that traditional banks are hesitant to engage with digital assets due to regulatory uncertainty.

In order to solve this, Schütz noted that SEBA Bank, which is licensed by Swiss regulators, acts as a trusted counterparty for institutions to engage with digital assets.

“This is why SEBA Bank has been able to partner with a number of major banks in 2022, including LGT Bank, the world’s largest family-owned private bank,” he said. This is also important from a consumer’s perspective, as findings from BNY Mellon’s survey notes that investors are primarily concerned with digital custodians’ legal and regulatory frameworks.

Will market chaos impact interest in digital assets and DeFi?

Regulations aside, the recent turn of events with FTX US and Binance may impact how traditional financial institutions view digital assets. While it’s too soon to understand the consequences of this debacle, Donoghue mentioned that the FTX US and Binance shakeup could have a short-term impact. “It could shift banks’ strategies to skip cryptocurrency services, and focus exclusively on digital securities more broadly, at least temporarily,” he said. 

Eric Berman, a regulatory expert at Thomson Reuters, told Cointelegraph that he doesn’t believe this event will hasten bank involvement in digital assets. “Banking institutions have taken it slow with crypto as it is. The FTX US and Binance situation probably underscores to the banking sector that it has done the right thing in taking a pragmatic approach.”

In any case, both Donoghue and Berman are aware that this event demonstrates the need for further regulatory clarity before traditional financial institutions can innovate with digital assets.

“The recent negative industry events have emphasized the critical need for safe and compliant infrastructure, business practices and regulatory oversight. So if anything, the demand for asset servicing from trusted institutions such as regulated global banks, has only increased,” Donoghue said.

It’s also interesting to point out that BNY Mellon’s survey examined how the Terra ecosystem collapse has impacted institutional investors. According to the report, 9% of institutional asset managers noted that the Terra collapse has not impacted their digital asset plans, while 50% reported taking a short-term pause to reassess, noting they will likely continue soon.

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Regarding whether the bear market will impact banks’ interest in digital assets, Butler explained that the crypto market is not much of a factor affecting banks, particularly when it comes to DeFi. For instance, he pointed out that JPMorgan used Polygon to conduct a live cross-currency transaction that involved tokenized Singapore dollar and Japanese yen deposits, along with a simulation of tokenized government bonds. According to Butler, those assets have no correlation with crypto prices. He added:

“Essentially, financial institutions are looking for ways to tokenize traditional assets — and this could be anything, from bonds and fiat currencies to real estate deeds — and transact them digitally. As such, these tokens retain the value of their ‘original’ assets, so this is more about the technology itself rather than crypto prices and bear/bull markets.”