2023 has been an incredible year for digital assets, with Bitcoin seeing a surge of around 150 percent since the beginning of 2023. Blackrock, the world's largest asset manager, has applied for a BTC ETF along with a growing handful of institutions, including Fidelity, WisdomTree, and Bitwise. Global institutional adoption of digital assets has dramatically increased by over 50% year over year, according to a Citi Securities Service institutional survey. Even funding and M&A have seen traction again, e.g. with the U.S. crypto firm Ripple acquiring Switzerland-based crypto custody firm Metaco for $250 million.

In particular, the European financial markets have been leading the way in terms of regulatory clarity for institutional investors in digital assets with the anticipation around the EU’s Markets in Crypto-Assets (MiCA) framework, which is set to come into force in early 2024. All this leads to institutional adoption of digital assets being at a significant threshold – which makes the decision for the right infrastructure all the more important for market participants such as banks.

Reducing Counterparty Risk: Essential Learning for Financial Institutions

In the realm of digital currencies, functions like custody and brokerage play pivotal roles, much as they do in traditional asset trading. These roles are typically kept distinct within the Traditional Finance (TradFi) sector, following strict risk management protocols. However, this critical separation of duties was overlooked by entities like FTX & Co, resulting in significant repercussions and their eventual collapse. Consequently, it's crucial for banks to establish and strictly follow internal governance protocols, especially when engaging with cryptocurrency exchanges and related service providers.

As financial institutions navigate the digital asset landscape, they encounter a highly fragmented market. This market comprises numerous centralized and decentralized cryptocurrency exchanges, over-the-counter (OTC) desks, and brokers. To adhere to the best execution policy, as mandated by regulations such as MiCA, banks must integrate multiple liquidity venues into their systems. These venues often exhibit significant differences in pricing and liquidity, presenting opportunities for strategic order placement to maximize benefits.

Furthermore, in risk management, diversification is key. Relying on a single exchange can lead to severe asset loss if that exchange fails. By connecting with multiple trading venues, banks increase operational complexity and liquidity costs, but they substantially lower the risk of default. Part of this approach includes thorough vetting of trading venues to pre-emptively address liability issues. For instance, it's important to ascertain who bears responsibility in scenarios where an exchange encounters financial issues.

Rethinking Cash Management in the Wake of Bank Failures

The collapses of U.S. banks Silvergate and Signature in early 2023 have had far-reaching consequences, impacting not only their direct clients but also the wider cryptocurrency trading ecosystem. These institutions were pivotal in enabling real-time USD transfers to cryptocurrency exchanges, which helped in reducing the amount of assets stored on these platforms. However, the current alternatives for cash management seem to be at a nascent stage.

While stablecoins are battling issues of volatility and transaction delays, the Single Euro Payments Area (SEPA) offers immediate liquidity in euros. However, its transaction limits and restricted market scope present hurdles for large-scale institutional trading. Moreover, the Federal Reserve's instant payment service, FedNow, is still in the early stages of gaining the necessary network traction. In contrast, off-exchange settlement solutions like those provided by Copper ClearLoop or Fireblocks appear to be the most promising for efficient cash management, facilitating the instantaneous transfer of funds to exchange accounts before trading.

In the realm of smart cash management, a central liquidity pool managed automatically is a valuable tool. This approach includes automating various functions such as pre-funding, rebalancing, and payment settlement. Another effective strategy is dynamic cash management, which involves adjusting the amount of money held at cryptocurrency exchanges based on trading hours, thereby increasing funds during active trading and reducing or withdrawing them completely during off-hours.

Seamless integration and intelligent automation of the entire trade lifecycle

For banks to effectively trade cryptocurrencies, they must incorporate additional systems into their existing core banking infrastructure. This includes a custodial service that is robust enough for institutional-grade trading, safeguarding private keys essential for the secure holding of client assets. Additionally, a trade order execution system is required, one that can interface with various cryptocurrency exchanges.

Moreover, there's a need for a comprehensive intelligent automation solution that can facilitate all of these functions, while also incorporating other critical aspects like liquidity and risk management. Currently, the Wyden platform stands out as the sole provider offering such a comprehensive range of functionalities. In developing their digital asset strategies, it's imperative for banks to consider their specific requirements, risk tolerance, and the demographics of their clientele.

Banks are trusted gateways to the new digital asset class

Established financial institutions have compelling reasons to advance their digital asset strategies. Among the various digital asset categories—cryptocurrencies, NFTs, DeFi, and tokenization—cryptocurrencies have been the most consistent in demonstrating market demand and additional revenue for banks. For retail consumers and investors, a regulated bank's offerings in digital assets can provide a balanced mix of security and convenience, and thus holds a true advantage.

As custodians, regulated banks ensure the secure storage of customer wallets. They simplify access to both crypto and digital assets, functioning as a comprehensive hub for all asset types, from traditional to digital. Wealth advisors within these institutions can offer extensive guidance on risk management and assist in diversifying portfolios. Additionally, expanding the bank's services to include options like staking not only enhances customer convenience but also provides the bank with valuable data, increases customer engagement, and positions the bank as a central, reliable partner.

Crypto regulation as key driver and opportunity for banks

The evolution of banking in the digital asset space is reaching a pivotal moment. While learning from the past "crypto winter" is beneficial, it's the regulatory frameworks, such as MiCA in Europe, that are taking center stage. This presents a unique opportunity for banks and other financial institutions to lead in institutional crypto trading. The infrastructure for an advanced and integrated trading ecosystem is already in place. The imperative now is for banks to rapidly adapt these technologies, spurred by the imminent regulatory certainty that MiCA will bring. This regulation is not just a guideline but a catalyst that should create a sense of urgency among banks to capitalize on the emerging opportunities in the digital asset market.

In this rapidly changing landscape, the role of regulation is more than foundational—it's transformative for a bank's digital asset strategy. This scenario is a call to action, particularly for European banks. It's crucial for these banks to not only build and refine their internal infrastructure and capabilities but also to aggressively pursue opportunities presented by these regulatory shifts. Staying ahead of the curve in understanding and adapting to these changes is not just important—it's essential for banks to not miss out on the potential benefits and leadership positions in the digital asset domain.

This article is from an external contributor. It does not represent Benzinga’s reporting and has not been edited for content or accuracy.