The crypto maturity model: How traditional finance can adopt cryptocurrency in stages

Over the last year, financial institutions have experienced unprecedented demand from their customers for exposure to cryptocurrency, and we've seen an inflow of institutional dollars driving bitcoin and other cryptocurrencies to record prices. Some banks have already launched cryptocurrency programs, but many more are evaluating the market.

That's why we've created the Crypto Maturity Model: an iterative roadmap for cryptocurrency product rollout, enabling financial institutions to evaluate market opportunities while addressing compliance requirements.

The crypto maturity model

Level 1: Open for business

The first step for banks is to train staff so that they understand which cryptocurrency businesses their customers are most likely to interact with and the varying amounts of risk those businesses would introduce.

Crypto-friendly banks can also begin taking on cryptocurrency businesses as clients. Silvergate Bank became one of the first banks to work with cryptocurrency businesses in 2013 and, since then, has onboarded over 900 cryptocurrency businesses as clients. In 2018, the bank rolled out the Silvergate Exchange Network, which allows institutional investors to buy cryptocurrency assets from several different exchanges. The bank's stock price has risen over 1,500% in the last year as bitcoin and other crypto assets have rallied.

Financial institutions are also now able to offer many more products and services to cryptocurrency firms. We've recently seen banks like Citi, JPMorgan Chase and Goldman Sachs offer M&A services and advise on IPOs. Many cryptocurrency businesses now also need foreign exchange services and more robust global settlement mechanisms.

Banks can tap into a huge opportunity by taking on cryptocurrency businesses as clients, but only if they do it safely. Luckily, risk assessment in cryptocurrency is actually easier than in most other industries due to the inherent transparency of most blockchain-based assets. Unlike with fiat currency, most cryptocurrency transactions are recorded on a public ledger. That means that with the right tools, banks can monitor cryptocurrency businesses' transactions, ensuring every client they take on fits into their desired risk profile.

Banks can tap into a huge opportunity by taking on cryptocurrency businesses as clients, but only if they do it safely.

Level 2: Synthetic cryptocurrency products

Once a financial institution has become comfortable working with cryptocurrency businesses, it may want to help both retail and institutional customers get exposure to cryptocurrency markets. That doesn't mean they have to enable direct trading of cryptocurrency. Instead, they can offer synthetic, cryptocurrency-based investment products that allow customers to capture some of cryptocurrency's upside without setting up custody infrastructure.

Asset management firm BlackRock recently invested in bitcoin futures, a useful way to test the cryptocurrency market and attract potential clients interested in crypto assets. Firms like Grayscale Bitcoin Trust allow investors to trade shares the same way they would any other public asset.

Long considered a possible game changer in the industry, no cryptocurrency ETFs have received SEC approval yet, though Canadian investment firm Purpose Invest recently launched North America's first ever bitcoin ETF. And asset manager VanEck recently launched an alternative ETF that holds shares in cryptocurrency infrastructure providers like exchanges, miners and storage providers.

Level 3: Custodial services

Custodial services represent the biggest chasm for banks to cross in their cryptocurrency journey, and only a few traditional financial institutions have rolled out such offerings.

However, those that have begun work on cryptocurrency custodial services offer a helpful model for others. BNY Mellon announced plans to launch a custodial platform in partnership with Fireblocks, a cryptocurrency custodial services provider, and digital asset custody company Northern Trust and Standard Chartered Bank announced plans to partner on a similar solution called Zodia Custody. Asset manager Fidelity took a different approach, using its early start to build its own custodial platform from scratch.

So far, traditional financial institutions have mostly steered clear of offering custodial services for retail customers, but fintech platforms offer an example of how they might do so. Square launched its cryptocurrency custody solution in 2018 by building its own cryptocurrency custody platform called Subzero, allowing its customers to buy over $4.5 billion worth of cryptocurrency in 2020.

The key lesson: While Square and Fidelity show that it's possible to go it alone, many financial institutions are partnering with companies that already have deep cryptocurrency expertise to launch their custodial services. That allows them to test a radical new offering with fewer resources invested, while also drawing on outside cryptocurrency expertise.

Level 4: Beyond custody

Very few financial institutions have gone beyond custodial services in their adoption of cryptocurrency. Fidelity recently announced plans to provide institutional clients the ability to pledge bitcoin as collateral in DeFi-based loans in partnership with BlockFi.

Payments are another place traditional financial institutions can incorporate cryptocurrency. Visa recently partnered with BlockFi to roll out the first ever credit card to give customers bitcoin rewards on all purchases they make, and has a partnership with Crypto.com to release a debit card that allows customers to use their cryptocurrency holdings for purchases.

Cryptocurrency trading is the next service we expect to see mainstream financial institutions offer. Goldman Sachs has already made some cryptocurrency trading possible for institutional clients through its cryptocurrency trading desk. But with the success of exchanges like Coinbase, we expect financial institutions to offer these services to retail clients as well.

Good times ahead

With cryptocurrency becoming increasingly mainstream, banks are no longer viewing it as money for criminals or looking for ways to ban it. Instead, they're recognizing the ways it can help their customers while driving revenue and trying to incorporate it into their larger strategies.

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