In the wake of the Digital Asset Summit 2023 held in London, financial institutions are now in a heated race to offer digital assets to their clients. After a period of uncertainty and skepticism, the digital asset market has emerged from the shadows stronger than ever. The thawing of the crypto winter has sparked renewed interest and confidence among investors, paving the way for broader acceptance and adoption of digital assets.

In the wake of the Digital Asset Summit 2023 held in London, Financial institutions are now in a heated race to offer digital assets to their clients.

The integration of digital assets has become a strategic imperative for banks and financial institutions. As traditional banking models adapt to meet the demands of a digital-first era, understanding and embracing the potential of digital assets is essential for staying competitive and relevant in the market.

In this blog post, we'll embark on a journey through the digital transformation process of banks as they navigate the complexities of integrating digital assets into their offerings.

Digital Assets for Banking Clients

Banks, with their established customer base, possess a unique advantage in offering new services through digital assets. From custody and trading to staking, the possibilities are vast. However, the journey begins with laying a solid foundation for custody and trading services.

Step I. Custody and Trading

Custody and trading of digital assets is the first step in offering digital assets by banks. This step can be implemented by banks themselves (e.g. with custody partners like Fireblocs or Metaco, Crypto Fiance), or in partnership with other banks (Sygnum, SEBA).

The initial consideration in offering custody services revolves around the technical setup:

• dedicated blockchain accounts for each client,
• holding digital assets within a pooled structure.

While the former ensures greater security, it may entail more complex implementation. Furthermore, the coverage of digital assets within most banks is currently around the top 10 - 20 of the largest in terms of market cap digital assets.

Target Clients

It's crucial to note that these services primarily cater to clients that looking to enter the crypto space.

Clients already holding crypto assets often prefer self-custody wallets, making it challenging to persuade them to transition to bank custody due to cybersecurity concerns and extra costs compared to free self-custody. For such clients, banks could offer the option of hosting cold wallets (hardware wallets) in secure bank facilities.

For clients interested in trading, platforms offering trading futures on crypto, such as perpetual, have gained popularity, with options like Paradex from Paradigm or dYdX being notable examples. Whitelabelling of such platforms would create a compelling offering for clients keen on trading.

Step II. Staking

Staking presents a compelling option for clients seeking to hold onto their cryptocurrency for the long term without engaging in active trading. With many major cryptocurrencies like Ethereum, Solana, and Cardano transitioning to proof-of-stake mechanisms, meaning that every year certain % of new tokens are minted (e..g. 4%), resulting in token inflation. Staking offers a means to protect against this token inflation while staking rewards should be equal to is (and for most tokens they are).

By allocating tokens to validators who maintain the blockchain network, stakers can earn staking rewards, similar, but not the same as an interest-free rate in traditional finance. However, it's important to note that while staking is relatively low-risk, validators failing to fulfill their duties may face penalties in a process known as slashing. To mitigate such risks, many staking providers offer insurance against slashing incidents.

Following the provision of digital asset custody, staking naturally emerges as a complementary service. Numerous custody providers, such as Sygnum and Crypto Finance, also offer staking services. Additionally, specialized staking providers like Chorus One and KLIM cater to this growing demand.

Liquid staking, represented by tokenized staking, offers an intriguing alternative. Buying and selling liquid staking tokens (LSTs) is simpler for users and technologically, but it does carry some market risk, such as temporary de-pegging of LST tokens.

Step III. Tokenized Assets

Tokenization opens doors to a wide array of assets, including art, real estate, and bonds. By leveraging blockchain technology, banks can tokenize assets internally or collaborate with specialized partners to offer clients innovative investment opportunities, such as Aktionairat in the tokenization of SME shares or Obligate in the tokenization of debt.

The tokenization of carbon credits or other projects that foster environmentally friendly and sustainable developments can be also considered (Tourcan Protocol).

In this step of issuing and trading of tokenized assets, the bank needs to consider with which blockchain network to get involved. Private and public blockchains each have their advantages and disadvantages. Private L2 blockchains (validiums) are a new and interesting alternative.

Intra-Bank Collaboration

Beyond client-facing services, blockchain technology presents opportunities for optimizing internal processes and facilitating collaboration between institutions. Faster settlements and reduced fraud risks are just some of the benefits banks can unlock through intra-bank blockchain solutions.

The main advantage of DLT is a faster settlement (2-12s) thanks to the transaction atomicity, which hugely simplifies the back-office process and reduces the fraud risks. An example process that the financial institutions can perform on-chain includes issuing and trading of tokenized assets (tokenized bonds) or tokenized deposits (stablecoins, wholesale CBDCs) that allow to reduce the costs and increase the efficiency of inter-bank or inter-institutions processes. For this step, the choice of a public blockchain is rather unlikely. The best option is a private blockchain, though prone to centralization risk and limited scalability, or validuim - private L2 chains on top of public networks.

Conclusion

The journey into the world of digital assets is multifaceted and requires careful navigation. By embracing digital innovation and leveraging blockchain technology, banks can enhance their offerings, increase revenues from new services(custody, staking), streamline operations, and stay ahead of the curve in an increasingly digital financial ecosystem.

Join us on this exciting journey as we explore the transformative potential of digital assets in finance.

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