Research Report | Business paths are becoming clearer, and crypto banks are expected to have a bright future

author

【Huobi Research Institute】Xu Miaoyan, Chen Han, Yuan Yuming

summary

In 2020, traditional financial institutions represented by Grayscale, PayPal and MicroStrategy are accelerating their entry into the crypto asset industry through multiple channels. Compliance custodians, as a solid bridge connecting the crypto asset market with the government and traditional funds, crypto asset custody services are increasingly becoming an important position for large banks such as Standard Chartered and DBS to rush to land. It is worth noting that DBS's upcoming digital exchange is only for institutional investors and qualified investors, which indirectly reflects that crypto assets are increasingly recognized by high-net-worth clients.

Currently, there are more than 30 banks that directly provide services to crypto asset companies, 90% of which are located in Europe and the United States. In the face of crypto asset banking business, small and medium-sized banks are stepping up their layout, while large banks are still cautious. At the same time, nearly 20 crypto asset payment processors are actively developing quasi-banking services.

Most crypto-asset-friendly banks only support deposit account services, while a few provide custody, loans or other innovative services. The main profit model is to use the interest-free deposits of crypto-asset companies for lending or investment, thereby earning high interest spreads or zero-cost investment returns. Among them, the development of Silvergate Bank is particularly noteworthy: it began to focus on providing services to the crypto industry in 2013 and successfully went public in 2019; it currently has 928 crypto-asset customers; interest-free deposits have reached US$2.2 billion, accounting for 95% of the total deposits; and it has formed a complete profit model of issuing interest-free deposits and testing custody business. In addition, emerging banks such as Sygnum and Revolut are actively innovating their businesses and opening up a new path for the development of crypto banks, which are attracting great attention from investors.

Looking at the global regulatory situation of crypto asset business: the US federal level has frequently issued favorable policies, but the specific details of crypto banks have yet to be implemented; in Europe, Switzerland is leading the way, while the UK and Germany are advancing cautiously; Australia's asset supervision has taken shape, awaiting the intervention of banks; in Asia, Singapore's crypto bank is only one step away from launch, while Japan and South Korea are still taking a wait-and-see attitude.

Crypto banking is gradually becoming a new track, with traditional and emerging banks accelerating their layout, and crypto companies also seeking new identities. Although it faces challenges such as high innovation costs and unclear profit margins, as the crypto market and regulatory environment mature, it will attract more players to enter the market. Looking ahead, Europe and the United States are expected to accelerate, and cases may be implemented in the UK, Germany, and Singapore; in the short term, traditional and emerging banks will differentiate their business, and in the long term, crypto banking will become an important part, promoting the exponential growth of the scale of crypto assets and user penetration, and eventually interacting with the real economy.

1. Who is rushing into the crypto asset banking business?

On December 16, 2020, Bitcoin broke through the 20,000 USDT mark for the first time since its birth in 2009, setting a new historical high. At the same time, the helmsmen of many industry giants publicly expressed their positive views on Bitcoin: Ray Dalio of Bridgewater Fund changed his previous skeptical attitude and said that Bitcoin is worth investing in; Wang Xing of Meituan said that "crypto assets may be the largest wealth transfer in the history of this planet." Grayscale Investments provides institutional funds with a channel for compliant purchases of crypto assets, while online payment giant PayPal and the US version of Alipay Square have opened up a vast retail market for crypto assets. American institutional funds represented by MicroStrategy are increasingly becoming the main buyers of crypto assets, and traditional financial institutions are continuously accelerating their entry into the crypto asset industry from various paths.

In the banking sector, crypto asset custody services have become an important position for major banks to rush to land. In August 2020, South Korea's large commercial banks, Woori Bank and Shinhan Bank, said they were actively studying the introduction of crypto asset services, and NH Nonghyup Bank was preparing to introduce crypto asset custody services; on December 9, Standard Chartered Bank and Northern Trust jointly released an encrypted digital asset custody solution, Zodia Custody, which is expected to be officially operated in London in 21 years; on December 10, Singapore's DBS Bank changed its 17-year view that Bitcoin was like a "Ponzi scheme" and did not consider participating, and officially announced the launch of the digital asset trading platform DBS Digital Exchange, which will start trading in late December and provide exchange services between four fiat currencies and digital assets, spot trading services and custody services.

However, it is no coincidence that crypto asset companies that want to enjoy services from traditional banks are facing difficulties in finding reliable financial service partners. As any customer who intends to open a bank account must comply with strict anti-money laundering (AML), know your customer (KYC) and counter-terrorist financing (CTF) policies, and undergo a complete due diligence to ensure that there is no violation of any financial sanctions, traditional banks need to use a lot of money and manpower to cope with the complex and underdeveloped crypto asset customer supervision system. In addition, compared with the huge traditional financial market, the overall scale and business volume of the crypto asset industry are still relatively small, and the input-output ratio is quite different, which is not enough to attract large mainstream banks to enter the market.

Globally, due to compliance costs and reputation risks, mainstream banks that directly provide services to crypto asset companies are still in the minority, and the banks are generally small in size. Most large banks are unwilling to provide in-depth services to crypto asset companies. However, for small and medium-sized banks facing fierce market competition, providing crypto asset customers will open up a new channel for them to attract new customers. Driven by many factors such as potential customer groups and new profit sources, a group of crypto asset-friendly banks have emerged.

1.1 Small and medium-sized banks are actively trying, while large banks are still cautious

As shown in Table 1-1, the median total assets of banks that currently accept clients from the crypto asset industry are only US$866 million, and most of them are small and medium-sized banks. In addition to JPMorgan Chase, only two large banks (Silicon Valley Bank and Signature Bank) serve crypto asset clients. Previously, at the end of 2018, Barclays Bank accepted Coinbase as a client, but a year and a half later, it lowered its risk appetite for crypto assets and cut off its business ties with Coinbase. Large mainstream banks have relatively stable customer acquisition channels and a solid existing customer base, and they still maintain a very cautious operating attitude towards crypto asset companies.

1.2 Nearly 90% of crypto-friendly banks are located in Europe and the United States

As shown in Figure 1-1, the 32 banks that provide services to crypto asset companies worldwide are mostly concentrated in Europe and the United States , of which 9 banks are located in the United States, 19 banks are located in Europe, and 4 banks are scattered in other regions. This is mainly related to the prosperous crypto asset market and relatively complete regulatory system in Europe and the United States.

As shown in Table 1-2, the total asset size of US banks is relatively high compared to banks in other regions. The three large banks that provide related services are all located in the United States; but the business model they provide is relatively basic (mainly supporting crypto asset exchanges/company account opening, providing basic banking services, and some providing custody or issuing crypto asset debit cards and other services). The following table specifically introduces the main service objects of these banks.

In Europe, there are 19 crypto-friendly banks (excluding two banks that have not yet officially started operations). Although the asset size of most banks is slightly inferior to that of the United States, they provide more abundant crypto-related banking services. Nine of them are headquartered in Switzerland and offer a range of services including custody, trading and consulting; four are headquartered in Germany, serving clients including Kraken, Bitwala and Bitcoin.de and other crypto service providers. The remaining six banks are located in the United Kingdom, Slovenia, Estonia, Liechtenstein and Latvia. The specific situation is shown in Table 1-3. Banks such as Vontobel, Falcon Private Bank and Bank Frick also provide various services based on crypto assets, including asset management, trading, futures, etc.

In addition, there are only four banks registered in non-European and American regions, namely VersaBank registered in Canada, Deltec Bank and Ansbacher registered in the Bahamas, and Pacific Private Bank registered in Vanuatu. The specific types of services they provide are shown in Tables 1-4 below.

1.3 Payment processing service providers actively develop banking-like services

In addition to traditional banks, payment processing service providers represented by Prime Trust, Mistertango, and AdvCash have also opened relevant services for crypto asset companies, and the main service types include quasi-banking services or payment services. Most of the service providers that provide such services are located in Europe, 3 are located in the United States, and a few are distributed in other regions. The specific situation is shown in Table 1-5 below.

In general, as the crypto asset industry continues to mature and compliance policies and supervision become increasingly complete, large mainstream banks may gradually begin to provide services to crypto asset customers, and the expansion and development of the crypto asset-friendly banking market is expected in the future. As for the United States, which has the largest number of banks, the U.S. Office of the Comptroller of the Currency (OCC) has proposed new regulations to prohibit large banks from discriminating against legitimate but unpopular businesses, including crypto asset companies. This will help improve the current situation of discrimination against crypto asset companies and help them easily connect to a wider financial system through the banking network.

In addition, statistics show that compared with 2019, there are 10 more crypto-asset-friendly banks, and compared with 2018, the number of such banks has tripled. The US OCC has also received applications from crypto asset service provider Paxos, crypto payment processing platform BitPay and other companies, hoping to convert their state trust company licenses into national trust bank licenses.

Trust Charter is one way to apply for a crypto bank, and it is expected that more crypto banks will be launched. However, the survival and rise and fall of crypto-friendly banks are always closely related to the regulatory policies of various regions. This article will introduce and analyze the regulatory policies of different regions in Chapter 3, so as to provide a specific outlook.

2. Banking based on crypto assets

Among the above-mentioned crypto-asset-friendly banks, Silvergate Bank in the United States has developed the most notably. As a traditional regional bank in the United States, it has all banking functions. By carrying out crypto-asset-related businesses, it has made up for its weak external expansion capabilities and opened up a new source of profit. It was listed on the New York Stock Exchange in November 2019. The key to the bank's growth strategy is that it has attracted a large number of crypto-asset industry companies to deposit interest-free deposits through the development of its internal transaction payment network SEN. This type of funds enables it to generate income in multiple dimensions such as interest-bearing deposits, conservative short-term bonds, and loan investment portfolios, creating a relatively typical profit model for crypto-asset-friendly banks, which has been emulated by many banks.

In addition, banks such as Switzerland's Sygnum and the UK's Revolut are quite innovative and have adopted differentiated business development routes. They may be potential growth points for crypto-asset-friendly banks in the future and are worthy of our close attention.

2.1 The first listed crypto bank: Silvergate Bank

2.1.1 Company Overview

Founded in 1987, Silvergate Bank is a commercial bank dedicated to "creating a banking platform for innovators, especially those in the crypto asset industry, and developing product and service solutions that meet the needs of entrepreneurs." It intends to continue to focus on crypto asset initiatives as the core of its future strategy and direction, and began to focus on serving the crypto industry in 2013.

To date, Silvergate Bank has served a large number of cryptocurrency industry leaders including Coinbase, Bitstamp, Genesis Trading, Polychain Capital, Paxos, Circle, etc. As shown in Figure 2-1, as of September 30, 2020, the bank had 928 cryptocurrency clients (69 cryptocurrency exchanges, 599 institutional investors, and 260 other clients including blockchain projects, mining companies, stablecoin issuers, and other cryptocurrency service providers), a significant increase from 756 clients in the same period of 2019. Most of the well-known stablecoin issuers in the United States are working with Silvergate.

The bank also stated that it has more than 200 potential crypto asset customers at various stages of customer acquisition, and the bank's crypto asset customer base will continue to grow.

Currently, Silvergate Bank's crypto asset solutions and services focus on three aspects: Silvergate Exchange Network (SEN), cash management solutions (customers can send, receive and manage payments in a timely, efficient and scalable manner through SEN, wire transfer or ACH), and other deposit account services (the bank has developed proprietary compliance procedures to prudently and effectively establish deposit accounts for crypto asset market participants). Among them, the most noteworthy is the internal banking network developed by Silvergate Bank in 2017 - Silvergate Exchange Network (SEN) .

In order to better serve the crypto asset community, SEN was provided to all crypto customers of the bank (only commercial customers, not individual investors) in early 2018, allowing commercial customers to transfer US dollars between different crypto asset exchanges in real time 24/7, thereby improving capital efficiency and enabling all-weather trading of various asset classes. During the SEN transfer process between customers, the deposit will be stored in the Silvergate Bank system. If both the sender and the receiver are SEN participants and there is enough transfer amount in the fund account, the transaction can be settled immediately.

As shown in Figure 2-2, for institutional investors who need to transfer US dollars from exchange A to exchange B, the delay in transaction execution under the traditional scheme may limit their opportunities to seize profit opportunities in market changes, or require them to retain additional funds in each exchange to cope with other trading opportunities. However, SEN has effectively increased the speed of transaction execution between accounts, significantly reduced the impact of price fluctuations of encrypted assets, and enabled institutional investors to quickly and efficiently transfer funds and implement corresponding investment strategies.

Data shows that Silvergate Bank customers are accepting SEN at an accelerating rate (see Figure 2-3). In the third quarter of 2020, SEN processed 68,361 transactions, a 70% increase from 40,286 transactions in the second quarter and a 455% increase from the same period in 2019. This strong growth also led to a 106% increase in its crypto asset fee income in the third quarter to $3.3 million. In addition, SEN's total transfer transaction volume in the third quarter of 20 reached $36.663 billion, a 64% increase from $22.4 billion in the previous quarter and a 252% increase from the same period in 2019.

2.1.2 Deposit business

SEN (based on Silvergate Bank's proprietary API and supporting customers to integrate the API into their own systems) and cash management solutions launched by Silvergate Bank in 2017 meet the needs of innovative crypto-asset customers, helping customers develop their business and expand operations, and boosting the company's continued growth in the number of crypto-asset customers (as shown in Figure 2-4) and deposit volume (interest-free deposits) (as shown in Figure 2-5).

Silvergate

Silvergate Bank 's deposits are mainly composed of interest-free deposits from crypto asset customers. As shown in Figure 2-6, since the SEN internal network was put into use in 2017, the bank's interest-free deposits have risen sharply, rapidly surpassing the interest-bearing deposits, and now occupy an absolute dominant position. As of September 30, 2020, Silvergate Bank's total deposits reached US$2.3 billion, an increase of US$610.2 million, or 36.5%, from the second quarter, and an increase of US$433 million, or 23.4%, from the same period last year. Among them, US$2.2 billion are interest-free deposits, accounting for approximately 94.9% of total deposits, an increase of US$601.2 million from the previous quarter, and an increase of US$769.9 million from the same period last year. Compared with the second quarter, the growth in total deposits was mainly driven by an increase in deposits from crypto asset exchanges, institutional investors and other crypto asset-related customers. The increase in customers is also fully reflected in the record SEN trading volume in the third quarter.

Fee income from crypto-asset clients increased from $2.438 million in the second quarter of 2020 to $3.293 million in the third quarter of 2020, accounting for 83% of Silvergate Bank's non-interest income. Deposit-related fees from crypto-asset clients increased by $1.636 million, nearly doubling from $1.657 million in the same period of 2019 (see Figure 2-7). The surge in trading activity from crypto-asset clients fully reflects the growing demand for Silvergate Bank's cash management solutions, foreign exchange services, and deposit solutions.

Figure 2-7 Silvergate Bank deposit-related fee income (thousand US dollars)

2.1.3 Loan business

In addition to the bank's traditional loan model, Silvergate Bank launched a new product for USD loans against Bitcoin collateral, called "SEN Leverage" loans in the first quarter of 2020. "SEN Leverage" has the function of lending with Bitcoin as margin, which allows Silvergate Bank customers to borrow USD against Bitcoin held on cooperative crypto asset exchanges.

As of September 30, 2020, SEN Leverage has completed its initial pilot phase, with approved credit lines totaling $35.5 million, significantly higher than the $25 million in the second quarter. The company plans to continue to expand its issuance, which is believed to be its main growth driver in the future.

2.1.4 Business Model Summary

For Silvergate Bank, the internal banking network Silvergate Exchange Network (SEN) is the core of its crypto-asset-related customer operations. While providing a more convenient channel for transfers between customers, it also meets the infrastructure needs of crypto-asset customers for traditional elements of financial services (fund transfers, customer account controls and other security measures). Customers can transfer and hold US dollar deposits efficiently and reliably, helping them maintain existing customer relationships and attract new customers.

According to the official survey website and other official information, among the nine crypto-friendly banks in the United States, only Silvergate Bank can be strictly defined as a crypto bank. However, the scale of interest-free deposits of banks such as Signature Bank has grown rapidly in recent quarters, which can be speculated to be due to the deposit of crypto assets. In summary, the main reasons why most crypto-friendly banks, represented by Silvergate Bank, are involved in the crypto-asset industry are:

Obtain high interest rate differentials or realize zero-cost investment returns: Banks do not pay interest on deposits from the crypto asset industry, which greatly reduces the bank's capital costs. For them, this is basically free money, and they can issue loans and easily earn high interest rate differentials from it; or use this type of funds to purchase various types of products such as interest-bearing deposits, short-term bonds, etc. from other banks to realize investment returns under zero-cost conditions.

Expand customer sources: Getting involved in the crypto asset field will help such banks win over exchanges, institutional investors and other customers in the crypto asset field, enriching their customer sources.

Pursuing business innovation: Accepting crypto asset industry participants will help these banks explore innovative financial products, expand business boundaries and increase revenue sources.

2.2 Emerging Crypto Banks with Different Business Models

Kraken Financial, which only supports custody and does not provide loan services:

Background: Kraken, a subsidiary of the US crypto asset exchange Kraken, was approved by the Wyoming Banking Commission in September this year to conduct banking business as a special purpose depository institution (SPDI). SPDI can operate regular banking business except for US dollar loans, but is required to provide 100% reserve funds for custodial crypto assets.

Crypto asset business (expected):

Deposit (custody) business;

Crypto assets-fiat currency exchange business;

Retail business for individual customers: debit cards, legal currency payments, and cash services;

Corporate client business: Pay wages in legal currency based on crypto assets, etc.

Due to the strict restrictions of SPDI, Kraken

Financial can currently only exist as a custodial bank and is prohibited from issuing US dollar loans, which prevents it from touching the bank's core profits. It is expected that in the initial stage, this business will be operated as a means of improving user stickiness and reducing the external costs of the parent company.

Sygnum, the innovative business development bank:

Background: As an emerging crypto bank, it was approved for banking and securities dealer licenses by the Swiss Financial Market Supervisory Authority (FINMA) together with SEBA in August 2019; in March 2020, it launched the Swiss franc 1:1 anchor currency DCHF; in September of the same year, it obtained FINMA's crypto asset trading license.

Crypto asset business:

Hosting;

Crypto-to-fiat currency brokers: Fiat currencies include Swiss francs, euros, Singapore dollars, and U.S. dollars;

Asset tokenization: primary issuance (Desygnate) and secondary trading (SygnEx, launched in 2021);

Asset management: alpha strategy crypto asset funds, ETP products;

Fiat-currency mortgage loans: Currently, collateral includes BTC, ETH, XRP, BCH, XTZ, etc.

B2B banking services: Provide banking service development interface and accept customized design.

At present, Sygnum has a wide range of business types, breaking the single business structure of crypto-asset-friendly banks that earn high interest spreads/zero-cost investment returns through interest-free deposits. It attempts to expand its business boundaries through asset tokenization (its shares have been tokenized, and plans to list them simultaneously in Switzerland and Singapore in the future), asset management and other means to achieve innovation in crypto-asset financial products.

Virtual Bank Revolut:

Background: Revolut was founded in the UK in 2015. It was initially established to solve the problem of high cross-border remittance rates. It has gradually become a virtual bank (without physical branches, relying only on the Internet or mobile phones to provide services), and has launched a number of services such as deposits, travel insurance, and personal butlers, effectively replacing many daily operations of traditional banks. In 2017, it launched built-in crypto asset trading and storage services; in 2018, it successively obtained the UK AEMI payment license and the banking license approved by the European Central Bank; it is currently applying for an SPDI license in the United States.

Crypto asset business:

Retail accounts: open an account online and trade crypto assets;

Crypto asset custody (deposits);

Cryptocurrency debit card: supports cryptocurrencies consumption and cashback (cashback is returned in BTC, ETH or Ripple).

It is worth noting that Revolut's revenue mainly comes from various fees and service fees. The loan business has not yet been launched, resulting in losses of 33 million pounds and 107 million pounds in 2018 and 2019 respectively. The current business operation model has not been implemented. To maintain the company's effective operation, Revolut still needs larger-scale financing activities (Revolut has completed a $500 million Series D financing, with a total financing of $836 million). However, it has significant competitive advantages in multi-currency transfer transactions and seamless integration between online and offline, so its subsequent development is still worth our attention.

3. Global Regulatory Trends in Crypto-Asset Business

At present, the crypto banking track belongs to the emerging market dominated by the supply side. The regulatory attitudes and regulations of various regions are objective factors that determine whether the bank's crypto business will be implemented. The supervision in the development of crypto banking mainly needs to focus on two directions: one is the region's recognition and policy on the legality of crypto assets; the other is the region's permission for bank involvement and business scope regulations. The former includes the compliance path, regulatory implementation and regulatory consistency of crypto assets and services, while the latter mainly includes the basis for banks to be allowed to intervene in the crypto track.

This chapter mainly discusses the current regulatory path, progress and progress of crypto-banking (business) development in major countries in each region for crypto assets. At present, Europe and the United States are in the leading position, while Australia and Asia are still in the concept formation stage. Among them, Switzerland belongs to the first echelon, with the best development environment for crypto-banking. In addition to a friendly regulatory attitude, it also has a clear regulatory framework and implementation regulations, and crypto-banking business has become diversified; the United States and Germany are in the second echelon. After the US OCC licensed banks to carry out custody business, crypto-banking is moving into the deep waters, and Germany has initially formed a development environment; while large banks in Singapore and the United Kingdom have officially announced their involvement, waiting for regulatory signals to become clearer. From a common point of view, the faster-developing countries have clearly defined crypto-assets, and have carried out functional classification to adapt to the existing regulatory framework, while cooperating with the implementation of special regulations. A clear development path is an important condition for the advancement of the crypto-banking industry. From a business perspective, traditional banks in leading countries are currently mainly testing custody business, while emerging banks are more diversified.

3.1 United States: Federal-level favorable policies are frequently issued, but the details are yet to be implemented

The US regulatory system is more flexible and complex. As a representative of the maritime law system, US legislation and case law develop interactively, and implement a framework of coexistence of multiple regulatory levels at the federal and state levels. Its regulatory trends are often used as a weathervane for global crypto assets and blockchain regulation.

Different regulatory agencies in the United States have different views on the qualitative differences of crypto assets as financial instruments or currencies, which has also led to inconsistent applicable laws. In addition, the independent judicial interpretation power of each state makes it difficult for crypto-related businesses to fully comply with regulations. Currently, storage and circulation are still subject to actual supervision by trust licenses and state money transmission licenses (MTLs). From 2017 to 2020, the U.S. Securities and Exchange Commission (SEC) gradually took the actual leading role in supervision, and the federal level unified the recognition of crypto assets in the direction of financial assets. At the same time, the SEC also made a preliminary classification of tokens based on their functions.

The formation of the concept of crypto banking in the United States is mainly due to a series of policy promotions by the OCC this year. In 2020, Brian Brooks, former chief legal officer of Coinbase, joined the OCC and gradually became the director under the promotion of the Trump administration. He issued a series of favorable policies for crypto assets, which also brought the OCC, a federal agency, into the public eye. In July this year, the OCC issued an open letter authorizing national and federal banks to provide custody services to legal crypto asset service institutions/users; in November, it proposed to formulate regulations prohibiting large banks from discriminating against crypto asset companies and refusing to provide services; in the same month, the OCC formulated the Payment License (Payment License).

Charter 1.0) officially opened for application, becoming a federal MTL license, providing benefits to the downstream of crypto banks. Since the OCC's policy benefits this year are mostly in the form of open letters and public explanations, and do not conflict with the current regulatory rules of the SEC, it has opened up a channel for banks to participate in crypto business. At the same time, since the written regulations have not yet been implemented, the specific implementation progress currently depends more on the attitude of the state government. For example, Wyoming has piloted the development of "special purpose deposit institutions" (SPDI) in order to stimulate the development of the financial industry. At present, non-bank companies such as Kraken and Avanti have been approved to carry out restricted banking business.

In general, the OCC has released a series of favorable policies this year, which do not conflict with the regulatory framework of the SEC, and have promoted the formation of the concept of crypto banks; and the positive response of some states is accelerating the implementation of crypto banks. On the other hand, compared with Switzerland, where the regulation of this track is more mature, the United States is not detailed enough in the classification of token functions, and the federal level is not clear enough about the compliance operation path of crypto companies, which makes the market segmentation between crypto companies and banks determined by market competition. In addition, it is also worth paying attention to whether the regulatory attitude will be repeated after the handover of the US regime in January 2021.

3.2 Europe: Switzerland takes the lead, while Britain and Germany proceed cautiously

After the subprime mortgage crisis, the unification of European financial regulation has accelerated. Currently, crypto assets are regulated by both the European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA) due to their financial instrument attributes. In terms of banks, EU member states are regulated by the European Banking Authority (EBA), while all European banks are regulated by the European Central Bank (ECB).

Before 2019, the EU recognized the commercial legitimacy of crypto assets but did not characterize the assets, neither prohibiting nor encouraging their development, resulting in different regulatory attitudes and progress in European countries. This situation improved with the update of the anti-money laundering decree last year: in January 2020, the EU's 5th Anti-Money Laundering Directive (5AMLD) officially came into effect, expanding the scope to companies that provide legal currency exchange, custody and other services, and crypto assets were characterized as financial instruments. In September of the same year, the European Commission (EC) proposed a "digital finance package" and a "crypto asset market" regulatory framework, and it is expected that legislation will be completed by 2024.

At present, most European countries have incorporated crypto assets into the existing system for supervision. Countries that actively intervened in supervision in the early stage are more advanced in the diversification of banking business; while banks in other countries are still in a wait-and-see stage. Among them, Switzerland, Germany, and the United Kingdom represent three trends in the development of crypto banks: the upper level actively implements supervision and banks actively carry out business; the upper level prudently promotes supervision and there are objections in traditional banks; and the upper level loosely supervises and emerging banks actively deploy.

3.2.1 Switzerland

Switzerland is one of the earliest regions in Europe where traditional banks have been involved in crypto business, and it is also one of the most diversified regions in the world in crypto banking business. Switzerland currently implements licensing and regulatory management for crypto banks, which has a clear compliance path and has opened up a market gap for bank involvement by tightening policies.

In terms of supervision, FINMA is an institution that integrates the regulatory functions of banking, insurance, securities and anti-money laundering. FINMA issued the "ICO Regulatory Guidelines" as early as 2017, classifying crypto assets to adapt to its current regulations. In January 2019, FINMA launched a fintech license for crypto companies, and the deposit limit of 100 million Swiss francs became the dividing line for whether a banking license is required. In August, FINMA issued the "Blockchain Payment Guidelines" (hereinafter referred to as the "Payment Guidelines") to tighten the regulatory rules for crypto assets and companies.

Since 2019, Switzerland's regulatory path has gradually become clear, and licensed operating standards have been gradually introduced. At the same time, payment guidelines require users on platforms such as wallets and exchanges to only make payments and transfers with external platforms that have verified ownership. In addition to crypto-asset-fiat currency exchange transfers, crypto-asset payments are also subject to supervision. Combined with the deposit limit requirement of 100 million Swiss francs, crypto companies have left a certain gap in the competitiveness of capital scale and transfer convenience, and also given traditional and emerging banks a handle to enter the market. From 2019 to 2020, many traditional Swiss banks such as Vontobel and Swissquote announced that they had been approved to conduct custody business; SEBA and Sygnum were approved for banking licenses and began to operate banking businesses centered on crypto assets; crypto banks (businesses) in Switzerland have moved from concept to implementation.

The accelerated landing of crypto banks in Switzerland is mainly due to three prerequisites: first, unified supervision and execution, which is more efficient; second, the classification of crypto assets to include them in the current regulations while formulating special regulations with more detailed rules; third, while opening up the compliance path for crypto companies, tightening compliance requirements, the resulting market gap gives banks room to intervene. The combination of the above factors rather than simply relaxing supervision has enabled Switzerland to maintain its leading position in the race.

3.2.2 Germany

Similar to Switzerland, Germany currently has a clear path in the development of crypto banks, and has tightened enforcement to a certain extent, creating a market gap for banks to intervene. However, due to the special structure of the German banking industry, its top-level supervision is more cautious than that of Switzerland. In actual implementation, case law is still the main signal release channel, making its crypto banks actually in the last step before landing.

In terms of supervision, the top regulatory agencies for crypto assets in Germany are the Federal Financial Supervisory Authority (BaFin) and the Ministry of Finance. In February 2018, BaFin first defined crypto assets as financial instruments and established a "precise case review" regulatory mechanism. In July 2019, BaFin proposed to add crypto asset custody business to the Banking Act; in November, the Bundestag passed a bill allowing banks to sell and store crypto assets. In March 2020, BaFin updated its guidance, pointing out that crypto enterprise custody business needs to apply for a license or cooperate with approved banks, and the transition period for existing business will last until November this year.

From the above policy changes, it can be seen that Germany has introduced a compliance path for banks to participate in crypto asset business for nearly a year. Although nearly 40 banks have expressed interest in crypto business, there is still no crypto bank that has been operating custodial business in compliance; Solaris Bank, which is known for its crypto-friendliness, has not yet been approved for its subsidiary established for bank custody business, and is temporarily relying on a temporary license to operate. On the other hand, since BaFin is more cautious than Switzerland as a whole, it has made slow progress in the introduction of special regulations to adapt to the business; and the new law is similar to the United States and needs to be passed by the federal states of Germany. In addition, Germany's traditional banking structure is relatively unique. More than 2,400 banks have jointly built a "three-tier" banking system in the form of private, public and credit cooperatives, with each type accounting for about 10%, 20% and 70% respectively. Currently, the banks involved in crypto asset business are mainly private banks.

3.2.3 United Kingdom

As a representative of loose regulation in Europe, the UK maintains a subtle attitude towards the crypto banking track. Currently, a large number of start-ups have obtained new banking licenses and non-banking licenses, and it is easy to carry out crypto retail business in the regulatory sandbox launched by the Financial Conduct Authority (FCA), but the overall scale is difficult to expand. Traditional banks are managed by both the FCA and the central bank. Since there is no clear attitude from the top, although they have shown interest, none of them has officially announced their involvement in the crypto business.

In terms of supervision, the UK adopts a "twin peaks" supervision mechanism. The Financial Policy Committee (FPC), an internal department of the Bank of England, is responsible for directing the FCA to conduct market behavior supervision. The FCA is also the main regulatory agency in the field of crypto assets. The UK's supervision of crypto assets is relatively loose. The "regulatory sandbox" launched in 2015 allows innovative businesses to be launched; in July 2019, the FCA issued the "Crypto Asset Guidelines" (hereinafter referred to as the "Guidelines"), which defines crypto assets as functional tokens and classifies them, denying their legal currency attributes; and crypto companies need to register their business.

FCA has not yet made clear its attitude towards traditional banks’ involvement in crypto assets, and its digital bank and electronic payment institution (EMI) licenses do not describe crypto assets. Traditional banks such as Barclays have previously expressed strong interest in crypto business, but have not yet officially launched products or services. In December this year, Standard Chartered announced that its Standard Chartered Ventures (SC Ventures)

Ventures has reached a cooperation with Northern Trust Bank to launch Zodia, a crypto asset custody solution, which has fired the first shot of a large bank in the UK. On the other hand, many emerging banks or payment service institutions (EMIs) in the UK have actually operated crypto retail banking business after filing the "regulatory sandbox". The business scope covers fiat currency channels, storage, etc. of crypto assets, which has attracted large crypto companies including Coinbase to apply for licenses and start businesses. This phenomenon of "regulatory breakthrough" is unique to the UK, and it also means that the compliance cost of starting banks participating in crypto business under the current British system is less than that of traditional banks. If Standard Chartered custody business is approved for operation, it may lead to the decline of large British banks.

3.3 Australia: Asset regulation is taking shape, banks have not intervened yet

Crypto assets are currently regulated as financial instruments in Australia, and have a relatively complete regulatory structure and regulations. At this stage, the central bank and the Prudential Regulatory Authority (APRA) have not come forward to support it, and banks lack the means to intervene in crypto business, and the concept of crypto banks has not yet been formed.

Australia's regulation is similar to that of the UK, and also adopts a "twin peak" mechanism: the central bank and the Prudential Regulatory Authority (APRA) are responsible for macroscopic and the Securities Investment Commission (ASIC) are responsible for microscopic behavior supervision. Currently, crypto assets are mainly regulated by ASIC in Australia, similar to the UK FCA. Since 2017, ASIC has issued ICO guidelines "Information Table 225", clarifying the nature of crypto assets as electronic value tools, and implementing financial services licenses (AFS) for token issuers.

Australian banks are mainly regulated by APRA, and the central bank is responsible for formulating monetary policies. The banking industry is the core of Australia's financial industry and an important economic center of Australia, so its supervision has been relatively cautious for a long time. In recent years, senior management of the Australian Central Bank has repeatedly stated that crypto assets will not be widely used as payment methods in Australia, and the emergence of Australian crypto banks remains to be done.

3.4 Asia: Singapore is a step away, and Japan and South Korea are watching

Compared with Europe and the United States, Asian countries are generally in the early stages of supervision. In recent years, Singapore, South Korea and Japan have developed rapidly, with basic regulatory qualitativeness and clearer regulations. Crypto banks are still in the concept formation stage because the basic regulations are not yet clear. At present, some banks in South Korea have announced their entry into crypto assets business; some banks in Singapore have begun preparations and are waiting for a clear regulatory attitude. Other countries are mostly in the stage of exploration or denial: Thailand recognizes the legality of crypto assets and securities attributes, and does not allow banks to open their business to individuals; India just cancels the crypto assets central bank ban by the Supreme Court in March this year; China has a ban on it until now.

3.4.1 Singapore

Singapore is at the forefront of Asia in crypto asset regulation, maintaining an active regulatory attitude and providing a clearer compliance path. Its regulations classify current mainstream tokens into payment categories, and current regulations do not involve banks for the time being. However, its more detailed token classification and clear regulatory rules are similar to Switzerland, while traditional banks have shown interest. The concept of crypto banking is being formed in Singapore, but it may be just one step away from its maturity to its implementation.

Due to its population structure and financial industry, Singapore adopts a highly unified but open regulatory model. The Financial Regulatory Bureau (MAS) is the top national financial regulation, and also takes into account the second position of central bank and market behavior supervision. In terms of supervision, Singapore is in the stage of actively expanding and improving supervision. Since 2016, it has successively launched regulatory sandboxes; it has issued the "Guidelines for the Issuance of Digital Tokens" (hereinafter referred to as the "Guidelines"), which classifies crypto assets; it has established the "Payment Services Act" (PSA) and launched corresponding licenses, which will be officially launched in February this year.

Compared with Switzerland, Singapore already has token classification, clear compliance paths and special regulations. In addition to the lack of explicit permissions, the resistance of the banking industry to intervene in the crypto track also includes a loose policy for crypto companies. The concept of crypto banking has not yet been formed in Singapore. Since PSA classifies mainstream crypto assets on the market as "payment" tokens, it is not currently within the scope of banking business. At the same time, PSA provides crypto companies with a relatively loose and clear regulatory path. At this stage, crypto companies that have already started their business and apply for licenses have a 6-12-month exemption period, which makes it essentially in the stage where filing can be legally operated. The looser environment makes banks intervene in crypto businesses need to directly compete with crypto companies in the market. The additional development costs and difficult-to-determined income may affect banks' enthusiasm for participating in crypto businesses to a certain extent.

Despite the competition with crypto companies, since PSA currently only has a minimum reserve requirement for crypto companies in storage and payment guarantee terms, and the license does not support financial management, credit and other businesses, banks are still competitive in custody and comprehensive businesses. Since PSA's current design has a weak security mechanism for crypto companies, if the policy is tightened in the future, there will be a market gap like Switzerland. Combined with Singapore's current mature regulatory framework, crypto banks may complete the process of maturing the concept to land in a short period of time. In December, DBS announced that it will launch DBS soon.

Digital Exchange provides crypto trading, redemption and custody services to institutional customers. It is reported that DBS is currently relying on the temporary RMO license under the Securities and Futures Act to conduct business, and its future trends can continue to be paid attention to as the regulatory attitude of Singapore.

3.4.2 South Korea

South Korea passed a bill this year to determine the legality of crypto assets and operating rules, which has become a major benefit; the concept of crypto banking has been reborn, but there is no compliance path yet. At present, traditional banks are more interested in custody business.

Since the 1997 financial crisis, South Korea has adopted a unified management model, coordinated by the Financial Committee (FSC), a directly under the jurisdiction of the Prime Minister, and implemented by the Financial Supervision Institute (FSS). In terms of regulation, before 2020, South Korea's supervision of crypto assets under the supervision of crypto assets has undergone a process of initial recognition of the legitimacy of mainstream assets, cracking down on ICOs, crypto assets and legalization of operations. Since 2020, South Korea has implemented a regulatory sandbox system in January, and in March the Congress passed the amendment to the "Legal Reporting and Utilization of Specific Financial Transaction Information" (hereinafter referred to as the "Special Gold Law Amendment"), formally determining the regulatory rules for crypto assets. The amendment to the Special Gold Law defines crypto assets and their operators as "virtual assets" and their operators. Operators, including those who provide transactions, custody, management and other links, will be regarded as financial companies and are subject to anti-money laundering, financing and other regulations.

The concept of crypto banking was once born in 2018. In the same year, the South Korean government tightened the real-name KYC transmission on the exchange, and was carried out by traditional banks; South Korea's NH R&F Bank announced that it would intervene in the crypto asset custody business. However, due to the unclear policy on crypto assets and the exchange's resistance to crypto information, the concept of crypto banking failed to be developed. Although the amendment to the TK Law released this year did not clearly indicate whether banks can intervene in crypto business, legalizing crypto assets has become an important benefit. As of August 2020, five large traditional banks in South Korea ranked high in cryptocurrency have announced their layout of custody business, including four commercial banks - Youli Bank, Shinhan Bank, National Bank; and a policy bank - NH R&F Bank.

3.4.3 Japan

Japan currently mainly manages encryption as a financial instrument and private payment means. Similar to Australia, Japan's supervision was launched earlier and the regulations were written later. In addition, Japan's supervision was strictly implemented, and the banking industry has not yet taken action, and the concept of crypto banking has not yet been formed.

Since 1997, Japan has formed a macro-prudential regulatory mechanism with the Finance Agency (FSA) directly under the Japanese Cabinet as its core, with the participation of the Bank of Japan, deposit and insurance institutions, and the Finance Office. In terms of regulation, before 2019, Japan issued an amendment to the Fund Settlement Law, which uses crypto assets as a legal means of payment. In 2019, Japan passed the Payment Service Act, Financial Instruments and Transaction Act, the "Related Rules for the Issuance of New Coins" and corresponding guidelines proposed by the FSA, to implement classified management of crypto assets, to implement license management for operating entities, and to legalize the public issuance and sale of crypto assets (IEO and ICO).

In terms of banks, there are no policy breakthrough cases in traditional banks, and the Bank of Japan has made many statements, saying that the main direction is the research on CBDC, and it is expected that it will be difficult to make a breakthrough in the future. In May this year, Nomura announced that it will be with digital asset security company Ledger and investment institution Global

Advisors cooperates to establish Komainu, a digital asset custody service company in British Jersey.

4. Summary and Outlook

Crypto banks are gradually becoming a new track, with traditional and emerging banks accelerating their layout, and crypto companies are also seeking new identities. In 2020, the crypto asset market experienced a rapid recovery after a cliff-like decline. Its total market value continues to rise and business models continue to iterate and innovate. Traditional institutions as investors are accelerating the influx of the market into the market. However, compared with the stability of basic services of traditional financial institutions, there is still a big gap in services in the crypto market, and the frequency of major risk events occurs higher. This is related to the still imperfect risk control measures and settlement mechanisms of crypto enterprises, lagging corresponding regulatory standards for emerging businesses or products, and the market vulnerability brought by the regulatory system. In this context, the intervention of traditional financial institutions, especially the banking industry, is becoming a new demand.

From 2019 to 2020, with the supervision and policy promotion of crypto assets and crypto banks in Europe and the United States, the concept of crypto banks has basically taken shape and its business development is also being implemented; Asia is still in the process of brewing, and supervision in Singapore, South Korea and other regions has not yet been implemented, and some banks have taken the lead in testing or announcing business plans.

4.1 Opportunities: The market and regulatory environment are becoming more mature

Regulatory risks intensify and bank custody demand increases

As market participants continue to influx, hacker attacks surge; uncertainties brought about by regulatory factors such as Switzerland's tightening of deposit caps for crypto enterprises and U.S. officials' claims to step up review of non-custodial wallets have also made crypto asset holders seek more stable institutions to manage their assets. In addition, since crypto business has a stronger demand for fiat currency entry and exit than financial businesses such as financing and listing, holders have a stronger demand for fiat currency entry and exit, while banks are more natural fiat currency channels than financial institutions such as securities and trusts.

Regulatory environment continues to mature, and crypto companies seek new identities

Crypto companies, especially compliant companies that provide transactions and custody services, have been seeking to obtain bank status and provide more credible credit endorsements. Due to the previously unclear policies of various countries, most companies have turned to seek alternative licenses such as trust, MTL, and payment. In the past two years, as the United States and Switzerland open or partially open banking licenses, it has provided a path for the transformation of crypto companies. Kraken's approval of SPDI has helped Paxos and BitPay to apply to become federal trust banks, while unlicensed entities such as Libra have moved to Switzerland.

Crypto business is developing rapidly, traditional banks seeking new growth portals

The scale of crypto assets has hit new highs in the past two years, attracting the attention of traditional banks. Compared with traditional banking business, crypto asset custody business offsets the pursuit of interest due to compliance and hedging needs, and can also charge a certain custody fee; while mortgage loans based on crypto assets have a shorter debt repayment cycle and a higher mortgage ratio than traditional credit, which increases the capital reuse rate and reduces the risk of bad debts, opening up a new growth point for the banking industry.

4.2 Challenge: High innovation costs and unclear profit margins

Traditional banks have a single profit model, and large banks still lack the motivation to concentrate their efforts

In the current cases, traditional banks have expanded earlier and actively, mostly small and medium-sized banks, mainly because the deposit and loan interest rate spread can bring new revenue, and the crypto asset business itself is more likely to break through geographical restrictions. However, traditional banks are still relatively single in current profit model, most of which only provide custody services and charge fees, and very few provide mortgage lending services, and the origin-based business based on crypto assets is rarely involved. At the same time, large banks have not yet concentrated on the market. In addition to compliance considerations, the crypto asset market size is still smaller than that of traditional banking. On the one hand, the profit margin is limited, and on the other hand, the market's leading advantage is insufficient, and large banks lack motivation to enter the market in the early stage.

The market is still in its early stages, and the compliance costs of bank innovation are high

Since the crypto banking market is still in its early stages, there are still many gaps in the implementation regulations in terms of the details, and in contrast, the continuous innovation of crypto business is constantly being innovative. In order to match market demand, banks have to take the lead in developing business without clear regulations when expanding new businesses, which also means that banks that intend to conduct business need to spend more communication and compliance costs to innovate, and the size of this type of cost is closely related to the local regulatory style and traditional banking attitude. The country led by Switzerland has already had relevant cases before it clearly stated that it supports the bank's business development; for example, Germany, even if there are already proposals to support banks in selling and storing crypto assets, there are still only a few banks in business development.

4.3 Outlook: Crypto assets become mainstream, crypto banks become the key

From a regional perspective , Europe and the United States will continue to attract traditional banks and crypto companies that want to apply for bank licenses to join; the United States, Switzerland and other regions will remain ahead; the United Kingdom, Germany and other regions may have landing cases; Asian regions can pay attention to Singapore and South Korea.

From the perspective of business and market , in the short term, traditional banks and emerging banks may compete in differentiated competition between institutions and individuals, custodial and crypto assets originating businesses; while large crypto companies will actively plan to obtain bank licenses. In the long run, crypto banks may become the most important part of the crypto industry and dominate the mainstream asset spot trading market. Competition in the track may intensify in the future, and the interest-free deposit model will be broken, and banks will launch differentiated services such as crypto asset financing and bulk clearing settlement.

In addition, from an ecological perspective , with the decline of banks, crypto assets will become mainstream based on banking business, and the asset scale and user penetration rate may generate exponential growth, and ultimately interact with the real economy. At the same time, crypto companies that mainly engage in trading business will face competition from mainstream asset transactions, but with the increase in user penetration rate, non-bank businesses such as leverage and derivatives, STO, NFT, DeFi wealth management and other non-bank businesses and customized businesses will create new opportunities.

References

[1]The Block Research：https://www.theblockcrypto.com/genesis/73780/a-comprehensive-list-of-crypto-friendly-banks-and-emis

https://www.theblockcrypto.com/genesis/79376/mapping-out-crypto-friendly-banks-e-money-institutions

[2]Silvergate Capital Corporation：https://www.sec.gov/Archives/edgar/data/1312109/000119312519275425/d568616ds1a.htm

https://ir.silvergatebank.com/financials/sec-filings/default.aspx

https://ir.silvergatebank.com/financials/financial-results/default.aspx

[3]OCC：https://www.occ.gov/topics/charters-and-licensing/interpretations-and-actions/2020/int1170.pdf

[4]Skalex：https://www.skalex.io/crypto-europe/

[5]ICBC：http://v.icbc.com.cn/userfiles/Resources/ICBC/fengmao/download/2018/gjjrjg20180410.pdf

[6]Tsinghua Financial Review: http://www.thfr.com.cn/post.php?id=1057

[7]PKU Financial Law Research: https://www.finlaw.pku.edu.cn/flyxjr/gk_hljryfl_20181025180041616718/2018_jrfy_20181029112449438403/d36q5y/492995.htm

[8]SWI: https://www.swissinfo.ch/eng/business/swiss-law-reforms-make-crypto-respectable/46024124

[9]MAS SG: https://sso.agc.gov.sg/Acts-Supp/2-2019/Published/20190220?DocDate=20190220#pr23-

https://www.mas.gov.sg/-/media/MAS/resource/publications/consult_papers/2017/Consultation-on-Proposed-Payment-Services-Bill-MAS-P0212017.pdf?la=en&hash=A85A6B79BE4C0BE70D0F2EB746D35ECE9178FB89

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