Everyone and their mom is buying crypto these days.
Traditional investors are doing it. Individual consumers are doing it. Your grandma can even buy you a $100 worth of Ethereum as a Christmas gift with Ether cards!
But one kind of stakeholder has resisted entering the crypto space so far. We’re talking about banks. The trillions of dollars they control have been conspicuously absent from the $300+ billion crypto market cap so far. The majority of investors are retail and other non-risk averse funds who can invest into crypto without any problems.
The question is, why? Why are banks, who have the equity and the motivation to work with crypto, avoiding Bitcoin, Ethereum and other tokens?
This article gives 5 reasons why — and highlights a solution that’s slowly helping banks get exposure to crypto with their capital without taking on undue risk.
Reason #1 is…
1. Enforceable, auditable titled ownership
In the eyes of the law, crypto ownership is a grey area.
Both Bitcoin and Ethereum tokens are unregulated and anonymous. This means that checking who owns any given wallet is virtually impossible without some form of transaction analysis or data registration at an exchange or other information collection source. As a result, crypto assets are inherently semi-separated from their holders’ legal identities.
This raises a number of potential problems.
For example, say a bank owns Ethereum. If the funds are lost to an external attack or internal theft, the chances of recovering them are near impossible. There’s no proof of ownership, which means there are no records, which means the money’s gone into thin air.
That’s bad — and it’s just one of many scenarios where things can go wrong for crypto investors. At the end of the day, BTC and ETH aren’t issued or controlled by a real-life organization like a bank, a fund or a government. This means that even if we did assign titled ownership to tokens, enforcing that ownership would be impossible.
All of this makes crypto risky. Banks can’t justify this kind of risk to their risk-averse stakeholders. This is the first reason banks aren’t buying up Bitcoin and Ethereum; assets without verifiable, enforceable property rights scare institutional investors.
Of course, most tokens aren’t just untitled. They’re completely extralegal — which, as you’re about to find out, is another tangible problem for banks.
2. BTC is extra-legal
Bitcoin, Ethereum and most altcoins are “extra-legal” in the sense that they exist outside the world’s established legal and financial system. Put simply, Bitcoin and Ethereum tokens and addresses aren’t linked to real-life identities or accounts. They’re neither controlled nor issued by any particular organization, meaning they can be used with no regard for the law.
To crypto users, this is a positive. It means you — not your bank or the government — control your assets. It also means you can make discrete, instant purchases. And unless you leave a paper trail — for example, by buying crypto from your personal credit card — nobody has to know.
For banks, the reverse is true. Investing in an extralegal asset can put a bank at odds with the local or national government. It also makes it difficult to show the assets on a balance sheet, transfer ownership and — yes — justify the purchase to clients.
Of course, Bitcoin, Ethereum and most other tokens are extra-legal by design. This is the whole point and the reason they have so much value. This is “digital gold” that can’t be taken away by anyone else. The problem is that banks are supposed to be 100% law-compliant, which puts them at odds with this feature (even if only formally).
This extra-legality also means…
3. Exposure to Extreme Clearing Risks
Cryptocurrency trading is extralegal, which prevents traditional financial organizations from dealing in it.
At the same time, there’s clearly a lot of demand and supply for crypto. To bridge this gap, private-owned crypto exchanges like Coinbase and Localbitcoins process trades. This is an effective solution — but not one that appeals to banks. Here’s why.
The first problem is that exchanges aren’t a counterparty to your transactions. Instead, they’re a platform that facilitates peer-to-peer exchanges. This means that any potential trade has no inherent backing. Nobody is legally responsible for it.
This makes any crypto exchange a risky proposition. That’s the first clearing risk.
The second clearing risk is the volatile nature of crypto. As explained above, any trade done through an exchange is ultimately between you and another party. The risk is that you send your money to the exchange and in some part of the process, it disappears. This could be because of a server update, or a failed transaction or any number of other reasons.
The larger exchanges have good customer service and you will probably will get your funds back at some point. But what if the price of the asset you’re trading swings up or down during those 90 minutes? For example, what if you agree to sell your assets at $9,000/BTC — and meanwhile, the price goes up to $11,000/BTC?
That’s right. You stand to lose a lot of money to slippage if you have already bought the asset. This risk exists for all investors and financial assets, but with crypto, it makes clearing large amounts of money far more risky than banks are used to. When you’re dealing with 7, 8 and 9-figure sums, a fraction of a percent makes a tremendous difference.
The next problem on our list is that of…
4. Unclear Tax Implications
The tax status of cryptocurrencies is still unclear. In many cases, it appears outright contradictory. For example, exchanging BTC for ETH falls under IRC Section 1031 in the US. But if US Dollars are used to facilitate the exchange, the parties now have to report a capital gain or loss.
A little confusing, right?
Right — and we’re not the only ones who think so. Out of the hundreds of thousands of Coinbase users, only 500 actually included their crypto gains on their tax returns. The IRS, being a little confused itself, served Coinbase — one the largest crypto exchanges in the US — with a “John Doe” summons. They want to know more about anyone who had transacted more than $25,000 using crypto currencies, and so they could tax them.
The best-case scenario is that all ends well. Crypto assets get taxed like real estate, bonds or cash.
The worst-case scenario is that there’s never a clear way to report crypto for a long time to come. An equally undesirable scenario is that the extra-legal nature of Bitcoin, Ethereum et al will force states to create contradictory or complex laws that make life difficult for banks, as every jurisdiction will have varying restrictions, guidelines, and taxes.
Either way, there’s a fear that paying taxes on crypto will be difficult, confusing or outright impossible in the short run. This is yet another reason banks are loathe to get behind this new asset class.
But the single biggest reason banks are reluctant to invest in Bitcoin is also the one we saved for last.
5. Storage and security
There are 2 ways to store cryptocurrencies.
The first is called hot storage. In this case, hot doesn’t refer to temperature; it refers to your crypto wallet being connected to the internet. In other words, a hot wallet is defined by your ability to deposit and withdraw money at any moment.
Hot storage is vulnerable to all common digital threats — as well as a few specific to crypto. For example, a hacker could steal your personal passcode by intercepting your WiFi data, or getting access to your e-mail account. Alternatively, the exchange where you store your hot wallet could be compromised.
Either way, hot wallets aren’t particularly secure, which is why most long-term investors prefer cold storage, i.e. crypto wallets that aren’t connected to the internet. These can be hard disk-based, paper-based or, most recently, in the form of a USB stick like a Trezor or Ledger.
Cold storage is a lot more secure than hot storage. It can’t be hacked because it’s offline. However, it can be lost, damaged or physically stolen. Moreover, all cold storage starts out as hot storage before being disconnected from the internet, which means it’s still vulnerable — just for a smaller period of time.
This is the final reason banks can’t consider Bitcoin, Ethereum and other crypto assets seriously. Telling your clients that there’s no way to guarantee security is liable to get you laughed out of a boardroom meeting, or worse.
Now let’s recap by going over the 5 reasons banks can’t invest in Bitcoin:
No clearly definable property rights
Extra-legality of crypto
Exposure to clearing risks
Unclear tax implications
Storage with limited security
Plainly speaking, crypto assets may be highly valuable to banks and their clients — but until they become available as real securities, banks can’t work with them.
The bad news is that the biggest bid to securitize the cryptocurrency in the US — the Winklevoss Bitcoin Fund proposal — was rejected by the SEC.
The good news is that a Europe-based team (called CyberTrust) has managed to create BTC, ETH and BCH derivatives called Crypto Global Notes. These are true securities that will eventually be traded on the Irish stock exchange. Because of this, they have clear tax implications, can be cleared risk-free, can be stored safely, and — most importantly — are 100% legal.
That leaves the problem of crypto security… Which CyberTrust addresses by storing their crypto tokens in the safest place in the world: a Swiss nuclear bunker managed by Xapo.
But the very best part? The Crypto Global Notes are redeemable, so if at any time you want to get your crypto assets back, you can.
All of these factors that, as of this moment, CyberTrust’s crypto securities are on their way to becoming the first crypto-derived security that banks can invest in without taking on risk or angering clients.
This means we’re seeing the first real move towards crypto assets banks can (and will) buy. If that sounds like something you’re interested in — whether as a speculative asset or a means to invest in securitized crypto — you’ll want to learn more about CyberTrust and their product by visiting their website.
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