Meet the digital twin: banks’ new partner in the cryptocurrency market
Cryptocurrencies are now mainstream and widely accepted. They were once regarded by serious investors as at best untrustworthy, and at worst worthless. Now governments and established financial institutions are seriously considering cryptocurrencies as a means of conducting transactions outside the established banking system.
There are several reasons for this change of attitude, and for cryptocurrencies newly established legitimacy. Cryptocurrencies in general, and leading currency Bitcoin in particular, have done well during the pandemic. As economies locked down in early 2020 the value of Bitcoin plummeted along with the values of many assets and many markets. However, Bitcoin recovered faster than traditional currencies, and has remained fairly stable.
This success and stability have raised awareness of the virtues of cryptocurrencies beyond the small community of early adopters and risk takers.
Members of the wider community are buying into cryptocurrencies, especially in developing regions where traditional banking is often not available or not trusted. Central banks from Brazil to South Africa are acknowledging its viability.
And it’s not only in developing regions. There are crypto-communities in other countries: locations where crypto is widely used and widely accepted. In Australia, Townsville is a great example of a small town where retailers are trialling bitcoin.
Townsville’s role in the cryptocurrency is bigger than transaction acceptance. It hosted the international Bitcoin Cash conference in 2019 and, had COVID not intervened would have hosted the 2020 event. It is a hotbed of cryptocurrency activity in part due to the efforts of Noel Lovisa, CEO of local software company, Code Valley. At the 2019 conference he announced plans to build a $50 million dollar Bitcoin Cash technology park in Townsville.
Meanwhile, regulators that had treated cryptocurrencies with great suspicion are starting to embrace them and give them some legitimacy. The European Commission, for example, has adopted a Digital Finance Package and the UK’s Financial Conduct Authority (FCA) is progressing a similar initiative. Regulation for something designed to be beyond regulatory reach seems inevitable, but could lead to wider acceptance.
With or without their intervention, the popularity of cryptocurrencies seems certain to continue to grow, leaving financial institutions with a choice of seeing it as threat to the mainstream banking industry and trying to keep it at bay, or accepting it and leveraging their strengths and established position to bring it into the mainstream.
Cryptocurrencies boomed during COVID, banks did not. Capital ratios are down and threats to solvency are higher than at any time since 2008. It has even been suggested that the impact of COVID will be greater in the long term than the impact of that disaster. Interest rates remain extremely low, and new ideas will be needed to deliver a better future than we are presently facing.
Banks are already responding by accelerating digital transformations, building digital resilience, using blockchain, artificial intelligence, machine learning and advanced analytics to improve the customer journey and counter financial crime.
The huge investment that banks have already made in digital technologies and capabilities gives them capabilities to extend into new markets and product areas previously deemed too risky and unmanageable to track. Crypto is one such market, but they need to find a way to engage in this new market and simultaneously maintain the competitive advantage they enjoy over disruptive digital rivals in areas like security, compliance, risk analysis, scale, experience and reputation.
Many banks have already explored digital twinning as a way to road test innovative ideas, and it represents an ideal way to explore the opportunity presented by crypto without adding to existing risk profiles.
By creating a digital twin a financial institution could demonstrate to central banks and regulators multiple crypto scenarios and show how they and their clients would potentially lose or gain from crypto.
The virtues of tether crypto, for example, could be showcased to show how volatility can be controlled. Banks could safely create and then try out a set of crypto product as blockchain-based financial products tailored for institutions that are governed by strict compliance rules.
Digital twinning would enable them to ring fence their market exposure while demonstrating how their traditional strengths could be of value in a new digital world.
They have techniques to understand their customers, as well as expertise and experience in combating money laundering and fraud. Arguably they are the organisations best placed to develop and deliver safe and effective crypto solutions.
There has never been a better time for banks to explore this exciting opportunity, ideally in partnership with another organisation able to bring to the party experience of analytics, digital twinning, blockchain, algorithmic trading and with a track record of innovation in financial services.
If banks fail to move now they could well be left behind while others achieve success and dominance. There are plenty of historic examples where former dominant players have been decimated by newcomers leveraging new and disruptive technologies.
Addendum: What is crypto?
A cryptocurrency is a monetary unit with no physical form. It is stored in the form of a digital ledger, using blockchain technology. Encryption is used to control and verify the movement of funds, the supply of which is not determined by a bank. Digital currencies like Bitcoin, Ethereum, Dash and Litecoin are often described as ‘decentralised’, distinguishing them from traditional currencies which are controlled and regulated by third parties like governments and central banks.
Richard Price is Head of FSI, UK&I with TIBCO.