US investment banks are ramping up efforts to expand in crypto markets amid projections that the annual industry revenue pool across trading, wealth management, transaction banking and securities services could grow to be worth several billion US dollars in the coming years.
Revenues at the top 50 crypto exchanges have more than tripled to a record of US$26.5bn in the first nine months of 2021, according to data firm Vali Analytics, on the back of bumper trading volumes. Major banks could expect to generate about 10% of those revenues in the coming years if the regulatory landscape settles, said Amrit Shahani, a partner at Vali, creating an annual pool of between US$1bn and US$3bn for the industry.
Bank executives are proceeding with caution, however, mindful of how costly a misstep could be in these fledgling markets that still lack a complete and consistent regulatory framework. That means avoiding cash cryptocurrencies and instead clearing crypto futures trades on behalf of institutional clients on regulated exchanges, and providing some private banking clients with access to external crypto-linked funds.
But while their presence may be small right now, the past two years have given senior management an idea of the potential opportunities in digital assets following a notable uptick in client demand for these products.
Citigroup, Goldman Sachs, Morgan Stanley and JP Morgan are at varying stages of building out their offerings across trading and wealth management, while also exploring the provision of securities services after specialist firms BNY Mellon and State Street set up digital asset units earlier this year. Elsewhere, Bank of America is considering strategies related to cryptocurrencies and other digital assets after recently launching research coverage of these markets.
“US banks realise crypto markets represent a credible opportunity and they are putting the wheels in motion to find the right strategy,” said Shahani. “Hedge fund and private banking clients are very keen on crypto. Banks know there will be a first-mover advantage if they can get on top of the regulation.”
Digital assets have expanded at a dizzying pace over the past several years to a market value of over US$2trn, according to an October report from BofA, presenting investment banks with a dilemma over how to approach this largely unregulated space. JP Morgan chief executive Jamie Dimon has repeatedly criticised bitcoin and called it “worthless”, but the US bank has also said it would get involved in crypto markets more broadly if there was sufficient client demand. A spokesperson for JP Morgan declined to comment for this article.
Institutional interest
Retail investors historically drove interest in digital assets, but that has changed lately with hedge fund giants such as Brevan Howard, Two Sigma Investments and Tudor Investment Corp all now active in crypto. Institutional clients accounted for 68% of the US$1.1trn in trading volumes on Coinbase in the first nine months of 2021, according to the crypto exchange's latest earnings. That’s up from 61% of the US$104bn in volumes on Coinbase during the same period in 2020.
Banks are responding with serious investments across the digital asset space. Goldman rebooted its crypto trading desk earlier this year with an eye on expansion; JP Morgan set up its Onyx unit last year to focus on digital assets and blockchain technology; while Citigroup recently said it would create a digital asset team with plans to hire up to 100 staff.
"This is an evolving landscape and it’s really important for us to get our strategy and infrastructure right to operate in this space. Whether there is a stable and robust regulatory framework in place for these products is a key consideration,” said Biswarup Chatterjee, head of innovation for global markets at Citigroup.
Most banks are a long way off trading cash cryptocurrencies. Instead, their trading desks are sticking to markets run on regulated venues, such as crypto futures listed on CME Group. Goldman and Morgan Stanley were the first two banks to provide clients with agency execution for crypto futures. JP Morgan now clears futures linked to bitcoin and ethereum at CME, while Citigroup recently cleared its first bitcoin futures trade at the exchange, with both banks also operating in an agency capacity.
In over-the-counter derivatives, there is now an industry-led initiative to create greater standardisation as these markets develop, with the International Swaps and Derivatives Association announcing in September that it was launching a project to design documentation for crypto-linked. Coinbase recently joined ISDA as a member in another sign of how these markets are becoming more mainstream.
“We’re seeing rapid growth in digital asset markets as well as increased institutional interest in trading crypto derivatives,” said Ciaran McGonagle, assistant general counsel at ISDA. “There is a lack of contractual standards in this market today – firms typically use their own bespoke documentation. We thought it’s an appropriate time for ISDA to develop standards to provide a more robust grounding to underpin the growth of this market.”
Emerging regulation
While much of the regulation backing these markets is still emerging and remains fragmented across different jurisdictions, there’s little doubt that a more robust financial rulebook is in the offing. In the US, Securities and Exchange Commission chief Gary Gensler has signalled his intention to impose greater regulations on crypto markets, including asking exchanges to register with the SEC.
One important area that remains in a state of flux is the bank capital treatment for crypto exposures, with several trade associations arguing recently that draft rules are overly punitive. Global regulators under the auspices of the Basel Committee are currently consulting on the proposals and banks will hope it revises its capital charges, which many say are constraining their ability to expand in this space.
Overall, banks would undoubtedly welcome greater regulatory clarity across these markets. In the meantime, they are treading carefully, while trying to respond to client demand.
"We are going to approach this in a very cautious manner – a lot of things are still evolving,” said Citigroup’s Chaterjee.
In wealth management, JP Morgan and Morgan Stanley now offer some private banking clients access to external crypto funds, with these products typically aimed at wealthier investors with a high risk tolerance. Citigroup and Goldman are also exploring providing similar access to wealth management clients.
Securities services, such as fund administration and record-keeping, is another obvious area for investment banks to get involved. BNY Mellon and State Street, two stalwarts in these markets, established digital asset units earlier this year and have plans to develop custody services for digital assets.
“State Street Digital was created to respond to the industry’s evolving shift to decentralized finance and a digital economy. In short, it’s an investment into tomorrow,” said Swen Werner, global head of digital custody and payments at State Street Digital.
The potential for widespread application of digital asset and blockchain technology in global finance is encouraging senior bank executives to take a wide-angle view of these markets, even if they are proceeding with care. The record crypto market volumes of 2021 may prove to be the exception rather than the rule, but the continued institutional adoption of the asset class is persuading many that crypto will be more than just a flash in the pan.
“There’s a lot of things going for the asset class and banks know it’s a massive opportunity. The big question mark is regulation – they will want that to come through before fully committing,” said Shahani at Vali Analytics.