The Bank of England recently made a decision to explore a sterling-backed digital currency. China is already piloting a central bank digital currency (CBDC) across major cities including Beijing, Shanghai and Shenzhen at the same time that it is cracking down on crypto assets not of its making. This was seen in bitcoin’s dramatic slide last week.

China's stance on CBDCs is partly politically motivated: ie broadening the social agenda to connect around a fifth of its population of rural poor that remains unbanked; and bringing digital payment giants such as Tencent and Alibaba into line.

Sweden and the Bahamas have both been early implementers of CBDCs. Fed chair Jay Powell announced that the US is exploring a dollar-backed digital currency, no doubt spurred by the enthusiasm met by crypto exchange Coinbase’s recent IPO.

It is all systems go and all-encompassing confusion about where this is heading.

The Bank for International Settlements estimates that around 80 per cent of monetary authorities globally are investigating the feasibility of digital currencies with around 9,000 of them in circulation.

The question is whether mainstream digital versions backed by central banks will eclipse the appeal of these “unofficial” currencies. At the moment, it is anyone’s guess.

Meanwhile individual jurisdictions are rewriting regulations to attract fintechs designing additional secure ways for investors to use and manage these digital assets.

For wealth managers, knowledge of the marketplace roughly divides into three areas: One: The accounting systems available to track crypto exchanges. Two: How people are transacting with these digital assets. Are they transacting through a centralised third-party institution or using decentralised peer-to-peer transactions through blockchain technology, for example. And three, what sort of custody do clients require for their digital assets? Are they so-called “hot wallets” for keeping the assets online and ready to trade at instant notice, or “cold wallets” for storing them securely with keys safeguarded?

Easy access to trading in and out of digital and fiat currencies comes at a premium and the reason for the rapid innovation in the custody space.

Even though the cashless nature of the pandemic has forced central banks to speed up their thinking rather than any immediate action on crypto use, the biggest complaint from fintechs is that regulators just aren’t keeping up.

On the flip side, the Financial Conduct Authority has been warning fintechs about "misleading" clients and unfairly comparing themselves to banks in the services they provide and the level of oversight and protections they receive from regulators.

For the UK, the stakes for finding the right balance are not inconsiderable. The UK holds more than 10 per cent of the global market share for fintechs, which is now worth around £1 billion a year to the UK economy. In 2020, investment into UK fintechs stood at just over $4 billion – more than the next four European countries combined.

Chancellor Rishi Sunak unveiled plans this Spring to supercharge growth. But what the Treasury had in mind was “too little, too late” for EQIBank CEO Jason Blick.

UAE
We spoke to Blick recently about why the digital private bank chose the United Arab Emirates for expanding services for targeting high net worth clients after appraising more than two-dozen venues around the world, including the UK and ones in Europe.

“Analysed from a tax perspective, a regulatory arbitrage perspective, from the ease of getting visas and setting up, the UAE was materially better than anyone else within striking distance. And we were surprised by that,” he said.

The bank is regulated in the Cayman Islands and the UAE, and between the two centres, Blick assures that the business can serve complex HNW clients from 180 countries. Services that include “white listed” wallets to verify that any cryptocurrency that comes in and out of the wallet is from a legitimate source, he says.

“We are one of the only banks in the world that provides crypto and stable coins, and we are moving into decentralised finance,” he said.

DeFi, as it is more commonly known, allows users to transact without the need for financial intermediaries such as banks and has been one of the more difficult aspects of financial innovation for the monetary authorities to effectively manage.

For EQIBank to operate the services it says clients are demanding, “There is no way we could do it in London. No way we could do it in the EU,” Blick explains. “But it is an integral part of what clients are coming and asking us to do." The bank provides sterling, US dollar, and Euro accounts, credit cards and lending services. It also enables clients to purchase and sell cryptocurrencies. "They can use stable coins to make transfers around the world, and move in out of their crypto wallet into USD, Euro, Sterling or other national currency accounts. They can also transfer crypto onto their credit card," Blick said, describing some of the activity.

For nomadic entrepreneurs like Blick, the problem isn’t a lack of technology or innovation but ongoing hesitancy from established financial centres and why some of the smaller jurisdictions "are boxing clever.”

UK efforts to embrace wider use of digital assets came into focus in February when the government published the highly anticipated Kalifa Review.

The review included a well-received revision of UK listing rules to allow dual-class share structures preferred by founders, along with other incentives to fire up London’s flagging IPO market, where the LSE has accounted for just 4.5 per cent of global IPO listings the last five years, in contrast to 39 per cent for the NASDAQ and the NYSE.

More instructive, the review laid out a new UK regime for crypto issuances and investments encouraging UK regulators to take a “bespoke” and “innovative” approach, raising questions in Europe of whether the UK is taking the light-touch approach which it fears most.

For Blick, the Kalifa recommendations were great for domestic fintechs, including a £1 billion “growth fund” to help firms get through Series B and really achieve scale. The review also marked 10 UK fintech “cluster cities” for further development.

But there was nothing in there in Blick’s view that makes the UK globally appealing for say Chinese or US fintechs to come here or for him to relocate.

“Sunak is really addressing the problems of 2019 and 2020,” he argues. “Rather than taking a proactive view in terms of what the future banking industries are going to be between now and 2025, he is really trying to fill a gap that many other jurisdictions have already fixed in a very competent way.”

In the Cayman Islands, which he describes as the hedge fund centre of the world, the arrival of crypto and digital asset hedge funds in recent months has boosted EQIBank's business.

“Their fundraising has been tremendously successful,” but they then face the problem that the banks won’t touch them, Blick said.

“It is a very real problem we have solved for dozens of funds over the last five or six months. They were literally going to their existing providers, which are well-recognised banks, but the banks were saying, ‘Look, we will keep your traditional business but I am afraid we can’t assist you in that way.’”

Blick spent a number of years in UK corporate law specialising in financial services and insurance, before becoming chief executive of Financial Partners Bank and then founding a commodities and derivative exchange in Cayman.

Pushback?
He accepts that there has been a significant pause in activity toward accepting crypto currencies and stable coins, and even further pushback on decentralised finance. "There is rapid growing acceptance in the US, and the arrival of Coinbase has gone someway to assist in that. But the vast majority of family offices and HNWs have no idea how to access cryptocurrency and stable coins," he said.

"If I am a guy on the street in London, who is going to tutor me on what these cryptocurrencies are? Who is going to look after them? Who is going create a wallet for me, and how do I know it is safe? Today there are a huge number of unregulated exchanges and providers around the world, which is counter intuitive for a HNW or a family office.

"From a practical perspective, the HNW doesn’t have access to that service and from a legal perspective there is no way a fund manager or an administrator would sign on for the risk of allocating 5 or 10 per cent of a fund to a cryptocurrency purchased through an unregulated entity."

"Our view is you can’t just offer crypto currency in a standalone box. You have to offer it as part of a variety of product sets with an institution you are really comfortable with."

Can't we all just work together?
Rather than see financial services further bifurcate as fintechs cut deeper into incumbents’ business lines, there has been fresh urgency to harness this innovation at the same time as capping its more unruly elements.

Bringing CBDCs into circulation is an obvious choice for central banks that has implications for fintechs expanding the use of competing cryptocurrencies, and incumbent banks that have benefited from years of established banking practices.

By offering easy settlement and instantaneous clearing, CBDCs reduce the costs associated with managing cash. By some estimates, G7 countries spend over $50 billion a year clearing and settling securities for central banks. Digital currencies also promote financial inclusion as they are potentially more accessible for the unbanked.

But challenges lie not least in their potential to cut banks out of the equation.

“If there is less demand for their ledgers to validate digital transactions or store value, will they lose part of their raison d'etre?" investment strategist at Rothschild & Co Victor Balfour asked in a recent note.

“Would loans end up being more closely matched to deposits, leading to a narrower model of banking? If such a model followed – and banks were no longer able to easily (and profitably) extend loans – would a crucial channel of credit creation be weakened?” he continued.

Although most transactions are already recorded digitally, the current system requires commercial banks to reconcile these movements.

"A CBDC could be recorded via a distributed ledger and remain centralised, with no need for banks to intermediate,” Balfour said.

Blick is even more blunt: "With central bank digital currencies, you can do clearing in seconds or minutes. If banks don’t innovate, don’t allow new technology to come in as part of their organic growth, they are going to be out boxed. They are no longer going to be able to hold on to your money overnight and rely on that to maintain a reasonable balance sheet for lending. They are going to have to adapt to the fact that there is a race to the bottom in fees," he said.

"If you are a Deutsche bank with a cost to income ratio of over 90 per cent, you’ve got some problems," Blick continued. "In this sense, a move towards a central bank digital currency is really a way for government to enforce greater efficiency on legacy industries such as banking."

Whatever the views about private versus central-bank supported new currencies, or whether bitcoin becomes a credible form of tender or lasting store of value, Balfour at Rothschild & Co says "there is genuine demand from savers, who see private money as less likely of being created profligately."

Blick is optimistic that the sector understands the merits of wider crypto use and believes some of the large global banks are slow movers because of difficulties leveraging existing technology in providing the necessary infrastructure.

“CTOs in larger banks are saying, ‘We honestly don’t know where to go with this?’” he said. These systems are simply not able to address the requirements of corporate banking solutions that involve crypto currencies.”

A second KYC constraint was a valid argument 3 to 5 years ago, but not now, Blick argues, not with onboarding using facial recognition and personal identification being verified against a public register.

A third is AML. "AML legislation today is built around carrying cash or using systems such as SWIFT. It is not designed for the complexities of decentralised finance, where the bank isn’t in the centre any more. These people are trading amongst themselves," he said.

AML will require clients to answer lots of questions: '“Where did you get your money? Why are you utilising crypto to this extent? What are your underlying business activities?”' Blick adds.

“But if we intend as an industry to bank and accept clients that are predominantly in crypto, it actually means that we are going to have to increase the level of KYC and AML on these clients to ensure we meet national legislation."