In our previous article (Cryptocurrency – The Future of Money), we provided an overview of the key ideas behind cryptocurrency. In this article, we look at how cryptocurrency and digital currency might impact the corporate banking and finance market.
What will it mean for our market in the short term?
Under current regulations, UK based Virtual Asset Providers (which include the exchanges and wallets usedby investors to store and trade cryptocurrency) are already required to register with the Financial Conduct Authority (FCA) and comply with a number of compliance rules.
One of the issues with digital assets under English law – in summary – is that it recognises ownership but not ‘possession’ of intangible assets. The Law Commission are currently undertaking a ‘call for evidence’ which may lead to a reform of English law in order to “lay a strong foundation for the development and adoption of digital assets”.
Amongst other things the Law Commission is seeking views on:
1. Security over digital assets;
2. Digital assets and possessability; and
3. Classifying digital assets as goods.
Two areas likely to be impacted by this reform in our market in the short term are security and financial covenants.
The concept of taking security over digital assets, and in particular digital currencies, is in its infancy and is confused further by conflicting case law and different treatment of different types of digital asset. If we gain clarity in these areas and ultimately feel confident that security can be taken and perfected, the market could see a big shift.
Organisations are becoming more sophisticated in what services they offer crypto holders. BlockFi, an American crypto-bank, gives its customers storage, leverage and management, offering interest on cryptocurrency held in a BlockFi account. Customers can also place their cryptocurrency as collateral and receive same-day traditional money.
Will borrowers soon demand these services of their day-to-day lenders?
Borrowers who hold significant digital assets (which might include crypto or other digital currency) are likely to push for them to be considered by lenders as part of the credit process at the outset when considering to lend, as well as through the life of the loan when calculating financial covenants. People can already borrow cryptocurrencies, so why not be able to offer security for a loan over an existing portfolio of digital assets?
If reforms lead to cryptocurrency being recognised as an asset then it follows that it would need to be considered in financial covenant testing. We may see Open Banking playing a role in the auto generation of base case models and covenant compliance measuring. Personal Open Banking service providers such as Plum, Moneybox and Yolt are regulated by the FCA and look to use data from ordinary current, savings and credit card accounts to offer services such as budgeting and automatic savings / investing. Corporate Open Banking services already offer account aggregation, bookkeeping, data analytics and faster account receivables.
It’s not inconceivable that a lender might encourage live sharing of a borrower’s data through Open Banking, in the same way that a health insurer might offer a free fitness tracker and discounted rates in exchange for health data. This could be used to send a red light to a lender in response to unexpected activity, for example in the case of asset based lending, and potentially reduce fraud.
The potential implications of cryptocurrencies are endless. Over 50 monetary authorities, representing the majority of global GDP, are exploring digital currencies. The Bahamas already has digital money in circulation. El Salvador has become the first country to recognise Bitcoin as legal currency and according to the press, a number of other jurisdictions aren’t far behind.
The Treasury and Bank of England have launched a taskforce to investigate a possible UK Central Bank Digital Currency – in contrast to the decentralised nature of Bitcoin – this could shift power away from privately owned banks to the state. Dubbed ‘Britcoin’, the currency would be an alternative form of GBP, but with the British financial services forming such a crucial part of our economy, it is unlikely any big changes would be made without wider consultation with and support from other institutions. In addition, we know and trust traditional currencies and any real change in how we operate day to day would likely be a long game.
In recent years there has been a shift towards ensuring that regulation offers crypto investors the same comfort and protection as investors in other financial assets. In particular, cryptocurrency exchanges (the way most cryptocurrency holders buy, store and trade) must now be registered with the FCA, conduct customer due diligence and report suspicious transactions (among other things).
The Times They Are A-Changin’
Until recent years, the banking industry has remained relatively resistant to technological disruption (after all, global banks still rely on programming language which originated in 1959 (COBOL) for bulk account and transfer transaction processing).
We may now be on the cusp of a seismic shift and the financial industry needs to prepare for a permanent overhaul – how quickly that overhaul will happen is up for debate. The governance of central banks, the robustness of our privacy laws as well as the basic principles around how digital assets are owned will all need to be reviewed. However, a move away from GBP and traditional bank deposits (whether hard cash or in its digital form) will not happen overnight and given the importance of financial services to our economy, there will be a lot of people who need persuading.