Financial Institutions in the Crypto Ecosystem: Opportunities and Risks

Cryptocurrency has exploded in popularity since the first Bitcoin was minted in 2009. Collectively, the total value of the cryptocurrency market is estimated to be worth more than $2.5 trillion today, according to IMF data.

Earlier this year, a survey conducted by the Pew Research Center found that 17% of Americans say they have used cryptocurrency, while the European Securities and Markets Authority believes the market cap for crypto in the EU to be around $1.7 trillion. Growth continues across the world, with the percentage of people who have used some form of crypto reaching over 50% of the population in Latin America – so it is vital to build trust in this ecosystem.

Crypto’s dependence on traditional rails

The continued popularity of cryptocurrency – and the use of traditional payment rails to invest in, trade or use crypto – means that it is nearly impossible for traditional financial services and virtual asset service providers (VASPs) to operate in isolation from one another. In other words, anyone who wants access to crypto is reliant on traditional banking rails in the first instance.

From the banking perspective, an institution may maintain a direct relationship with a VASP through the provision of direct banking services to an exchange. Banks can also be indirectly exposed to VASPs, as bank clients use their accounts to transfer funds via credit, debit, Automated Clearing House (ACH) or other fiat-denominated mechanisms to fund crypto wallets.

Conversely, VASPs depend on banks to transmit funds via fiat on- and off-ramps, as well as to provide critical banking services that are vital to the health of any company (e.g., supporting employee salary payments). Put simply, VASPs cannot support crypto-denominated activities without access to the traditional banking system. Meanwhile, banks add an additional level of oversight to the activity at that exchange.

As this bilateral relationship continues to mature, there’s an opportunity for both parties in establishing access to the banking system with proper controls and risk mitigation. Both banks and VASPs are vulnerable to the risks associated with crypto without the proper risk mitigation controls in place. They could face potential financial losses, reputational damage and even regulatory sanctions or the loss of operating licenses. It is therefore in the interest of everyone to be as transparent and accountable as possible while working together to meet the needs of consumers.

Higher-risk activities can be managed with commensurate controls

With around four times more fraud in crypto than in fiat transactions, innovation is vital to providing greater safety because consumers demand the ability to transfer funds through exchanges into crypto.

Tools like those offered by Ciphertrace, a Mastercard company, enable banks, crypto exchanges, wallet providers and other VASPs processing digital asset transactions to better assess risk for both the destination and origin of fiat funds. Ciphertrace also provides insights to help assess the risk associated with crypto-related transactions and applies data-driven analytics to gauge the effectiveness of internal controls. These insights underpin tools like Crypto Secure, which gives banks a way to easily check a VASP’s rating and to apply better risk mitigation strategies.

Fourteen years after the first crypto transaction, the importance of risk assessment has grown in line with blockchain technology itself and its increasing popularity among consumers. All the more reason that data-driven insights – which position financial services firms and VASPs to make informed risk appetite decisions – are important. This allows customers to tailor risk management controls and enhance user and customer experience appropriately.

While there will always be risk in all financial transactions, both on and off the blockchain, Mastercard remains focused on developing tools to mitigate it. Through its enhanced capabilities, it is providing financial institutions with the data they need to comply with regulation as well as enhance customer and consumer safety. Ultimately, this improves user experience and keeps trust central; this is vital to navigating future opportunities and risks associated with blockchain technology.