The Challenging Union Between Traditional Finance and Crypto

Traditional Finances May Be Becoming More Accepting of Cryptocurrency and Blockchain, but the Partnership Remains Challenging.

How can cryptocurrency companies close the gap with traditional finance?

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There have been some hard-fought victories to better integrate cryptocurrencies and traditional finance. A case in point: the approval of the first spot Bitcoin (BTC) exchange-traded funds (ETFs) in the United States on Jan. 10.

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The U.S. Securities and Exchange Commission’s (SEC) approval of the ETFs may herald further capital inflows and greater institutional participation in the crypto market, but digital assets have yet to make inroads into the banking sector and the vast majority of financial institutions.

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Furthermore, the reluctance with which the SEC finally approved the ETFs is worth remembering. The SEC rejected multiple spot Bitcoin ETFs from multiple challengers, with its first refusal dating more than a decade back to July 2013.

Eventually, as large fund managers from the traditional finance (TradFi) world, such as BlackRock, got involved and legal action surrounding Bitcoin ETFs was concluded, the SEC approved.

In a statement on Jan. 10, SEC Chair Gary Gensler said, “While we approved the listing and trading of certain spot Bitcoin ETP shares today, we did not approve or endorse Bitcoin.”

The approval, as begrudging as it was, meant 10 years of denials were finally over.

Elsewhere, the industry faces multiple challenges for acceptance in what remains a largely TradFi world.

A Challenging Marriage

Old money may be softening to crypto and blockchain, but the union remains a difficult one.

Bob Ras, co-founder of Coreum — a blockchain protocol developing smart tokens for tokenized securities and real estate — told Blocking.net that regulators have long been skeptical of crypto projects, even those with the intention of adopting traditional industry standards.

Recent: CBDCs: User privacy problem or currency of the future?

Ras experienced this firsthand during the development and launch of Sologenic, a platform he co-founded for trading tokenized stocks.

“We saw the gap between the traditional financial market and blockchain assets,” Ras said, “So we started a project called Sologenic. Sologenic bridges the traditional financial market with crypto assets. During those days, the idea was to obtain a MiFID [Markets in Financial Instruments Directive] license — a security broker-dealer license inside Europe.”

But the journey to a broker-dealer license was fraught with difficulties.

“Unfortunately, they wasted two years of our time,” said Ras.

Given the intransigence of European regulators, Sologenic decided it would instead offer tokenization solutions for institutions only, sidestepping the need for a MiFID license.

Decentralization and Control

While regulatory burden plays a role in the separation of TradFi and decentralized finance (DeFi), another divide comes from differing philosophies in how finance should operate.

Sologenic initially ran on the XRP Ledger blockchain, but the specific needs of the platform drove the Sologenic team to build Coreum, a layer-1 blockchain with smart contract functionality designed to comply with institutional demands.

During the development phase of Coreum, Sologenic had to consider why TradFi and blockchain remained distant despite all the efforts to merge the two. The answer wasn’t simple.

“Right now, if you look at all the blockchains in the world, there’s no blockchain that is focused 100% on enterprises,” said Ras. “No blockchain that is 100% in compliance with the [banking standard] ISO 20022, that has AML [Anti-Money Laundering] and KYC [Know Your Customer] on-chain.”

A more fundamental issue was also at play: DeFi makes institutions nervous.

As Ras explains, “No financial institution actually utilizes [blockchain] technology significantly. We had some cases, but the mass adoption is not there. We have to ask the question ‘Why?’ I think it is because financial institutions have to stay within the regulatory framework.”

Ras told Blocking.net that a lack of checks and balances makes traditional institutions balk. Without it, they can’t guarantee they won’t fall foul of regulations, so “you need to give them some level of control in order to get them to adopt the technology.”

Ultimately, Coreum decided the best way forward was to provide administrative-level powers for regulated financial entities.

Bridging the Gap

The approval of a spot Bitcoin ETF may be a sign that the stock market is ready for crypto, but the financial sector may prove to be a tougher nut to crack.

There is still strong crypto skepticism from many in the sector. On Feb. 22, the European Central Bank issued a report about the possibility of a spot Bitcoin ETF in Europe.

Recent: Visa and Mastercard: A boon for wallet holders, a threat to crypto exchanges?

The report’s title, “ETF approval for bitcoin – the naked emperor’s new clothes,” is instructive. Suffice it to say that report authors Ulrich Bindseil, director general of the ECB’s Market Infrastructure and Payments division, and Jürgen Schaaf, an adviser to the same division, are not big crypto fans.

Changing hearts and minds in the traditional finance sector is a major challenge. So, while TradFi and crypto are becoming more closely connected than ever, much work still needs to be done.

Q&A: What’s on readers’ minds?

Q: Are there other regulatory barriers preventing the adoption of cryptocurrencies by traditional financial institutions?

A: Yes, regulatory barriers are a significant challenge that hampers the adoption of cryptocurrencies by traditional financial institutions. Apart from concerns about falling foul of existing regulations, institutions also have to grapple with issues of user privacy and transaction transparency. Striking a balance between blockchain’s inherent transparency and financial privacy is still a hurdle that needs to be overcome.

Q: How can decentralized finance (DeFi) address the concerns of traditional financial institutions?

A: DeFi platforms can address the concerns of traditional financial institutions by incorporating regulatory compliance features such as anti-money laundering (AML) and know your customer (KYC) protocols in their offerings. By providing institutions with a level of control and administrative powers, DeFi can help bridge the gap between the decentralized nature of blockchain and the regulatory requirements of traditional finance.

Q: Will the approval of Bitcoin ETFs lead to widespread adoption of cryptocurrencies in the financial sector?

A: While the approval of Bitcoin ETFs is a positive development, it does not guarantee widespread adoption of cryptocurrencies in the financial sector. Strong skepticism and regulatory hurdles still exist, and changing the hearts and minds of traditional finance players will require further efforts. The road to full integration between cryptocurrencies and traditional finance is a challenging one, but progress is being made.

Future Outlook and Recommendations

Despite the challenges and skepticism, the approval of the first spot Bitcoin ETFs in the United States indicates a growing acceptance of cryptocurrencies in the stock market. This could potentially pave the way for greater institutional participation in the crypto market and further capital inflows.

To bridge the gap between traditional finance and decentralized finance, continued efforts are needed to address regulatory concerns and provide institutions with the control they require. Blockchain protocols like Coreum, which are designed with compliance features and administrative-level powers, could play a significant role in facilitating the adoption of cryptocurrencies by financial institutions.

As the crypto industry evolves, it is crucial for regulators and industry players to work together to develop a regulatory framework that promotes innovation while ensuring consumer protection and financial stability. With the right balance between regulation and innovation, the future integration of cryptocurrencies into traditional finance could be a game-changer.

References

1. “CBDCs: User privacy problem or currency of the future?” – Link
2. “Visa and Mastercard: A boon for wallet holders, a threat to crypto exchanges?” – Link

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