A Banker’s Guide to Smart Blockchain Innovation

A Banker's Guide to Smart Blockchain Innovation

If there’s one thing we can expect from 2022, it’s that banks continue to scale the blockchain space, the same space they were once so eager to avoid. Another seeming inevitability is that the blockchain ecosystem will continue to grow, with more tokens, projects, and services taking off. Put two and two together, and you get dozens, dozens of Blockchain Innovation Officers and CIOs about to learn what a circus is sometimes. Here’s how to make sure they’re not wasting their time.

While the blockchain ecosystem was once considered the digital iteration of the Wild West, the vast frontier where almost everything happens, things are now somewhat different. Times are changing and the industry is now more lenient and welcoming of regulation. It is still vast, however, with more than 7,000 cryptocurrencies there. And that’s not to say that every project doesn’t launch its own coin.

Also, not all parts are created equal. While some of them are equipped with vision and utility, not to say purpose, others have nothing to offer other than a supposed tokenomics model for them on the moon. The industry is embracing open source design, which helps it advance through the contributions of thousands of talents, but there’s also a downside. It’s easy for developers to fork or replicate a popular project, apply a sneaky new feature to it with new branding, and push it live for a quick buck.

This brings a whole new dimension that policy makers exploring the crypto space need to consider – some of its segments are driven by virality more than anything else. As an example, in early 2021, Dogecoin, a meme coin whose symbol is an internet famous dog, exploded, becoming one of the most popular cryptocurrencies. Other dev teams saw an opportunity, released more Shiba Inu themed coins, and now there are probably more dogs on CoinMarketCap than in your neighborhood shelter – and some of them
dogs bite hard. Squid Coin, a scam that cost its sponsors $3.38 million playing the popular South Korean show on Netflix, is another good example of how virality can get the better of investors.

These examples also reveal one of the many questions facing banks looking to dive into crypto: what assets do they want to open to their customers? After all, despite its eventual downfall, Dogecoin did
some of its wealthy investors. Or maybe it’s best to stick with the bigger, more established pieces? All of this is just the tip of the iceberg.

Build the foundation

The first and biggest question a bank’s decision makers must answer when formulating their blockchain strategy is deceptively simple: how far do they want to go? Should they just give customers access to the five most popular coins to buy and sell? Or is it a full step up, with access to native staking, DeFi, and everything blockchain has to offer? This decision is central to everything that follows, and a clear goal will help a lot.

Another question, related to the previous one in many ways, is how risky the bank has a risk appetite. It is also a crucial piece of the puzzle because, as we have already seen, the crypto space is full of assets and services with all kinds of risk-reward profiles. Banks have more to lose from an unfortunate incident than a young crypto-native company, and they should act with a full awareness of the damage they can suffer if something goes wrong.

The last preliminary question is the custodial model that the bank will adopt. Custody, or the ability to hold and move crypto assets on behalf of customers, is the basis for banks to offer any type of crypto service. Ultimately, the choice here is between sub-custody, or outsourcing the custody to a specialist third-party provider, and self-custody, where the bank takes on the task itself. Both options are viable and the optimal choice very much depends on the bank’s objective and risk profile.

Although a thorough discussion of the two options would require another article, the general rule is that sub-custody is quicker to do, but involves a series of limitations, as any service the bank wishes to offer will depend on the capabilities of the partner. It also introduces third-party risks into the picture. Self-custody requires a better understanding of the operational theater and may require more time to implement, but offers banks much more flexibility and control over their own service portfolio.

stairway to the moon

With the fundamentals out of the way, banks will need to delve into the specifics of any concrete service they wish to offer. Nonetheless, the crypto space has long had a few parameters to look at and red flags to avoid.

When it comes to listing the coins that customers can buy and sell, banks should first and foremost look at their risk profile. Bitcoin may offer a completely different level of risk than Whatevercoin which only launched yesterday, but the latter can hypothetically replicate the spectacular growth of Dogecoin, offering clients the prospect of massive gains unless it it’s a scam, which is also a possibility. To avoid them when selecting new coins to add, banks should stick to the following principles:

  • The higher the market capitalization, the better. A high market capitalization suggests a large and active investor and user base behind a product. This not only means that it is believed by many to be safe and legit, but also that it has been extensively tested by everyone who uses it before integration with the bank.

  • Security by seniority. Older projects, especially those with a high market capitalization, tend to be more secure and proven. Their value makes them a lucrative target for hackers, and the longer malicious actors have had to try (and, ideally, fail) to compromise them, the stronger the initial design. This goes for both Layer 1 and Layer 2 protocols.

  • Dig into the details. Different rooms come with different degrees of usefulness and versatility. Some of them support DeFi, others feature robust native staking, others are even more versatile. Banks should be careful to look for coins whose functions match their overall strategy.

Banks should also make sure to verify the developer teams behind the projects they want to integrate. Legit developers are usually over the top, for example, while scammers usually prefer anonymity and shadows. A white paper is also often a good indicator of the seriousness of the project. A good one should make sure to give a good indication of the feasibility of the underlying technology, not just through declarative statements, but through actual research and testing. Another thing to look for is how comparative it is against thousands of other projects: if it really does something new, it may be a better choice than its rivals. Finally, a white paper also reveals the rigor of the contributors. Grammatical errors are a red flag – yes, seriously. They reveal the amount of tweaking the developers have the patience to put into a foundational strategy document, and if it’s lacking, it’s kind of telling.

If a white paper gives banks the opportunity to examine the ideas and theoretical underpinnings of a specific project, the next step, at least for open source projects, is to examine the practical implementation. A code audit is another important piece of the puzzle, and this is where the open source spirit of the crypto world comes in handy. Most projects tend to keep their source code on GitHub, open to researchers for review. To get a good idea of ​​whether to go ahead with the integration or not, banks would be wise to have the project audited by a seasoned third-party team.

After the audit is complete, another major pre-launch step is testing. In this regard, banks need to get used to using testnets, twins of regular blockchains specifically set up as test environments. All strong DeFi protocols go through the testnet development stage, and their testnet versions usually get all the latest updates first. As such, testnets provide an ideal environment for banks to get a feel for what they can gain from an integration before proceeding.

While providing banks with a plethora of new opportunities and revenue streams, the blockchain ecosystem requires some recognition before it can take off successfully. Nevertheless, by setting their priorities from the start and putting their strategy on the right footing, banks can explore it on their own terms and at their own pace, offering their customers the best possible service and making the most of the prospects. at hand.