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19 August 2022

19 August 2022

Crypto Banking 101: What is Crypto Banking?

Crypto Banking 101: What is Crypto Banking?

Crypto Banking 101: What is Crypto Banking?

The banking industry is going through a period of rapid innovation at the hands of digital technology. At the forefront of this innovation is crypto banking. In this article we provide an overview of crypto banking and outline some of the fundamentals of crypto banking operations.

The banking industry is going through a period of rapid innovation at the hands of digital technology. At the forefront of this innovation is crypto banking. In this article we provide an overview of crypto banking and outline some of the fundamentals of crypto banking operations.

The banking industry is going through a period of rapid innovation at the hands of digital technology. At the forefront of this innovation is crypto banking. In this article we provide an overview of crypto banking and outline some of the fundamentals of crypto banking operations.

What exactly is crypto banking?

Crypto banking is the management of digital currency by a financial service institution or bank. Unlike traditional banks, which only hold fiat currency and traditional financial assets, crypto banks also hold cryptocurrency. The role of crypto banks is to make it possible for service users to exchange and interact with fiat money and cryptocurrencies. Crypto banking services may include checking accounts, custodian banking, cross-border payments, and yield solutions. Some crypto banks also offer crypto interest accounts. These operate in a similar way to traditional banking accounts: banks borrow the money in savings accounts to lend to third parties, paying their customers interest in return. 

Where does crypto fit into national banking systems?

Banking is supported by a hierarchy of money with a central bank reserves at the top, followed by the deposits of the major national banks. Below that are deposits from banking reserves that do not have direct access to the central bank reserves (such as eurodollars in the US Fed system). 

Cryptocurrency is similar to non-national banking reserves, but instead of being a national currency sitting in a foreign account, it is a currency that sits on a blockchain. For instance, a stablecoin like USDC is backed 1:1 with the US dollar but the coin falls outside US bank regulation. 

Cryptocurrency is therefore giving rise to a new hierarchy of money within banking systems. At the top is the currency issued by the central bank, which is the purest form of currency but also the most centrally controlled. Levels of control loosen through commercial bank deposits and foreign bank deposits until we arrive at cryptocurrency. At the base of the hierarchy, crypto is the most permissionless form of currency supported by banks.

What is the business model for crypto banks?  

Historically banks have made money through net interest revenues, which is the sum of the percentage interest they charge to loan money minus the percentage interest they pay to borrow money from customers who bank with them. 

The usual risk associated with this model is that either 1) the borrower is unable to pay back a loan or 2) changes to interest rates make existing loads unprofitable. In crypto banking there are two additional risks: 1) where a loan is over-collateralized and the bank must liquidate the collateral to cover losses and 2) the blockchain code is exploited causing financial losses. Full reserve banks mitigate these risks by maintaining 100% reserves in fiat at all times. Others use fractional reserve methods to create a buffer on the balance sheet between assets and liabilities.

What stops crypto banks from lending too much? 

There are two core factors that constrain crypto banking operations and thereby mitigate risk. The first factor is solvency – the ability of a bank to meet its financial obligations. Solvency includes ensuring that banks don't lend more than they can pay back, and that they do not make poor investments. 

As mentioned, full reserve banking mitigates these challenges by ensuring that no risks are taken with bank deposits. Most fiat-backed stablecoins, including those offered by BVNK, fall within this bracket. Fractional-reserve banks generally operate in line with the Basel III regulation, which demands that they maintain a sufficient surplus. 

The second major constraint is liquidity. The challenge for banks is to ensure that they do not tie-up all of their higher-value assets, as doing so may mean they would struggle if all customers decided to withdraw their money at once – even if the bank was technically solvent. Once again, Basel III is important as it defines the total value of higher-level money banks should maintain. Some banks incentivise crypto investors to lock their capital away for a number of years to help ensure a sufficient pool of liquidity. 

What is the future of crypto banking?

The banking and crypto sectors continue to intersect and crypto banks are maturing fast. One area that is developing particularly fast is the emergence of crypto banking and payment platforms like BVNK that enable corporations to bridge their fiat and cryptocurrency banking in one place. Such platforms will help businesses meet increasing demand from customers for reliable crypto payments options, while enabling businesses to more easily and cost effectively send money around the world.

Crypto banking news, events and updates

Crypto banking news, events and updates

Crypto banking news, events and updates

Our blog is dedicated to bringing you the latest industry news in crypto, banking, treasury management and investments.

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Get in touch with us today to find out how BVNK™ can make running your business simpler.

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Get started

Get in touch with us today to find out how BVNK™ can make running your business simpler.

Open a Business Account

Contact Sales