“It’s Simple, But It’s Not Easy”
Banking bitcoin posed a high risk over the past number of years. Much has been documented about Operation Chokepoint and the destruction of Signature Bank and Silvergate Bank by the FDIC.
The tides have started to shift as both industry players and incumbents see an open opportunity to grab market share for banking and financial services within the industry.
First, as you can see in the recent @WSJ article below, many large crypto companies, including Circle, BitGo, Coinbase, and Paxos, are exploring or have already started forming their own bank. Kraken has a bank license in Wyoming as well. Saylor’s Strategy and some large bitcoin miners with large BTC holdings have a similar opportunity. Source: wsj.com
Like John D. Rockefeller did with Standard Oil, these firms have an opportunity to own all levels of production and products, pioneering new offerings, like bitbonds and tokenized treasuries, as the world is reshaped by this wholly new commodity.
At the same time, at Two Prime, we are in conversation with multiple existing banks looking to figure out how to engage in this industry, mostly through offering lending services. Though interested, these groups largely don’t have the technical savvy or experience to do this solely on their own.
What are the real opportunities here, and do they require a bank license?
1. Custody of BTC
The first step in banking bitcoin is providing custody. Historically, these fees are quite high as compared to the custody of traditional equities, but are compressing over time. This business line will not be a huge profit center in itself, but it is sticky. It brings assets into a financial services provider in order to offer more of the products below. Groups that are qualified custodians, banks, broker-dealers, or a futures commission merchant can offer this service and build additional products on top. There are already many bitcoin and crypto custodians moving in this direction, while traditional banks start to also integrate this basic service.
2. BTC-Secured Loans
This is the most obvious and digestible place to start. Over-collateralized loans backed by BTC are low-risk and can produce higher interest than a mortgage with much more liquid collateral than a musty old house. This doesn’t require a banking license necessarily. However, many borrowers will prefer the oversight a banking license implies. The sector also varies widely from retail to institutional loans, and what licenses and oversight is required. Similarly, loans against BTC ETFs will rise in popularity and are actually easier to offer as they already exist within traditional financial pathways.
3. T+0 Fiat to Stablecoin Conversion
Currently, converting large sums of fiat to stablecoins is expensive or slow. It can be done same day via prime brokers, but they charge absurd fees for taking near-zero risk. Alternatively, Two Prime and others can directly mint and redeem stablecoins with firms like Tether and Circle, but the process often takes an extra day. This is often not possible for certain transactions. A bank that can float the sum and turn around immediate stablecoins or fiat wires at reasonable rates stands to be at the center of a lot of capital flows. With access to short-term interbank credit at very low rates, banks are uniquely positioned to offer this.
4. Yield on BTC
The next thing we know is that many want us to put their BTC to work. We think it’s unlikely most groups will feel comfortable with DeFi yield solutions in the near term. Yield can come either from allowing the bank to rehypothecate BTC, with rates currently in the 3-5% range for unsecured BTC loans, or derivatives trading with custody of BC remaining at a bank.
All of these products are logical next steps, but executing on them at scale has yet to be achieved. Groups need to avoid the pitfalls of blowing up via poor lending risk management, margin calls, technical errors with custody and transfers, and poor trading or re-hypothecation processes. Each of these functions does not REQUIRE a banking license and the layers of compliance overhead that it entails, but groups that can offer trusted solutions in a regulated fashion stand to gain profoundly.
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