Can Bank-backed Exchanges Solve the Trust Problem in Cryptocurrency Trading?

Authors: Dr. Bo Bai (Executive Chairman and Co-Founder of MetaComp and MVGX Exchange), Source: Consensus Magazine; Compiler: Song Xue, Golden Finance

Last week, a 12-member jury found former FTX CEO Sam Bankman-Fried guilty of all seven fraud-related charges, ending months of industry introspection. In 2022, the structure of the cryptocurrency industry has changed due to a series of bankruptcies and scandals due to poor risk management, governance, and oversight, and many people are starting to think about its future as new personalities emerge.

The financial institutions that cryptocurrencies initially tried to distance themselves from now dominate the headlines. ** Financial giant Franklin Templeton added fuel to the fire of tokenizing real-world assets with the launch of a tokenized money market fund earlier this year, while other companies such as Deutsche Bank and HSBC have also expressed interest in or have already launched blockchain-based financial products in the market.

The rules of engagement are changing. "Institutional-grade" is the new normal. Investors are now more interested in tokenized equivalents of existing products than they were previously interested in mechanisms such as liquidity mining, staking, etc. ** Decentralized finance (DeFi) seems to be outdated, to put it bluntly. So what does this actually mean for those of us in the trading space?

1. Redefine the institutional level

Previously, the institutional-grade concept was a product issue, not an infrastructure issue – whether it was spot or margin trading capabilities, or even new contract types for digital assets such as perpetual futures, which had not been seen before. After last year, it began to stand for something more pragmatic: security. **

In the post-FTX era, the tide has shifted. Both institutional and retail investors are now less concerned with returns, guarantees, or other aspects and more concerned with whether the entity is trustworthy. ** It's a bit counterintuitive for an industry based on blockchain, a technology with trustlessness as its core principle.

For bank-backed exchanges, trust is what attracts customers – trust in the brand, as well as the existing regulatory and compliance framework related to the exchange and its affiliation with financial institutions. In fact, this is the only legal difference from other centralized exchanges that operate with the same license on the same site.

In countries with clear regulatory regimes for digital asset trading, such as the UK or Singapore, the advantage of having bank support is just another step in the door to compliance.

This year, the debate over the segregation of client and corporate funds between exchanges has intensified, leading to increased scrutiny, especially among institutional clients evaluating the safest exchanges. In fact, 90% of institutional investors surveyed trust TradFi (traditional finance) companies to custody their digital assets. Often, these hosting solutions are already fundamentally separate from brokerage solutions in terms of design. **

For instance, Standard Chartered Bank launched Zodia Custody, an institution-focused digital asset custodian backed by SBI and Northern Trust. Its sister company, Zodia Markets, an institutional digital asset trading and brokerage venue, is a completely independent company with a different shareholding structure.

**Under a sound regulatory regime, there are multiple ways to provide safe and trustworthy digital asset trading services through banks. **

Known for its non-custodial trading capabilities, institutional clients can choose where to hold their assets from a network of trusted custodians.

Second, know your customers

While bank-backed exchanges are meeting the changing needs and expectations of a new customer base in the crypto space, the reality is that they are only meeting the needs of a small number of people. From all angles, they don't offer anything new in terms of product or accessibility.

DBS Bank, the largest bank in Southeast Asia, is one of the few financial institutions to launch its own digital asset exchange. However, it operates on a membership-based structure only, and participation is limited to financial institutions, corporate-accredited investors, and professional market makers.

Individual investors can only trade on DBS' exchanges through member entities, such as the private banking arm of the bank. In addition to the restrictions, its popularity has increased. Earlier this year, its BTC trading volume increased by 80%, according to the bank's statement.

Of course, what makes the DBS model so successful is its unique paradigm that operates in a city-state that has long supported public-private sector dialogue. Under a sound regulatory regime, there are multiple ways to provide secure and credible digital asset trading services through banks.

3. Restrictions on Utilization

Earlier this summer, EDX Markets caused a stir when it launched in the US, making it the closest US exchange to being backed by a bank. With the support of financial giants such as Charles Schwab, Citadel Securities, and Fidelity Digital Assets, it hopes to bridge the gap between financial institutions and digital asset-native businesses.

Despite the SEC's increasingly stringent regulatory scrutiny over the past year, the emergence of EDX Markets has been a bright spot in all enforcement actions over the past year.

But until the dynamics change to allow these bank-backed exchanges to accept retail investors, my hunch is that the market will remain as it is. These developments have less to do with operational choices and more to do with overcoming regulatory hurdles. **

Now, more than ever, security and trust are an integral part of cryptocurrency. However, relying solely on the reputation of traditional banking should not be the only solution. ** Blockchain is essentially the right technology for building a financial system that doesn't rely too heavily on individual ethics and stewardship, and after a year of industry scrutiny turmoil, we're slowly seeing its benefits re-emerge as the dust settles.

Exchanges built for crypto native investors still have an advantage over latecomers. If we all want a piece of the pie, the banks need to queue up. **