From banking failures to DeFi revolution: is crypto shaping the future of finance?

The recent banking failures of Silvergate, First Republic, and others, once again raise concerns for the banking industry.

Following the 2008 banking crisis, there was strong mistrust in the banking system. This mistrust certainly catalysed the creation of a decentralized monetary system, now mostly known as cryptocurrency. The main advantage of a decentralized money system is the limited influence of any external central intermediary such as a government or central bank.

Decentralized finance

Decentralized finance, also referred to as DeFi, is a shift from traditional, centralised financial systems to peer-to-peer finance using blockchain technology (also known as distributed ledgers).

A Blockchain is simply a highly secure transaction database shared by all computers (nodes) participating in a specific cryptoasset network.  All the computers forming the network hold and share the same information history hence there is no need for any centralised authority, such as the US Securities and Exchange Commission (SEC) or the Financial Conduct Authority (FCA). Using the blockchain to transact using cryptocurrencies removed the fees banks and other financial companies charged for using their services.

There are a number of additional advantages to cryptocurrency transactions using decentralized finance:

• No geographical limitations.
• Faster transactions and easier access to the service.
• It is almost impossible to manipulate any records on the blockchain network, therefore, it offers greater security.
• It offers more transparency and therefore improves due diligence, as it can help avoid financial scams and negative business practices.

So DeFi can be used for cryptocurrency, but it also allows for many other many traditional financial services to be built on blockchain technology. It offers new opportunities for asset management, lending and borrowing, options trading and stablecoins.

What is cryptocurrency?

Cryptocurrency is an umbrella term for the many hundreds of digital or virtual currencies that are available.  Each different cryptocurrency relies on cryptographic technology to secure transactions and control the creation of new units.  They are designed to be secure, transparent, and resistant to fraud, providing individuals with a digital medium of exchange and store of value. Cryptocurrencies have their own decentralized network based on blockchain technology s.

Cryptocurrencies are usually not issued by any central authority, making them theoretically immune to government interference or manipulation, as with some other DeFi applications.

What is MiCA?

On 16^th May 2023, The Economic and Financial Affairs Council of the European Union approved the highly-anticipated and controversial Markets in Crypto-Assets regulation, also called MiCA.

MiCA covers a number of different elements, including cryptocurrencies, digital assets, utility tokens and stablecoins. The overall purpose and objectives of MiCA are further explored in one of CUBE’s previous blogs.

It forms part of a wide-ranging digital finance package that the EU is working on and will be effective by the end of 2024.

What are some of the key pain points of cryptocurrency?

There are a number of common concerns around cryptocurrency and MiCA. The following are some of the concerns that firms might have with regard to cryptocurrencies:

• Market Abuse system
• Proprietary trading
• Client money
• Complaints
• Custody

1. Crypto Asset Service Providers (CASPS)

The new legislation requires CASPs to have systems, procedures and arrangements in place to monitor and detect market abuse. The requirement also includes the obligation to inform supervisors of any breaches. It will be the responsibility of a CASP to stop insider information. It is expected that by the end of Q2 in 2024, the European Securities and Markets Authority (ESMA) have developed standards for CASP on market manipulation and for reporting breaches.

2. Pre and post-trade data

MiCA further does not allow exchanges to provide trading services for privacy coins without clearly identifying the transaction history first. Further guidance and standards developed by ESMA can be expected on pre-and post-trade data.

3. Client funds

Crypto asset companies will have to keep clients’ funds within accounts that need to be clearly separated from the exchange’s own funds. However, there are some exceptions to this rule, such as where the exchange is also an EU payment service.

4. Technical standards

ESMA will set out regulatory technical standards to further specify the requirements, templates and procedures for complaint handling. The MiCA regulation states these requirements should be submitted within 12 months of it coming into force.

5. Crypto custody

There are a number of requirements in relation to custody. Crypto custody means securing the private key that proves the ownership of the funds held within the crypto wallet. In traditional banking, the custodian is a financial institution. However, for cryptocurrency, the custodian can be the cryptocurrency owner themselves. Under MiCA, the custodian will be liable for the loss of assets and will be required to be EU authorised, meaning part of its business need to be done in the EU and at least one Director needs to be based in the EU.

CUBE comment

From baking failures to the DeFi revolution, there is no doubt that cryptocurrency is playing a significant role in shaping the future of finance. Crypto has the potential to provide financial services to the unbanked and underbanked populations globally. This could lead to greater financial inclusivity and empowerment for millions. The rise in DeFi has opened up new doors for innovative financial products and services. DeFi platforms enable far greater accessibility, liquidity and programmability, transforming how we access financial services. While it presents exciting opportunities, crypto and digital finance face regulatory scrutiny to protect consumers and prevent illicit activities

Many are put off by cryptocurrency as they are uncertain about what it is. Others are concerned about the lack of regulation and security around it. CUBE’s horizon-scanning technology allows firms to gain oversight over upcoming regulations and plan ahead. The MiCA regulation is only the beginning of a series of ESMA standards and with similar regulations being developed in other jurisdictions. France, Canada and Singapore are just a few competing in the race to be the global crypto hub. In the UK, the government has conducted several consultations and we are currently expecting the response to the latest consultation which closed at the end of April. In a recent blog, CUBE unfolded the developments around cryptocurrency in the UAE.

CUBE can help you keep up with regulations and therefore, open up opportunities for new investment opportunities and business expansion.

Discover how CUBE can help your firm with crypto regulations.