Crypto crisis: the end of Bitcoin and other cryptocurrencies or a wake-up call for stronger regulation?

The crypto market has undergone an unprecedented development in the past few years, with many ups and downs. Quite recently, however, a crisis has emerged in the market, which many see as a challenge for the future of cryptocurrencies altogether. This has made many investors lose their confidence in the crypto market; they are now wondering whether it really provides the stable and lucrative investment opportunities it promises.

In order to regain the investors’ trust and stabilize the cryptocurrency market, crypto service providers must be reliable, and regulation of the sector needs to be increased. More regulation can help prevent fraud and abuse and thus restore the crypto market’s reputation among investors.

In this interview, Dr. Nils Bulling, Head of Strategic Innovation, Ecosystem & Digital Assets at Avaloq, shares his personal view on the current crisis in the crypto market and his predictions of how cryptocurrencies such as Bitcoin could develop in the future.

The fascinating world of DLT and digital assets

Dr. Nils Bulling is Head of Strategic Innovation, Ecosystem & Digital Assets at Avaloq, a global leader in digital banking solutions.

Hello Dr. Bulling! It’s very kind of you to let us interview you on this exciting topic. First of all, we would like to know more about your personal fascination with DLT and digital assets. What sparked your enthusiasm and what are you currently focusing on in this dynamic environment?

I first learned about these topics in 2008/2009 when I read Satoshi Nakamoto’s groundbreaking paper, “Bitcoin: A Peer-to-Peer Electronic Cash System”. Back then, I was teaching “theoretical computer science and artificial intelligence” and researching intelligent agent systems. In these scientific fields, topics like game theory, computer science and cryptography play a role – they also constitute the foundation for  blockchain and distributed ledger technologies. I learned, for example, that the Bitcoin network is very secure not only because cryptographic methods are applied but also because miners are incentivized to constantly solve resource-devouring mathematical puzzles.

After this first discovery of the subject, it took a few years until it started coming up now and again in my IT and strategy consulting work. At Avaloq, I was initially involved with the general blockchain strategy as part of the overall strategy for innovation. These tasks also extended to interactions with our parent company NEC, which is engaged in this field. A little later, I took over responsibilities in digital asset product management at Avaloq. This allowed me to actively promote the further development of the product into a scalable service offering.

I do like a challenge, and this topic certainly was – and still is – challenging, not only from a technological perspective, but also because it is being discussed so controversially. When you’re working on blockchain technologies, you need a lot of persuasiveness and perseverance, if only because no one can say with certainty how quickly the market will develop. What makes blockchain even more exciting is, of course, that many consider it to be a potentially disruptive technology. This means that those who do not engage with it run the risk of falling victim to a changed market situation with new offers and business models. My focus at the moment is on promoting our digital asset strategy, exploring strategic partnerships and opportunities and further developing the product offering.

With your employer Avaloq being a leading provider of digital banking solutions, you have first-hand insights on what drives financial services providers today. What are your impressions of your clients with regard to the current upheavals in the crypto market and what trends do you see emerging in with regard to DLT and digital assets?

Even in the context of this challenging market situation, I do not observe any substantial change in the attitude of banks towards digital asset offerings. As in the past, there are those who endorse them, those who are rather skeptical and those who are still on the fence. Nevertheless, I have the impression that financial institutions are becoming more and more open-minded, despite the current crisis in the market. There appears to be no decline in investor demand, either. Personally, I think that the currently emerging trend will let banks benefit from the recent development. Many of their customers will value trust even more than before.

In addition, convenience and a pleasant user experience in digital asset services will become increasingly important, I believe. Traditional financial institutions can provide both – trustworthiness in the form of secure custody as well as easy access and convenience in their advisory services as well as in their role as a service orchestrator for broader digital asset offerings. Regulated financial institutions benefit from a clear advantage in terms of trust. Initial use cases for banks are often limited to trading and custody. Then, staking, NFTs and advanced trading functionalities would make suitable additions to their service portfolio, I think. Decentralized finance (DeFi) and traditional finance will also continue to grow together – for example, by giving bank customers the option to integrate their private wallets with their bank.

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And how does Avaloq deal with the challenges and risks of the crypto industry, especially with regard to security aspects of DLT applications for financial service providers?

Partners are cornerstones of our digital asset strategy. We put a lot of effort into finding the right partners and entering into strategic partnerships. Thereby, we want to offer our clients a holistic service portfolio that meets the high demands of financial institutions. The overall solution must be equally secure, scalable and future-proof – it has to be able to cover not only today’s use cases, but also those on the horizon. In this context, integration with legacy systems as well as a modular and open system design are essential. Moreover, topics such as public cloud are also relevant for the discussion, as services are increasingly being offered from the cloud and need to be taken into account accordingly.

We see it as our role to discuss these technological aspects with our partners and clients. This becomes especially interesting when dealing with new kinds of challenges that emerge from the new technologies themselves or simply do not exist in traditional finance. Raising the necessary awareness and acceptance is a lengthy process – and that is indeed important and right.

In addition to the technological issues, successfully launching a digital asset offering also involves commercial and operational aspects that can be challenging. This also includes creating a resilient business case. Especially the customer adoption curve and the development of revenue streams are unpredictable factors in that regard. With this in mind, it is crucial to consider new pricing approaches. Moreover, blockchain technology affects operational processes and requires adjusting them. A basic understanding of the technology’s inner mechanisms is necessary, especially when it comes to designing appropriate banking offerings and interacting with end customers.

Quo vadis crypto and the call for more regulation

Around the world, the fragmented regulatory landscape is creating tension in the cryptocurrency market: in regions where there is too much regulation, innovative use cases are potentially nipped in the bud, while too little regulation elsewhere is likely to fuel further scandals such as the crash of Terra or the collapse of FTX. How do you think recent regulatory developments such as the proposed MiCAR regulations or the DLT Pilot Regime will impact the crypto markets?

In my opinion, more regulation is needed to bring digital assets into the mainstream and to stimulate further growth. Alongside the regulated market, an unregulated or decentralized market will probably continue to exist – albeit more suitable for a small circle of risk-taking, tech-savvy investors. However, the majority of investors will switch to regulated market participants. This would be an exciting potential development enabled by blockchain technology and DeFi. Such a two-pronged approach would continue to fuel innovation. New concepts could first be tested in the unregulated market and then – depending on their maturity and the needs of the customers – spill over into the regulated market.

The EU’s DLT Pilot Regime shows that DLT is gaining momentum independently from crypto trading. It is a promising approach when it comes to trading efficiency and settlement of digital securities. This further corroborates the crypto use case: to unlock the full potential of the technology, both settlement parts – payment and security – should be handled via the blockchain. This allows for an immediate atomic settlement in the delivery versus payment (DvP) model.

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Implications of the crypto crisis for the financial market

As mentioned before, recent reports of crypto exchanges going bankrupt or falling victim to hackers, as well as numerous cases of fraud, have raised skepticism among investors towards the fledgling crypto market. Nevertheless, the interest in cryptocurrencies seems to be unbroken, especially among retail investors. How is this possible and what do you think: will cryptocurrencies be able to prevail as an alternative asset class in both retail and institutional business in the long term?

My guess is that many current investors will become more cautious when looking into these investment opportunities, but that they will continue to believe and invest in digital assets. Looking more closely, many of the crypto platforms that failed had issues with too little control and too much risk-taking. Traditional, regulated players in the financial market could benefit from the crypto platform crisis, since they enjoy a lot more trust. This could attract potential investors.

Moreover, not only crypto assets have fallen, but stocks as well. Currently, a recovery process can be observed. In 2022, the number of cryptocurrency users didn’t grow as fast as in the past, yet there was still a steady increase from 306 million users in January 2022 to 402 million in November.[1]

I think as soon as more banks start offering crypto products to their customers, corresponding advisory services will follow. Cryptocurrencies or coins will become established as an asset class. But in the future, a distinction will likely be made: between more reliable coins (those associated with benefits such as executing smart contracts) and pure high-risk speculative coins.

As employees and digital asset enthusiasts at zeb consulting, we are particularly interested in how banks and asset managers position themselves in the market for DLT and digital assets. What tasks do you think these players are facing when it comes to making the crypto market more secure and fulfilling their role as an intermediary to investors in an equally trustworthy and effective manner?

I believe investors have a specific set of requirements regarding the trustworthiness and convenience of crypto offerings. Regulated banks are, in principle, able to meet all these investor needs. Take the security requirements of crypto investors – in order to cater to this demand, banks need only provide corresponding custodial services. Financial institutions can respond to the desire for convenience and efficiency by offering easily accessible crypto products and outstanding user experience. Competent advisory services will be appreciated by many investors. A lot of customers will be much more open-minded towards digital assets, if they are offered by their investment advisor who already advises them on traditional assets and whom they trust.

And last but not least, banks are also in an ideal position to act as orchestrators of various digital services for their customers. This may, for example, come into play in the context of the Central Bank Digital Currency (CBDC) and payment processes, the digital identity of customers or the tokenization of assets. In all of these fields, banks can significantly increase efficiency for their customers by providing the necessary access and orchestrating the corresponding processes.

Conclusion and market outlook

In addition to cryptocurrencies, we at zeb are particularly interested in the developments of other forms of digital assets, especially security tokens (i.e. tokenized securities) and the crypto securities that can be found in the German financial market. What potential do you see in tokenization in the context of the financial market in the medium to long term, and what do you think are the most exciting use cases to keep in mind on this journey?

The potential of tokenization is enormous, both for digital securities and non-bankable assets (nBAs). Around one-third of all assets worldwide belong to this class of illiquid assets, the nBAs. These range from luxury real estate to art collections. So far, however, banks have not been able to handle them in the same way as conventional stocks or bonds. Distributed ledger technology may change that, as it allows financial institutions to offer nBAs in the form of tokenized assets. On the one hand, tokenization makes nBAs much more accessible, since the minimum investment in, say, a Picasso is much lower. On the other hand, it also promotes the emergence of liquid markets for the digitized nBAs. Tokenization makes asset management more democratic, as the resulting new asset classes are accessible to a broader audience.

The same applies to digital securities: they contribute to democratization. And they are also on the rise. In Switzerland, for example, the first DLT-based digital bond was launched on the SIX Digital Exchange (SDX) in November 2021. In January 2023, the city of Lugano in Ticino also issued a six-year unhedged CHF bond, with a total issue volume of CHF 100 million maturing in 2029. By the way, this instrument is listed on SDX as well as SIX Swiss Exchange and can be traded on both stock exchanges. Aside from that, in Germany, Deutsche Börse is currently launching its own digital issuance platform for electronic securities under the name “D7”.

What is particularly interesting about this development is that it will allow regular bank customers to act as private equity investors in the future. They can look into different projects on their own, analyze them and then invest in the respective companies, which used to be accessible exclusively to better-funded customers. I can well imagine that a whole social ecosystem will develop, with expert forums, rating apps and social platforms.

To conclude the interview, we would like to know what factors you see as most relevant to increasing adoption of DLT and digital assets by financial institutions and investors, and why?

First and foremost, the crypto market needs more regulation. This will set the foundation for adoption on a big scale. The financial institutions themselves need to provide simple and sufficiently broad crypto offers. In order to scale and manage operational risk, banks need to make sure that these crypto solutions integrate with existing core banking systems. Banks must define a clear digital asset strategy that complements their overall strategy. If the digital asset offering is viewed in isolation, it will initially be difficult to build a reliable business case due to the adoption curve and uncertain growth assumptions. Even in its early stages, a crypto offering is very beneficial for banks precisely because of the opportunities it offers indirectly: these encompass customer satisfaction, cross- and up-selling, future growth and risk mitigation – the latter in the context of “not missing the boat.”

Thank you very much for the interesting interview, Dr. Bulling. We wish you all the best, both personally and professionally, and would be happy to welcome you back for an interview or a guest commentary on BankingHub soon!

Feel free to contact us!

Julian Schmeing / author BankingHub

Julian Schmeing

Partner Office Munich
Philipp Kerber / author BankingHub

Philipp Kerber

Senior Consultant

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