Banking in the shadow of Bitcoin? The institutional adoption of cryptocurrencies

Summary

Focus

The market capitalisations of cryptocurrencies and related economic activities have grown phenomenally in recent years. While the role of retail investors has received much attention, we know less about the role of financial intermediaries in this sector. How significant is the presence of traditional intermediaries such as banks and investment funds in crypto markets, and what motivates them to take on cryptocurrency exposures? And how important are novel intermediaries such as crypto exchanges?

Contribution

We gauge the significance of financial intermediaries in crypto markets, using a novel global supervisory database of banks' cryptocurrency exposures and a range of additional data sources. We assess the factors that determine banks' holdings of cryptocurrencies. In addition, we investigate the role played by novel crypto exchanges, and examine the cross-country drivers of institutionalisation.

Findings

The potential for cryptocurrencies to scale up quickly calls for a comprehensive approach to assessing and mitigating risks, even though the interlinkages between crypto markets and mainstream finance have remained limited. The exposures of major banks to cryptocurrency exposures are currently still very modest, amounting to less than USD 200 million in 2020. We find that banks are more likely to hold cryptocurrencies when country indicators for greater innovation capacity, more advanced economic development, and financial inclusion are high. We also show that substantial activity is concentrated in lightly regulated crypto exchanges. This "shadow crypto financial system" serves both retail and institutional clients, such as dedicated investment funds.

Abstract

The phenomenal growth of cryptocurrencies raises important questions about their footprint on the financial system. What role are traditional financial intermediaries playing in cryptocurrency markets and what drives their engagement? Are new nodes emerging? We help answer these questions by leveraging a novel global supervisory database of banks' cryptocurrency exposures and by synthesising a range of complementary data sources for other types of institutions. We find that major banks' exposures currently remain at very modest levels. Across countries, higher innovation capacity, more advanced economic development, and greater financial inclusion are associated with a higher likelihood of banks taking on cryptocurrency exposures. We show that substantial activity is concentrated in lightly regulated crypto exchanges. This "shadow crypto financial system" serves both retail and institutional clients, such as dedicated investment funds. An uneven regulatory treatment across banks and crypto exchanges and significant data gaps suggest that a proactive, holistic and forward-looking approach to regulating and overseeing cryptocurrency markets is needed. It should focus on ensuring a more level playing field with regard to financial services provided by established financial institutions and intermediaries in the emerging crypto shadow financial system by introducing more stringent regulatory and supervisory oversight for the latter.

JEL classification: E42, G12, G21, G23, G28, O33.

Keywords: cryptocurrencies, decentralised finance, digital currencies, financial regulation, financial supervision, exchange, stablecoin, Bitcoin, Ethereum.