Why banks don’t trust the current bridge to crypto and how Web 2.5 can fix it.

In our last article, we explored why it’s crucial that crypto platforms have a bridge to banks. We examined the current pain points around building trusted bridges and what some Web 2.5 infrastructure providers are doing to support golden standard bridges.

Anyone can build a bridge. But if there’s no trust in it, then there are only two outcomes. Either hesitancy to use the bridge in the first place. Or long tailbacks as traffic moves slowly and cautiously across it.

This week, we look at the fiat-crypto bridge from the bank’s side. Why don’t banks trust the current bridge, and how can Web 2.5 providers like Fiat Republic assuage their fears?

Opportunities and risks

As of August 2022, the total market capitalization of cryptocurrencies stood at $1.1 trillion Crypto represents a $1.1 trillion opportunity for banks. Yet, while the opportunities are huge, so are the risks, probably the biggest of which is falling foul of regulation.

To comply with anti-money laundering requirements, banks must know their customers, their source of funds, their overall source of wealth, the purpose and intended nature of the transactions they initiate. So much so, the financial industry spent an estimated $37 billion globally on AML/KYC compliance technology in 2021.

However, whilst this is a significant operational cost, it cannot remove the risk of getting it wrong. European financial institutions saw a big increase in regulatory fines for AML and data breaches last year at $3.4 billion, up from $1 billion in 2020.

As well as the direct costs of regulatory investigations and fines, there are indirect costs related to loss of brand value, reputation and trust. Plus, the opportunity costs to banks of lost productivity and commercial contracts.

Banks need to trust the bridge to crypto but feel they can’t. They face Godzilla-like threats and scary consequences, which has created a zero-risk tolerance culture for crypto.

Poor visibility

The bridge between traditional finance (TradFi) and banks is surrounded in fog. Banks are often at least one step removed from the end-customer when they sign up crypto exchanges as customers so have reduced end-customer data visibility. That lack of visibility creates the problem of fear of the unknown.

When you think about it, a lot of data is generated in the usual A to B to C crypto customer journey. First when fiat currency is transferred to a crypto platform (A – off chain), then when it’s converted into crypto and sits on the blockchain for a certain period of time (B – on chain), and then when crypto is converted back into fiat again which is typically sent back to where it originally came from (C – off chain again). The mainstream banks loose sight of a crypto-related transaction at step A – i.e. when their customer sends money out of their bank account to the crypto platform. Then again, the bank on the receiving end of this transaction (i.e. the crypto platform’s bank) is in an even worse position – they don’t know anything about the customer who just wired the money to their crypto platform of choice, as 99% of the time it’s a different bank from the one the customer in question used to send the money. No matter the leg of the crypto-related transaction, banks simply don’t have access to the right data at the right time, in the right format and because of that multiple risk-management-related problems arise.

Banks and crypto companies are stuck in a vicious circle of requests for information (RFIs), manual compliance reviews, suspended payments and, in a worst-case scenario, the dreaded process of ‘debanking’. Barclays debanking Coinbase in August 2019 and several UK banks stopping customers from transferring funds to Binance in July 2021 are some of the high-profile examples.

In a nutshell, banks don’t trust the current bridge to crypto because they’re not wholly confident they know the customers crossing that bridge or the crypto platforms on the other side of that bridge for that matter. They also lack visibility of on-chain and off-chain money flows and the associated transactional data, so are missing a crucial audit trail should anything go terribly wrong.

A golden standard and a trusted bridge

Banks need a Web 2.5 player that can deliver a golden standard, trusted bridge. This is made up of three fundamental pillars.

First, a trusted systemic KYC reliance model is reassuring for banks as regulated entities. All participants in the network are regulated, either as virtual asset service providers (VASPs) in the case of crypto firms, or as e-money institutions (EMIs) in the case of payment service providers.

Second, streamlined onboarding, which saves bank the time, resource and hassle of onboarding crypto platforms one by one. All participants sign up to a harmonised set of compliance protocols. Crypto platforms perform KYC on their end-users in line with agreed protocols, and Fiat Republic performs deep KYB on its crypto clients.

Third, robust transaction monitoring, which gives banks confidence that they’re truly following the money on a day-to-day, transaction-by-transaction basis. Some companies can track crypto flows on-chain. Others can monitor the endpoints when fiat is converted into and out of crypto. Fiat Republic combines both crypto and fiat analytics and insights for maximum transparency between the two sides of the bridge. We also ask as a trusted data broker, maintaining the balance between end-customer privacy and catching the bad guys (and teaching the banks to do the same).

This is what Fiat Republic is building for banks. A golden standard bridge that they can trust, giving visibility of money flows on/off-ramp, on/off-chain. A safe entry point into the industry. We sit at the intersection of banks, crypto and regulators. Our essential infrastructure is creating the only trusted bridge needed for frictionless money flows to support the mass adoption of crypto.

Stay tuned for the next part of our Web 2.5 series, when we explore why the smart money is investing in Web 2.5 infrastructure.

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