Cryptocurrency Bank Development

Cryptocurrency platforms are increasingly referring to themselves as «crypto banks». They claim to be ready to take on the functions of traditional banks in the world of virtual currencies. The term «bank» in this case serves as bait to attract new clients. After all, virtually all existing crypto banks are still far from traditional financial institutions in all aspects, from the portfolio of services to legitimacy and regulatory mechanisms. «Bank» sounds solid and inspires greater trust, but a crypto bank is essentially an investment fund and a regular cryptocurrency platform that takes on only a part of the traditional functions: currency conversion, fund storage, cashing out, acquiring, etc. However, today any platform can call itself whatever it wants, if its jurisdiction allows it.

Typically, «crypto banks» refer to themselves as decentralized platforms that combine the features of exchanges, exchangers, and peer-to-peer lending services. The main task is to create a service and payment infrastructure to connect the crypto community with the fiat world. However, there is no mention of an equivalent to traditional banks in the world of cryptocurrencies, neither in terms of functionality nor in terms of operating principles.

There is no strict definition of crypto banks. If a platform wants to and its jurisdiction allows it, it can call itself whatever it wants, including a crypto bank. However, in essence, the use of the term “bank” for many crypto platforms is merely a marketing move, as this term inspires trust and is associated with something reliable.

Currently, the functions of transferring, making payments, and exchanging cryptocurrencies are mainly performed by exchanges and exchangers. However, for many users, this is inconvenient, unsafe, or expensive. Therefore, the emergence of specialized services that allow for cryptocurrency payments is natural and inevitable. In fact, a crypto bank is just a regular cryptocurrency platform that takes on only a part of the traditional banking functions: currency conversion, fund storage, cashing out, acquiring. However, while crypto banks largely duplicate the functions of crypto exchanges and exchangers (helping to transfer, exchange, convert, and cash out money), they offer lower fees (1-3%) and additional functionality such as cashback, withdrawal cards, peer-to-peer lending, deposits, deferred payments, guarantees, letters of credit, and more. Sometimes they also attempt to invest in traditional and cryptocurrency instruments and markets.

Platforms that call themselves crypto banks are one of the sources of financing for ICO startups, which are viewed with suspicion by traditional banks. Few are willing to deal with cryptocurrency projects, largely due to the lack of regulatory framework. A platform that provides credit to an ICO project and opens an account for it will be in demand.

Another area of activity for crypto banks is peer-to-peer lending among users. Borrowers and lenders agree on interest rates and repayment terms, while the service acts as a guarantor and takes care of technical matters. The only difference from regular peer-to-peer lending is that transaction histories and user data are recorded using blockchain and smart contracts.

How Crypto Banks Interact with Regulators

The legality of platforms like crypto banks depends entirely on the jurisdiction. If a jurisdiction recognizes cryptocurrencies as a form of money, then crypto banks, cryptocurrency licenses, and the legal existence of such platforms are possible. In jurisdictions that recognize coins and tokens as assets, crypto banks are theoretically legal as well, but they have to operate through indirect means, essentially conducting barter transactions. Of course, it is possible to be an «ideological» crypto startup and operate without any licenses, but then it would not be possible to convert to fiat currency. In such cases, existing infrastructure of payment systems needs to be used. The easiest way is to partner with a bank and operate under its license.

Currently, only a few blockchain companies have banking licenses, so other crypto banks have to resort to workarounds, intermediaries, and legal loopholes. This allows them to offer banking-like services, even if a comprehensive regulatory framework for this has not yet been established. For example, almost all crypto banks issue prepaid crypto cards rather than full-fledged crypto cards. Essentially, users top up the card with fiat funds by selling cryptocurrencies to the project. All transactions are conducted through a partner bank. The client may think they have made a payment with cryptocurrency, but in reality, it is the fiat funds of the crypto bank.

To work with fiat funds without a banking partner in Europe, for example, you need to obtain an E-money License for issuing electronic money. Obtaining an E-money License expands the platform’s capabilities and provides access to additional banking options, such as bank accounts and own acquiring. The E-money License brings platforms into the legal field and guarantees regulatory assistance in case of disputes.

What Services Do Crypto Banks Offer?

Technically, crypto banks operate on blockchain, smart contracts, AI, and machine learning. The specific operating schemes and functionalities of crypto banks vary widely and depend on jurisdiction, the platform itself, and its agreements with financial intermediaries. Some platforms only provide storage and settlement functions, while others issue cryptocurrency cards, and some accept deposits and participate in peer-to-peer lending.

Let’s consider several examples of crypto banks operating in different jurisdictions and working on different scales. For example, Galaxy Digital offers asset management, investment in blockchain projects, and over-the-counter trading. It clearly aims to become an institutional platform in the crypto world. German crypto bank Bitwala only works with Bitcoin but accepts deposits, and amounts up to €100,000 are protected under the German deposit insurance system. Peer-to-peer lending platforms, such as Loanbase, Bitlendingclub, Pure Central, BTCJam, BitBond.com, and BTCpop.co, among others, act as intermediaries, but no one guarantees the return of funds.

Industry Should be Monitored Closely

Platforms that position themselves as crypto banks claim to be ready to be the lifeblood of the financial world, accumulating monetary flows. However, derivative instruments or poorly constructed solutions for debit cards based on weak partnerships are not enough for this. With all of this, they only look like intermediaries. To become full-fledged banks, crypto platforms need to build payment infrastructure, negotiate with regulators, and guarantee the preservation of funds to their users.

But there is a demand for crypto bank platforms. Cryptocurrency enthusiasts constantly talk about a happy decentralized future in which users can send funds to each other in fractions of a second, without fees and intermediaries, and where cryptocurrency will be accepted as payment for any goods. However, in practice, it turns out that there is a demand within the crypto community for duplicating the traditional financial system using blockchain.

Cryptocurrency users want to not only «hodl» but also fully utilize their assets: spend them, take out loans, and earn interest. Wallet functionality is not enough for this. That is why exchanges and trading platforms appeared on the market first, and then gradually crypto banks, crypto loan platforms, peer-to-peer lending, investment platforms, asset management, tokenized asset issuance and purchases, decentralized exchanges, stablecoins, and more were added. Moreover, crypto banks potentially have a huge market – they can be useful not only to crypto investors. In the world, 1.7 billion people do not have access to banking services. They need platforms that are not burdened by bureaucracy and regulatory limitations.

However, in the near future, we should not expect the emergence of crypto banks as official financial institutions. The market still needs to solve its own problems. But while regulators are hesitant and traditional banks view the crypto world with skepticism, dozens of startups are currently fighting for future leadership. What this battle will lead to is unclear, but it is definitely worth keeping an eye on.

There is a trend towards convergence between crypto projects and traditional banks: the addition of cryptocurrencies to PayPal and broader integration of traditional services into the crypto space, such as crypto-linked cards, bill payments, deposits, and peer-to-peer transfers. Optimizing financial relationships between companies and individuals, minimizing fees, and ensuring security are what will attract the next generation of users. However, the final say here will be with government regulators: fully allowing the operations of crypto banks will only be possible with strict regulation of transactions and the institutions themselves.

As of December 1, 2023, the number of cryptocurrency holders worldwide was about 575 million. Analysts expect that in 2024, this number could grow to 850 million and even 950 million. Therefore, in the future, crypto banking will become a conduit for financial services not only for crypto users but also for people in remote corners of the world who do not have access to traditional banking services.