Crypto and traditional finance: A risky but promising alliance

What do BlackRock, Invesco Galaxy, WisdomTree, and Fidelity have in common? Obviously, at first glance, these are financial sector companies each with its own specificities. But anyone who has been following the crypto industry trends in recent months knows that each of these companies has, in one way or another, engaged in this industry. This is good news for the latter as it sees its financial influence expand, somewhat confirming its relevance in terms of investment. However, what seems to be a sustained adoption of crypto by financial ecosystem institutions does not hide significant systemic risks. It is these that we will focus on in this article.

Volatility, the 1^st risk of the adoption of cryptos by financial firms

A few months ago, BlackRock, the world’s largest asset manager, had made a big splash. Previously reluctant regarding investments in cryptos, the company led by Larry Fink had announced its commitment to the flagship crypto: Bitcoin (BTC). Convinced by the financial relevance of the asset, the company submitted a cash Bitcoin ETF request to the Securities and Exchange Commission (SEC). The objective was to make the asset accessible to investors who wished to expose themselves to it.

Since then, several other leading asset managers have embarked on a similar approach. There is a tangible trend toward the adoption of cryptos, not just Bitcoin (BTC), by asset managers. Especially given the increasingly diversified and profitable options they offer to financial companies.

Yet, the growing adoption of cryptos by financial institutions exposes them to a major risk: price volatility. This unpredictable and rapid characteristic of crypto value fluctuations can indeed cause significant financial threats to these institutional investors. Bitcoin (BTC) is the most telling example. In 2022, the most popular crypto witnessed a drop of over 50% after having reached a peak of about $69,000 in 2021. Nevertheless, the asset has been making a comeback in recent months, at around $43,745.

Needless to say, the adoption of crypto exposes financial companies that engage in it to multiple dangers related to its intrinsic volatility. The first concern is substantial capital losses. Moreover, risk management becomes an arduous task due to this volatility. Traditional risk management tools struggle to anticipate the rapid price changes of cryptos. This complicates the implementation of effective strategies. Finally, the volatility of crypto prices can tarnish the reputation of these institutions as significant losses can undermine their credibility.

Crypto adoption and security challenges of financial firms

It should be remembered that the crypto industry is based on the emerging technology of blockchain. The problem is that its evolution is not fixed. It is constantly progressing. This context of perpetual technological innovation generates significant security risks for financial institutions venturing into this market. Among these are the dreaded denial of service (DDoS) attacks, SQL injection threats, and malware assaults. Each year, millions of dollars in cryptos are stolen by hackers around the world, using these methods that bankrupt several companies.

And despite efforts to combat crypto cybercrime, these practices seem to have a long life ahead of them. At least that’s what recent investigations by TRM Labs indicate. It is an American company specializing in blockchain analysis and combating financial crime in the crypto sector. Financial firms venturing into crypto must be aware of this reality. They can then protect themselves from it while effectively and proactively confronting it.

Crypto adoption by financial firms and regulatory uncertainties

Regulation is perhaps the most significant risk financial institutions face in their frenzied adoption of crypto. As a reminder, the regulation of the crypto industry is still developing. Being in its infancy, it generates a significant level of legal uncertainties.

Consequently, financial companies that engage in the crypto industry navigate in an uncertain environment. A situation that exposes them to various risks of non-compliance, whether in their crypto investments or in providing services related to these assets.

Moreover, non-compliance with current standards is a source of litigation and administrative sanctions such as fines. This is exactly what the exchange Binance recently experienced. In addition, legal uncertainty further complicates obtaining insurance or warranties. This has the effect of increasing costs and associated risks with the adoption of crypto.

All these threats are somewhat manageable. To achieve this, financial firms launching into crypto must prioritize certain judicious practices in order to perpetuate their activities. Among these are training their staff, implementing regular audit procedures to assess the effectiveness of the security measures put in place. They must also consider opting for cyber insurance to cover potential losses resulting from cyber attacks, which are rife in the crypto sector. Not to mention practices in terms of technological and informational monitoring, pledges of making informed financial decisions.

Conclusion 

The growing adoption of cryptocurrencies by financial firms presents undeniable opportunities for them. However, it is not without risks. These are indeed significant. Between the volatility of crypto prices and safety challenges, institutional investors are exposed to substantial losses. Regulatory uncertainty in the crypto field does not help as it increases the risks of non-compliance, leading to penalties and additional costs. That being said, finance sector companies can thrive in this new environment. Provided that they opt for relevant practices that allow them to minimize risks and ensure a sustainable adoption of crypto that should increase progressively.