Crypto and banking: tokenization of the global financial system is yet to come | Opinion

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In response to your question, I’d like to address the challenges and risks that tokenization may introduce to the banking industry. The fall of cryptocurrency exchange FTX and the subsequent crypto banking crisis are examples of the potential risks associated with digital assets and their integration into traditional financial systems. While China has been successful in implementing its digital yuan for domestic retail and public sector payments, there are still many unanswered questions regarding tokenization on a global scale.

In this segment of a three-part interview series for crypto.news, Selva Ozelli speaks with William Quigley, a notable figure in the cryptocurrency and blockchain sector, and the co-founder of WAX and Tether. The conversation in Part Two focuses on the intersection of cryptocurrencies and banking. Previously, in Part One, they discussed the prison sentences of Sam Bankman-Fried and Changpeng Zhao. In the upcoming Part Three, Quigley will share his insights on the future developments in the NFT (Non-Fungible Token) market.

1) In Part One of our interview, you indicated that you began your career at Andersen as a bank auditor. Coincub recently issued a crypto banking report that ranks the most crypto-friendly banks in the world. What are your thoughts on tokenizing the banking system?

I could write a book on this topic, but I will summarize my thoughts briefly.

During my lifetime, the way we manage and transfer value through money has undergone significant transformations. Initially, we digitized money, shifting from physical currency to electronic transactions. More recently, we’ve seen tokenization gaining popularity. Each advancement in our monetary infrastructure brings new advantages and challenges.

As a financial analyst, I can tell you that the transition of the global financial system towards tokenization is just beginning. However, this shift could bring about profound changes in how various financial instruments such as commercial bank deposits, payments, government and corporate bonds, money market fund shares, gold and commodities, real estate, and other assets and liabilities are recorded on blockchains and distributed ledgers. These new technologies have the potential to introduce innovative functions that were previously unimaginable.

As a crypto investor, I’m excited about the developments in the tokenization of assets reported by Coincub. Financial institutions worldwide are exploring this innovative solution to enhance value transfer using blockchain technology for faster, more secure, and cost-effective international payments and other transactions. By employing encrypted distributed ledgers, we can eliminate intermediaries like correspondent banks and clearing houses, providing real-time, trusted transaction verification.

Through tokenization and distributed ledger technology, we can bypass numerous challenges by functioning continuously worldwide and providing real-time settlement finality. Tokenization grants us the following advantages:

  • Programmability—which may make it easier for the bank and bank customers to automatically remove funds, respond to liquidity stresses immediately and automatically, and move liquidity when and where it is needed.
  • Instant settlement—which may provide the ability to hard-wire future transfers of value on the ledger that automatically self-execute based on the occurrence of future conditions, thereby increasing the speed and intensity of bank settlements. 
  • Atomic settlement—which may reduce the risk of loss in the time between payment and delivery or the simultaneous exchange and settlement of payment and delivery, including among multiple parties.
  • Immutability of the shared ledger—which may serve as a transaction record and reliable audit trail. Blockchain-based IT infrastructure can significantly reduce payment errors and cut down on account reconciliation time. The transparency and immutability of the ledger can help regulators and law enforcement agencies obtain accurate and verifiable data on token transactions and seize assets from criminals.

The process of tokenizing the financial sector will undoubtedly encounter hurdles and potential risks as various parties, including financial institutions, technology creators, regulators, and other interested groups, work on its implementation. However, the advantages of this innovation are already becoming apparent in the global banking industry. One notable example is China’s digital yuan, introduced in 2020, which could position China at the forefront of the development of state-supported digital currencies, or central bank digital currencies (CBDCs), within their financial system. To date, the digital yuan has primarily been utilized for domestic retail and public sector transactions totaling approximately 100 billion yuan ($14.5 billion), as reported by the People’s Bank of China.

2) What challenges and risks will tokenization introduce to the banking industry? The fall of cryptocurrency exchange FTX, which we talked about during the first part of our interview, was a watershed moment whose knock-on effects—included a market slump, a crypto banking crisis in 2023 with five bank failures, regulatory backlash, and further bankruptcies. On April 26, U.S. regulators closed Philadelphia-based Republic First Bank, marking the nation’s first banking failure of 2024 due to “material weaknesses in internal control over financial reporting.” However, this may only be the beginning of more bank failures, as consulting firm Klaros Group analyzed about 4,000 U.S. banks and identified 282 smaller banks that face potential losses tied to higher interest rates. 

As a financial analyst, I can attest to the fact that from a technological and operational standpoint, there are numerous open-ended queries regarding the tokenization of the global banking system. If tokenization is indeed set to become a pivotal component of our future financial architecture, with smaller banks being absorbed by larger ones as they falter, several crucial questions remain unanswered:

  • Will there only be a small handful of unified, interoperable ledgers of banks on which all tokenized transactions occur globally?  
  • Or will many banks maintain their own blockchains? 
  • To what extent will these banking blockchain platforms be interoperable so that customers using different blockchains can transact globally and seamlessly with each other in a safe and secure manner?
  • How will cyber security and other financial risks be handled among banks? For example, when Silicon Valley Bank failed last year, stablecoin USDC broke its dollar peg after Circle, the United States firm behind the coin, revealed that $3.3 billion of its $40 billion of USDC reserves backing it were held at Silicon Valley Bank. In contrast, at Tether (USDT)—the world’s first-ever and most traded stablecoin, which I co-established—reserve deposits transparently reported to the public daily were better managed against the risk of bank failures. 

From a legal, regulatory, and tax standpoint, each country establishes unique frameworks for regulating digital assets and blockchains. The transfer of ownership and related rights connected to a specific token may not automatically follow border crossings, necessitating further clarification.

As a crypto investor, I’m eagerly anticipating the answers to many pressing questions surrounding blockchain technology and its applications. These include issues related to security, scalability, interoperability, and regulatory compliance. The future is uncertain, but one thing is for sure: financial institutions, developers, regulators, and other stakeholders are working diligently to advance this technology on a global scale.

3) In Part One of our interview, you indicated that you co-founded the first ever fiat-backed stablecoin Tether, the world’s most traded digital asset, taking the lead in the industry with fierce competition from Meta, BRICS countries, and others. Tell us about Tether stablecoin.

Tether, introduced by Tether Limited Inc. in 2014, is a stablecoin backed by fiat currency. Tether Limited is itself owned by iFinex Inc., a company based in the British Virgin Islands, which additionally manages Bitfinex – a Hong Kong-based cryptocurrency exchange catering to investors and traders residing outside the US.

Starting from May 2024, Tether has been produced on a total of 14 distinct protocols and blockchains. Tether’s stablecoins are designed to minimize volatility, typically by linking their values to the worth of traditional currencies or fiat money, such as the US dollar, euro, or Chinese Yuan. Facebook attempted to launch a stablecoin named Libra, which later became Diem and ceased operations in 2022. Since 2017, BRICS countries have expressed interest in issuing a stablecoin backed by a basket of fiat currencies as an alternative to the US dollar and Tether (USDT). Last year at the BRICs Summit, Tether introduced #BRICST, a BRICS stablecoin, which is pegged to the Chinese Yuan and offers a yearly return of 10% to cater to this demand.

Among stablecoins, Tether holds the largest trading volume, accounting for approximately 64%. This digital currency surpassed Bitcoin‘s market dominance back in 2019, making it the most traded asset globally. As of May 4, 2024, its circulation includes over $110 billion, €36 million, ¥20 million, Mex $19 million, and AUDT 246,000. The sheer size of Tether’s circulation raises concerns about potential systemic risks for digital asset markets and the broader financial system.

As a researcher studying the investment landscape of digital assets, I can confirm that Tether is often viewed as a relatively safe option due to its role in hedging against market volatility. However, it’s crucial for investors to be aware of the inherent risks involved with this stablecoin. To mitigate these risks, Tether takes several steps to maintain transparency and accountability.

4) As the most traded digital asset, Tether is unavoidably used in illicit transactions. According to TRM Labs, USDT was linked to $19.3 billion of illicit transactions in 2023 and was the most used stablecoin for criminal activity in crypto last year. Do you have any comments concerning the illicit use of Tether?

Starting from December 1, 2023, Tether has been working closely with law enforcement and regulatory bodies. They have implemented a proactive measure allowing for the freezing of wallets on a voluntary basis. This applies to transactions linked to individuals or entities included in the United States Office of Foreign Assets Control (OFAC) Specially Designated Nationals (SDN) List, which encompasses both companies and individuals associated with sanctioned countries. More recently, Tether announced a collaboration with blockchain analysis firm Chainalysis. This partnership aims to monitor transactions involving Tether tokens on secondary markets. The monitoring system will assist Tether in identifying potentially risky crypto addresses or wallets that might be used to circumvent sanctions or facilitate activities such as terrorism financing and money laundering.

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2024-05-18 14:20