The Future of Crypto and Blockchain: Why Financial Services Leaders Should Advance a Digital Assets Strategy
Cryptocurrency gets the most attention of any blockchain technology, particularly given recent market volatility. These technologies have been the foundation for many other use cases for more than a decade. And some opportunities, in crypto and elsewhere, are now maturing. Yet leaders of many traditional financial services firms have, on the whole, held back, unsure of how to seize the opportunities, given the volatility and opacity of many blockchain initiatives as well as regulatory uncertainty. Interviews conducted in Q2 2022—including during the periods of heightened volatility—with industry experts and experienced executives at traditional financial institutions and blockchain specialist firms have allowed us to gain an understanding of what opportunities are likely to develop and when, as well as how soon certain disruptors could present substantial challenges. The sharp decline in crypto prices and an increase in market risk factors will cause some leaders to reconsider their commitment to future investments. Instead, we believe this is a critical time for leaders to define a strategy that gives them optionality and ensures readiness for a future that will continue to transform toward a digital assets economy.
The near-term future of finance
As we write this, almost 15 years after Satoshi Nakamoto’s whitepaper on Bitcoin, there is active concern in the market regarding a crypto winter triggered by falling crypto prices, a sharp fall in trading activity, and the collapse of algorithmic stablecoins.
It is clear that the crypto market is not a price inflation hedge as many had expected, or a significant source of diversification given the correlation with the broader equity market. All this has intensified the need for oversight and a clear regulatory framework to govern crypto assets.
Nonetheless, blockchain technology does not directly depend on the pricing of current tokens. Therefore we expect to see continued investment into blockchain infrastructure for enterprise applications, independent of the volatility of crypto assets. In fact, the current pullback in crypto assets will lead to further consolidation of firms and tokens and could provide a unique opportunity to attract crypto-native talent to blockchain projects.
All that said, it is now also clear that institutional players, given their access to sophisticated tools for risk management and trading, are better suited to dealing with digital assets relative to retail investors. We expect that clients of traditional financial institutions will continue to push them to support digital assets.
A survey we conducted in spring 2022 suggests that three-quarters of financial services executives included said they expect their firms to increase their investments in this area; they are most keen on digital assets as an exchange of value.1
Centralized crypto finance companies and some early-adopting traditional firms including BNY, Fidelity, US Bank, Mastercard, PayPal, and JP Morgan, have been active on this front. Yet both traditional firms and big tech companies are losing talent to the new crypto players because these new players offer a culture of innovation, the opportunity to fundamentally change the landscape of finance, and the potential for personal wealth creation.
To experiment successfully, traditional firms will need to overcome their concerns about volatility, scalability, and regulatory uncertainty as they do so.
We see three major catalysts to growth:
- Market demand: Customer interest and adoption is a critical indicator for future investments. In addition, the speed at which central banks become comfortable with digital currencies will play an important role in shaping the market.
- Path to profits: Ultimately, incumbents need to see clear incremental business cases for new crypto applications. While this should not prevent experimentation, banks will need to consider unit economics over time, as spreads tighten.
- Supply readiness: Given the need for unique expertise and IP, incumbents need to watch the evolution of the ecosystem of providers in this market as well as build and attract their own blockchain talent.
In addition to market volatility, we see four other major inhibitors to growth:
- Threat to existing business: Some crypto use cases are designed to remove friction and transaction costs from today’s financial system. Banks need to tread carefully and consider the near- and long-term impact of disrupting an existing business model.
- Cyber-specific risk: Cryptocurrency-based crime hit a new all-time high in 2021, with illicit addresses receiving $14 billion over the course of the year, up from $7.8 billion in 2020.2 And $3.2 billion in cryptocurrency was stolen in the same year, of which 72% was stolen from DeFi protocols, according to Chainalysis.3
- Scalability and sustainability: Despite huge growth, digital assets represent only about 1% of overall global financial wealth. Further, the speed and throughput of various chains remain abysmally low relative to current payments networks. In some cases, transaction costs (for instance, gas fees for Ethereum) remain high, especially when the networks are congested. Finally, retail interest may ebb as returns from crypto investments are expected to moderate over time.
- Regulatory uncertainty: The most material challenge to future investments is the lack of a clear regulatory framework. Several questions remain regarding the legality of digital assets and the jurisdictional authority across the different regulators. In this environment, many incumbents are unwilling to push the boundaries of regulation, especially when some business cases remain dubious in their value creation potential.
We scored the 12 use cases described below (see sidebar, "Crypto and blockchain: 12 use cases") based on our view of the relevant catalysts and inhibitors for each of them. “High” indicates significant client demand and contribution to profitability; “low” indicates that client demand exists but infrastructure and/or regulatory hurdles need to be overcome. In the following chart, the most near-term attractive use cases are in the upper left:
Against this backdrop, incumbent financial firms would do well to make some no-regret moves—learning about the space through participation in discussion forums, for example, and keeping tabs on technology players emerging in their space. Over time, it will be critical for senior leaders to engage directly on strategy, investment, and talent needs. They can start to develop their next moves—and the leaders they will need to make them—by addressing a few questions:
- Path to play:
- Given your strategy, customer base, and current talent, where can you play today on the spectrum of wait-and-watch to experimentation to active participation? To maintain or improve your competitive position, where do you need to be playing in three years?
- What are your underlying beliefs about the future of crypto and client demand, and what are some no-regret decisions you can make now?
- Capabilities needed:
- What are relevant start-up firms to track, invest in or partner with?
- Do you have an updated view of how your client needs will evolve?
- How can you keep abreast of relevant developments in this space?
- How can you best find the leaders you need?
How to be relevant in that future
This emerging landscape requires traditional finance firms to develop a new playbook to participate and win. Over the next two or three years, we see a different path for larger and smaller incumbent players:
- Large incumbent financial firms: The onus of supporting and championing crypto will fall on large banks and other financial institutions. But each large player’s chosen approach will depend on its beliefs, risk appetite, risk of disruption, and client needs. Most will actively experiment with select use cases, as some have already started doing. They may act by themselves or in partnership with other financial or technology players. A select few are already willingly embracing crypto by building infrastructure and products, while staking out their position as first movers.
- Focused banks and financial institutions: These firms will likely play to their existing strengths and wait to see what works for the larger players. Community banks, for example, might steer clear of the allure of the new world but a focused, digital-first player like WebBank will embrace crypto by enabling new economy players as their preferred banking partner.
Beyond senior engagement and commitment, we see three critical enablers for success.
1. Partnerships
Being clear about the respective value proposition that traditional finance and centralized crypto firms each bring to partnerships will be important. We have seen two models. In the first, traditional firms bring relationships with institutional clients, while centralized crypto firms bring unique IP to solve crypto-specific challenges. As an example, BNY Mellon is building a custody solution for clients with collaborators. In the second, the two types of firms form virtuous ecosystems, so institutional clients get access to an end-to-end solution. For instance, Coinbase is a primary investor in Circle; BNY Mellon is serving as the primary custodian for the Reserves of Circle’s USD Coin; BlackRock invested in Circle with an eye to likely manage Circle’s assets; and Stripe announced support for Circle’s stablecoin, USDC, to enable payments for Twitter content creators.
Such partnerships are attractive to technology and crypto firms because of traditional players’ large client bases and brand reputation, as well as the likelihood of investment from the incumbents. These may be mega players like Coinbase or smaller firms like Fireblocks, NYDIG, Chainalysis, or Lukka.
2. Organization
Firms that are early in their journey rely on an enterprise strategy function to define the business case and near-term road map, and then prototype early solutions. Firms that have a stronger commitment to digital assets are building business units with a dedicated executive leader to grow and scale their propositions. Sometimes these lie within an existing line of business—for instance, BNY Mellon stood up a digital custody business within its broader custody business—or they can be independent business units, such as Fidelity Digital Assets, which are unencumbered by the traditional operating model and equipped with dedicated talent, investments, and technology.
3. Talent
Succeeding with crypto initiatives also requires a proactive approach to managing talent, given fierce competition to attract the right leaders.
Skill sets that are critical to success include product, engineering, risk/compliance/legal, and strategy. A model where the crypto business sits in an existing line of business will also require leaders with capabilities related to transformation such as creating new ways of working and collaborating across boundaries. In addition, other Heidrick & Struggles work has identified four leadership capabilities that will be critical for new leaders: leading through influence, driving execution, creating possibilities from new thinking, and having an ownership mindset. When taken together, these allow leaders to build strong, trusting, and inclusive relationships across their firms, which helps new ideas get heard and supports resilience on their teams. (For more, see “Transformation in financial services: Succeeding with new leadership roles to thrive in the new normal” and “Future-ready leaders: Finding effective leaders who can grow with your company.”)
Partnering with start-ups that have complementary solutions will give incumbents a chance to connect with high-end talent who might otherwise hesitate to work in large banks—and it may prevent some traditional-firm executives from jumping ship. Investing in these start-ups will also help incumbents get their business cases prioritized.
Financial services executives who responded to our Spring survey indicated their companies are spreading the net wide to find talent, most often hiring from tech companies, developing their own emerging leaders, and establishing partnerships or hiring consultants.4 And they are implementing these tactics in collaborative ways that develop other internal talent as well. As an example, BNY Mellon has invested in attracting crypto talent with experience in security and ledgers, and has them working with existing leaders with experience in building platforms.
Over time, successful incumbents will bring together the best of both worlds: the stability, resilience, and regulatory compliance associated with banks, with the innovation, creativity, and intuitiveness of technology start-ups. Understanding the landscape now—and making right bets on strategy and talent—will best position firms for success.
Crypto and blockchain: 12 use cases
As traditional finance firms seek to understand where they can play most effectively, they should assess 12 use cases that take advantage of the unique characteristics of blockchain and cryptocurrency: retail trading and yield products, institutional trading, asset and wealth management, fund servicing and custody, B2B payments and trade finance, B2C merchant acceptance, merchant payouts, remittances, enterprise payments, data services, alternative investments, and privacy.
Store of value: Digital assets as an investment class
Digital assets gained record adoption as an asset class in 2021 as investors continued to be attracted by their growth potential, low correlation to other asset classes (though that is now in question), and diversification benefits. There are several ways digital assets are adding value: retail trading and yield products, institutional trading, asset and wealth management, and fund servicing and custody.
Retail trading and yield products
After being dominated by crypto-native players such as Binance, FTX, Kraken, and Coinbase, this market has attracted newer retail brokerages and payments providers. Among the non-crypto-native players, only a few firms, such as Robinhood, have built native capabilities, while most are entering the market through partnerships. Meanwhile, crypto companies that offer yield-based products are in wait-and-watch mode as the regulatory scrutiny in this area has been more intense, particularly in light of recent market events. Despite the regulatory uncertainty, customers will continue to seek new ways to get the most out of crypto holdings.
Institutional trading
Institutions are playing a critical role in expanding the crypto market. This interest has spawned an entire ecosystem of providers that offer OTC trading, prime brokerage, market research and data, and custody services to institutional traders. Another major catalyst for institutional participation has been CME’s offering of products based on bitcoin futures.
Asset and wealth management
Crypto firms have built significant scale in vehicles that offer crypto exposure to retail and institutional clients. Many asset managers are actively evaluating their digital asset strategy, and some have filed applications to launch bitcoin ETFs. As the industry matures, we expect that wealth managers will increasingly offer managed accounts with exposure to crypto assets in diversified portfolios. The promise of asset tokenization continues to attract asset managers. Over time, this could enable deconstruction of assets such as fixed income and ETFs into tokens with unique characteristics, and also enable securitization of real assets.
Fund servicing and custody
Institutional investors with exposure to digital assets are seeking custody and safekeeping solutions for crypto assets. Crypto custody differs from traditional custody in that what is custodied are private keys that are used to authenticate and permission to access the use of the underlying digital assets.
Risks
With the recent decline in Bitcoin and Ethereum prices, we expect retail demand to weaken in trading and yield products in the short term. This could also impact institutional trading given their dependence on crypto assets loaned out by exchanges. Further, the collapse of Celsius will slow down the adoption of yield products and lead to greater focus on a consumer protection framework to oversee the space. This weakening in retail and institutional demand will have a downstream impact on custodians and service providers, who built their crypto propositions in reaction to client demand.
Transfer of value: Digital assets for value exchange
With the advent of stablecoins, digital assets are proving viable as a currency and payment mechanism. Stablecoins are meant to enable on-chain, low-cost, friction-free transfer of value, and collectively exceed $155 billion in supply.5 However, questions remain around the regulatory framework for setting and maintaining stablecoin prices.
B2B payments and trade finance
Stablecoin's promise of near-instant, 24/7, non-intermediated payments with potentially low fees has tremendous value in B2B use cases such as payments and trade finance. This becomes especially relevant for cross-border transfers, which involve high fees and long settlement periods.
B2C merchant acceptance
Firms are looking to solve a variety of use cases, including enabling customers to spend on a credit line backed by their digital assets, earning crypto rewards, and enabling merchants to accept digital assets either directly or through a fiat off-ramp. Use of cryptocurrency for payments will have tax impact and tax reporting implications that are still being worked out.
Merchant payouts
Stablecoins can be used as a currency for creators on certain platforms to receive their payouts.
Also over time, payments through layer 2 chains such as Lightning, which are built on top of existing blockchains such as Bitcoin or Ethereum to make them more scalable and efficient, have the potential to disrupt traditional networks by improving throughput and lowering transaction fees on smaller payments.
Remittances
Cryptocurrency and blockchain could remove many current problems in the remittance industry once regulatory and infrastructure issues are resolved. Customers would choose crypto remittances if it meant fast transfers and lower fees. Many large recipient countries for remittances, such as India and China, currently do not allow incoming cryptocurrency remittances due to money laundering concerns and likely given their agenda for central bank digital currencies.
Risks
Stablecoins are an essential driver for these use cases. While we expect regulations to soon shed light on transparency rules and safeguards, there is a risk that other stablecoins, especially algorithmic coins, unwind and create more ripples in the market. Over the long term, a small number of credible players will mitigate these risks and help drive momentum.
Blockchain infrastructure
The original promise of blockchain was an open, immutable, transparent, distributed ledger to record transactions and track assets. We continue to see significant traction in use cases that take advantage of blockchain-based technology to modernize processes. The following use cases—enterprise payments, data services, alternative investments, and privacy—are well suited for continued use of certain permissioned blockchains.
Enterprise payments
Several banks have been piloting private, blockchain-based solutions to solve the inherent challenges facing current clients and to offer on- and off-ramps to digital assets. A blockchain with tokenized money could enable payments between incumbent financial institutions and their counterparties, including other financial institutions and clients.
Data Services
An ecosystem of data providers and data-related services has rapidly developed to support the growth in all crypto and blockchain use cases. New providers span the trade lifecycle from market data to transaction monitoring and compliance use cases.
Alternative Investments
The processes for creating, managing, and exiting investments in the alternatives space are operationally intensive, given the need for data exchange and reconciliation across multiple stakeholders. Several firms are working together to develop distributed ledger-based enhancements for the alternative investment ecosystem. Their objective is to create a secure, shared, auditable record for each alternative investment as a way to alleviate current operational challenges.
Privacy
Solutions allow crypto-enabled finance applications, especially in a decentralized finance (DeFi) setting (see sidebar, “Why decentralized finance (DeFi) is lagging”) to authenticate users and anonymously check for attributes such as a loan applicant’s credit score or to verify that a user has completed due diligence on a crypto platform without having to share their ID documentation again. This is important in a context where permission-less apps need to work with permissioned or private data.
Why decentralized finance (DeFi) is lagging
Centralized finance, even with the benefits of distributed ledgers and cryptocurrencies, has several inherent shortcomings: concentration risk from centralized control, financial exclusion, inefficiencies (for example, slow transfer of funds and legacy brick-and-mortar costs), and lack of transparency (for example, confusing pricing schedules and unknown risk of failure of providers).
DeFi aims to solve these issues across multiple protocols including exchanges, lending, derivatives, payments, and asset management. It is no surprise that Total Value Locked (TVL)—that is, the USD value of all assets locked into corresponding smart contracts—grew rapidly just in the first half of 2022.6 However, there is significant volatility in TVL, as evidenced by the mid-2022 crypto pullback.
And there are a number of real risks and downsides associated with DeFi at this point in its evolution. Smart contracts, unless carefully audited and protected, can have software bugs or allow developer malpractice. Hackers can economically exploit smart contracts. The majority of cryptocurrency stolen in 2021 involved DeFi protocols. And the use of DeFi to launder money increased by an estimated 1,964% between 2020 and 2021, according to Chainalysis.7 DeFi also introduces governance risks, because Decentralized Autonomous Organizations (DAOs, which are responsible for ongoing updates to the protocol) can be manipulated through the timing and supply of governance tokens. And DeFi protocols need to access off-chain data, such as asset prices, through so-called oracles that are vulnerable to attacks.
In addition to these DeFi-specific risks, the use of blockchain infrastructure in DeFi comes with the challenges of scalability and the perils of custody given the use of private keys that can be lost with self-custody or hacked with third-party custody.
Regulators are on high alert as DeFi protocols have started to gain momentum. We expect close scrutiny from regulatory agencies as the space grows. All that said, we expect DeFi to raise the bar on centralized finance but do not see widespread adoption or impact to traditional finance firms in the foreseeable future.
About the authors
David Richardson (drichardson@heidrick.com) is a partner in the Financial Services Practice and leads the global Market Infrastructure & Data Services sector and co-leads the Crypto & Data Assets sector in the Americas; he is based in Heidrick & Struggles’ New York office.
John Rolander (johnsrolander@gmail.com) is an expert in financial services who has advised global financial institutions in Europe, Asia, and the United States.
Todd Taylor (ttaylor@heidrick.com) is a partner in Heidrick & Struggles' New York office and the global managing partner of the Financial Services Practice.
Kunal Vaed (kunal.vaed@gmail.com) is an independent advisor and a former financial services executive, who led digital wealth businesses at JP Morgan and E*TRADE.
Srini Venkateswaran (srini.venkateswaran@gmail.com) is a strategic advisor to financial services firms and start-ups, and is based in New York.
Adrianna Huehnergarth (ahuehnergarth@heidrick.com) is an engagement manager in the New York office.
Acknowledgments
The authors wish to thank the following executives for sharing their insights: Mark Casady, General Partner, Vestigo Ventures; Nikhil Chandhok, Chief Product Officer, Circle; Mike Demissie, Head of Digital Assets and Advanced Solutions, BNY Mellon; Seth Goodman, Chief Revenue Officer, WebBank; Gunjan Kedia, Vice Chair of Wealth Management and Investment Services, U.S. Bank; Phil Kelly, Head of Business Development, O(1) Labs; Cyril Mathew, Global Head of Business Development and Partnerships for Crypto/Web3, Stripe; Dan O’Prey, Chief Product Officer, Bakkt; Sarthak Pattanaik, Chief Information Officer, Digital Assets, Treasury Services, Clearance and Collateral Management, BNY Mellon; David Puth, CEO, Centre Consortium; Brian Quintenz, Advisory Partner, a16z; Roman Regelman, CEO of Securities Services and Digital, BNY Mellon; Sandra Ro, CEO, Global Blockchain Business Council; Christine Sandler, General Partner, Walden Bridge Capital; Raj Seshadri, President, Data and Services, Mastercard; Kristin Smith, Executive Director, Blockchain Association; Hadley Stern, Global Head of Digital Asset Custody, BNY Mellon; and Kevin Werbach, Professor of Legal Studies and Business Ethics, The Wharton School, University of Pennsylvania. Their views are personal and do not necessarily represent those of the companies they are affiliated with.
References
1 Proprietary survey conducted by Heidrick & Struggles in May 2022.
2 Mengqi Sun and David Smagalla, “Cryptocurrency-Based Crime Hit a Record $14 Billion in 2021,” Wall Street Journal, January 6, 2022.
3 The 2022 Crypto Crime Report, Chainalysis, February 2022.
4 Proprietary survey conducted by Heidrick & Struggles in May 2022.
5 “Total stablecoin supply,” The Block, accessed May 31, 2022.
6 Casey Wagner, “Large Institutional Transactions Push Total Value Locked in DeFi to $239B,” Blockworks, April 20, 2022.
7 Mengqi Sun and David Smagalla, “Cryptocurrency-Based Crime Hit a Record $14 Billion in 2021,” Wall Street Journal, January 6, 2022, wsj.com.