Beyond Core Banking - the challenge of new digital assets

Will our Core Banking platform support our clients in new digital assets?

For many FIs things crypto generally and Bitcoin specifically were simply banned, not accommodated. A few chose to do what a good provider should do; they stepped up and supported their clients’ needs. We know that many banks shoe-horned some Bitcoin and ETH processing into their core banking platforms. A best-efforts version 1.0 to meet a very niche client demand; give the security a fake ISIN number and process BTC like a security, so it is off-balance sheet, send trading orders out manually, hold in an omnibus account and reconcile manually to the outside brokers holding the position. In Switzerland we’d call this “Handgestrickt”, over in New York they might say “Sellotape and Band Aids”.

Let’s allow that tokenisation, aka new digital assets, is going to be quite a big thing. What you have today for your existing client business most likely scales; 10 clients, 100 even, multiple orders; your machinery is likely finely tuned and well oiled.

The new in “new digital assets” is both an opportunity and a threat; any sentence with the word “new” in it, will invariably also have the word “change”.

So, if you have a version 1.0 of your processing set-up, or even just a Core Banking system, but have not touched crypto, what would a solution which scales to work like your legacy set-up look like?

If you are a bank serving retail aka private clients, what might they expect from you? Buy, sell, best execution, custody, margin or Lombard lending to name a few. In other words, pretty much the same capabilities you provide for them today. What do you need to get there?

To help me understand what those capabilities might look like, I spoke to Andrew Wishart, the Head of DACH Sales at Wyden. His input helped me formulate what I hope is a well coloured picture of the things to think about. Read on for my notes on how you might think about this challenge.

What are the challenges?

Let’s start with Order and Execution Management aka OEMS. Today, there are multiple places where you execute orders, but there is a common standard: FIX and FpML. You don’t have to maintain a bunch of bi-lateral connections. The new world offers a couple of challenges; first, there is no FpML equivalent, so connections are bi-lateral. You need one-to-many connectivity. And the brokers and execution venues can make changes anytime and unilaterally.

The landscape of execution venues may well also change completely. Today, there are a limited number of venues where a particular equity might trade. In the world of new digital assets, we can expect to have AMMs. Automatic Market Makers.

Then comes something fundamental and new; pre-funding / earmarking. Execution venues expect you to hold the position you want to sell or to use a network like Fireblocks where you can earmark aka block the position so that the venue is sure you will have what you want to sell if the order is confirmed. Now, ear-marking is not new for a core banking system, but that is an internal thing for control and not something you communicate to an exchange or execution venue.

Execution processing. Today’s legacy processing is built on buying and selling securities vs. a cash amount in a currency. So, yes, you could do that shoehorn thing for BTC and buy some of that ISIN vs. CHF. Now what would you do if a client wants to buy BTC, or any asset vs. a stablecoin, say USDC? The answer for a legacy system would be “computer says no”, because every purchase or sale needs to be booked versus an amount of currency. You could work around this by using a suspense account to process the purchase vs. USD and then selling USD vs. USDC. Awkward and will not scale.

Then come all things portfolio management and custody. Those new digital assets will be in a wallet. That might be a custodial wallet, i.e. a service like the one you have for legacy securities. Now just maybe the provider can end aka push you a daily statement that looks like a SWIFT or ISO 20022 format for your reconciliation engine to ingest. On the portfolio side, clients will expect an integrated view of all their holdings. Imagine that they started with 100 in “legacy assets” and then took 20 of that and invested in “tokenised assets”, you would imagine they will expect a few basic things: a portfolio statement covering the whole 100, the ability to borrow money in a margin or Lombard loan, against the whole 100, with some LTV assigned to the tokenised parts. Maybe not to BTC, but for sure if it is a tokenised money market fund.

On your side, you may also want to have individually segregated accounts rather than a single omnibus holding for all clients together. For sure you will want to charge custody fees. You will also need to manage “gas fees”; these are an upfront commitment without which nothing happens on a blockchain. And you will need to incorporate those fees into your billing process.

In summary

The standard CTO view on new tech needs is: #1. re-use, #2. buy and #3. build, in that order. And the standard CTO-Schtick also includes a quip about “if you get to #3, go back to #2”.

Under #1, you might consider asking your core-banking provider if they have a solution. Just maybe they say they do. Question #1: is it complete, is the price fixed? Software firms are well known for saying yes to everything and then charging you for the work to develop the solution, and then for on-going maintenance fees. Question #2: Who else is using what you have built in production and can I talk to them?

In parallel, to make sure that you have as informed a picture as possible, you should go and talk to those selling “digital specific” solutions. Same questions.

From both of those angles, you should get a sense of how long it would take to implement. Whatever that amount of time is, you will eventually need to make a decision. You could of course, kick the can down the road; keep going with the shoehorn solution, with an eye on the timeline for a more strategic solution. I would make the case that this has an opportunity cost; if you are shoe horning things, that takes extra effort and if you are not working on the strategic solution, you are not learning how this whole new ecosystem works.

Going forward you are likely to see the need for multi venue orchestrators such as Wyden that sits in between the various trading, storage, data streaming & booking systems which not only support the connectivity but also the idiosyncratic crypto nuances such as number of decimals, 24/7, near-time/real-time booking engine and not to forget crypto vs. crypto legs on-chain, which use a blockchain based custody solution which supports control of cryptographic keys.

With all things bleeding edge in financial services, there are a number of risks when I write: There is every risk that I haven’t understood properly, or just missed a few salient points, or just come to an implausible conclusion. If any of these things are true, please call me out on them.

In any case, please do share a comment or two.

Please feel free to get in contact via LiquidityFinder here.

Author - Olaf Ransome

Olaf is a liquidity and financial services expert. He is the founder of 3C Advisory.