Virtual asset service providers (VASPs) are continuing to disrupt and mature, and are starting to scale up and professionalize within the financial services industry. This trend presents opportunities for traditional asset managers and investors, according to a new KPMG report on “Investing in Virtual Assets” released this week.
With the growing institutional interest in Bitcoin and other cryptocurrencies, VASPs such as cryptocurrency exchanges, digital wallet providers, crypto ATMs and custodians are gearing up for growth, under the watchful eyes of regulators.
“Home to more than 30 VASPs, Hong Kong has emerged as one of the global centres in crypto,” said Paul McSheaffrey, partner, head of banking and capital markets, Hong Kong of KPMG China, in a media release. “And since the Hong Kong Securities & Futures Commission announced its opt-in regulatory scheme in 2019, many players are looking to professionalise their service offerings to meet regulatory and institutional grade requirements.”
Virtual assets are a digital representation of value that can be digitally traded, or transferred, and can be used for payment or investment purposes, according to the Paris-based Financial Action Task Force (FATF), a global money laundering and terrorist financing watchdog. Digital assets include cryptocurrencies such as Bitcoin as well digital representations of real-world assets, such as tokenized gold or tokenized real estate.
The report highlighted four areas that will support VASPs in their drive towards institutionalization: first, customer engagement to meet the needs of institutional investors; second, reliable regulatory compliance to address anti-money laundering (AML) and countering the financing of terrorism (CTF) risks; third, scaled and stable operations for clearing trades, settlement and custody; and fourth, robust governance.
“In the next one to two years, we expect to see more VASPs follow the institutionalization route, increasingly becoming part of the traditional financial services ecosystem,” said Ben Usinger, lead for KPMG’s crypto and blockchain advisory in Hong Kong, in a media release.
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Hong Kong’s Securities and Futures Commission (SFC) is one of the first jurisdictions in the world to introduce a comprehensive framework for the regulation of virtual asset trading platforms.
Hugh Madden, chief executive officer of BC Technology Group, said in the KPMG report: “In recent years, maturity of regulation has brought a number of advantages to the Virtual Assets industry. As a result, we have seen many relevant financial services jurisdictions issuing considerations, rules or conditions for VASPs. This helps to bring legitimacy to the sector in the eyes of institutional investors.”
Increased regulatory scrutiny will drive the growth of fully centralized exchanges, while decentralized exchanges may co-exist in a regulatory “grey zone” the report says. “Still, the rapid speed of innovation in decentralized finance means that services may arise that are suitable to the relevant regulatory compliance.”
Earlier this month, the FATF issued draft guidance that defined DeFi platforms and stablecoins as VASPs and subject to AML/CTF obligations. The guidance, if approved, may pose an existential threat to the booming DeFi industry, some analysts say.
The FATF’s travel rule, which requires VASPs to provide information about their customers and the associated transactions, is a challenge because VASPs do not yet have widely accepted industry standards like SWIFT.
The report notes that VASPs and traditional financial services institutions are collaborating to build messaging solutions such as the travel rule protocol. No single solution will suffice and there is a need for interoperability and multi-party service integration, the report states.
See related article: What’s in DeFi’s future — and what does it mean for traditional banks?
Another challenge for VASPs is that many global banks are not yet fully servicing VASPs, so often they can only open bank accounts with virtual banks. Opportunities will emerge, the report says, as both traditional and challenger banks realize the potential of servicing participants in the virtual asset industry. For example, in the U.S., JPMorgan has extended banking services to cryptocurrency exchanges Coinbase and Gemini.
Traditional banks themselves are facing pressure to evolve and are ramping up the competition, setting up their own virtual asset services or making investments into crypto-native companies. South-east Asia’s largest bank, DBS Bank, has launched a digital exchange providing tokenization, trading and custody services, and Standard Chartered’s venture arm, SC Ventures, offers virtual asset custody out of Singapore.
Last week, New-York based BNY Mellon — the world’s biggest custodian bank with US$41.1 trillion in assets — invested in crypto custodian Fireblocks‘ US$133 million series C funding round.
See related article: As big investors buy into bitcoin, demand for crypto custody grows
With increasing scrutiny from regulators, crypto-native companies will have to manage compliance with evolving regulatory requirements across the countries that they operate in.
Binance, the largest cryptocurrency exchange in the world, announced this week its strategic partnership with CapBridge Financial, a Singapore-based regulated integrated private markets platform. Binance also recently hired former FATF executive secretary Rick McDonell and Josée Nadeau, the former head of the Canadian delegation to FATF, to provide guidance on the company’s global compliance and regulatory strategies.
The announcements follow a report earlier this month that Binance is being investigated by the U.S. Commodity Futures Trading Commission over concerns that it allowed U.S. residents to buy and sell derivatives in a violation of U.S. rules. “By joining forces with CapBridge, Binance will be able to work with a fully licensed firm to broaden services securing compliance with local regulations,” said Changpeng Zhao, chief executive officer of Binance, in a press release.
“Whether a ‘native VASP’, or a traditional financial services organization moving into the space, collaboration is the key to success,” the KPMG report states. “Rather than a ‘build it yourself’ approach, the best results will come from a strong and scalable ecosystem, together shaping and seizing the opportunities in this fast-growing market.”
See related article: Hong Kong plans to ban retail investors from trading cryptocurrency