Table of contents
Author
Investment advisory in digital assets: The next step for banks and wealth managers
For years, digital assets have offered an attractive alternative to traditional investments. A recent survey by Avaloq confirms that investors remain positive about digital assets, despite the recent crypto winter and the collapse of notable exchanges and crypto-native firms. Today, of the investors Avaloq surveyed in Germany, Switzerland and the UK, 42% say they invest in cryptocurrencies – 4 percentage points higher than in the previous year's study. This is supported by data from the European Union, which shows that the market capitalization of digital assets increased eightfold from 2020 to 2022.
Financial institutions have started to address this demand through trading and custody services. But to really stand out from challenger banks and exchanges, traditional financial institutions need to leverage their unique value proposition: investment advisory services based on trust. Below are some of the considerations for banks and wealth managers looking to integrate digital assets into their offering.
The status quo of digital asset offerings
Avaloq’s experience shows that banks and wealth managers are still reluctant to include highly volatile digital assets in their discretionary mandates due to elevated reputational risk, regulatory uncertainty or a lack of in-house expertise. Instead, many opt to simply execute investment orders from their clients. These execution-only models are often complemented by custody services, as clients already trust their bank with the safekeeping of cash, securities and other traditional assets. The advantage of this approach for traditional financial institutions is that they become a one-stop shop for their clients’ fiat and digital assets. This business case is supported by Avaloq’s survey data, which shows that around 90% of investors would be keen to invest in digital assets via their traditional financial provider if the option was available to them. The main technical requirement for banks and wealth managers is to implement suitable infrastructure, for example by upgrading their core banking system to integrate digital assets alongside traditional investment products. Alternatively, they can opt to connect to a sub-custody offering of another financial institution with an established digital asset offering.
Risks associated with giving investment advice
Arguably, for banks and wealth managers, providing investment advice comes with risks compared to an execution-only model. There are three main types of risk. The first is legal and regulatory uncertainty. Banks and wealth managers operate under strict regulatory frameworks to ensure financial stability and investor protection. The absence of clear guidelines can expose banks to legal and compliance risks when it comes to promoting or recommending investments in digital assets. The EU’s pioneering Markets in Crypto Assets (MiCA) Directive, which was published in June 2023, may provide the legal clarity that traditional financial institutions need when it comes to comprehensive digital asset offerings by regulating areas such as marketing and reporting. The second is a lack of in-depth expertise in the field of crypto investments. Given that digital assets are a new and rapidly evolving investment class compared to traditional financial instruments, many relationship managers may not have the skillset to advise their clients on crypto investing. They are rightly concerned about potentially misguiding clients or failing to properly identify investment opportunities. To solve this, financial institutions should offer training to build up expertise and confidence as well as partner with external experts with insight into blockchain technology, global regulations and emerging investment trends. Finally, reputational risk can deter traditional financial institutions from expanding into digital assets. If, for example, an investment recommendation for crypto assets results in significant losses for clients, it could undermine the credibility of the firm’s entire advisory business. The lack of long-term forecasts for performance coupled with recent volatility can further amplify these concerns. At the same time, the decentralized nature of digital assets requires targeted anti-money laundering (AML) and counter-terrorist financing (CTF) checks to help reassure both regulators and the general public.
Future business cases for digital assets
Managing these risks enables banks and wealth managers to leverage their expertise in investment advisory services to serve the evolving needs of their clients. With the right expertise and technology, advisers can offer innovative digital asset services that go beyond simply buying and selling Bitcoin, Ether or other cryptocurrencies. Future use cases for digital assets could include staking, for example, which rewards investors for temporarily locking up their digital assets and allowing them to be used to validate transactions on the blockchain. In exchange for staking their digital assets, investors are issued with new coins, creating a new avenue of asset growth. Another use case is crypto lending services, which would enable investors to borrow cash against their crypto holdings by pledging them as collateral. This would give investors access to short-term liquidity without having to sell their long-term investments in digital assets. Finally, in the future, banks and wealth managers could even use tokenization as a new avenue for individuals to invest in non-bankable assets, such as real estate, as well as native digital assets such as digital art. By issuing digital tokens, a bank or wealth manager could transform a luxury item into a tradable digital asset. This would create new business opportunities for the financial institution and broaden access to the high-end luxury sector among retail and mass-affluent individuals. While tokenization is still in its infancy, the concept is relatively easy for banks and wealth managers to integrate into their existing offerings, as they already have the experience and data to evaluate the underlying asset.
The need for a digital assets foothold
A digital assets offering is becoming increasingly important for banks and wealth managers to remain competitive. Avaloq enables financial institutions to seamlessly integrate digital assets into their core banking system, with automated trading and settlement, real-time pricing and performance calculations as well as integrated AML checks and reporting capabilities. With Avaloq’s turnkey solutions, banks and wealth managers can also give their clients access to secure crypto trading via self-service web and mobile banking channels. As a leader in wealth management technology, Avaloq is committed to keeping its clients at the forefront of innovation while ensuring constant compliance with rapidly evolving regulations.
