Adjusting Risk Strategies for Digital Assets: A 70-30 Approach Outlined for Financial Institutions
In the rapidly evolving world of digital assets, banks are adapting to the challenges and opportunities presented by blockchain technology and cryptocurrencies. As the digital asset revolution gains momentum, financial institutions are shifting from tentative engagement to active exploration of safe and compliant ways to integrate these technologies.
One of the key adjustments banks must make is the development of tailored risk and control frameworks. Recognising the differences between traditional banking systems and blockchain operations, banks are creating detailed risk and control frameworks specifically designed for blockchain processes. This includes transaction processing adapted to blockchain networks, advanced cryptography for crypto-native key management, and decentralised infrastructure considerations for business continuity and incident response.
Clear governance structures and oversight mechanisms are also crucial for effective monitoring of crypto-related activities. Given the novel risks and operational models presented by digital currencies and blockchain technology, banks must implement comprehensive vendor and third-party due diligence to manage unique risks within the crypto ecosystem.
Traditional custody models based on physical assets and centralised controls are inadequate for digital assets. Banks are adopting new security paradigms such as multi-signature wallets, hardware security modules, and distributed key management systems to securely store and manage blockchain-based assets. Enhanced authentication, real-time monitoring, and cybersecurity systems tailored to blockchain’s operational environment are also being implemented to mitigate the high stakes of breaches.
Banks can leverage tools that analyse blockchain’s on-chain data to improve compliance, fraud detection, and overall risk assessment. Smart contracts, which automate agreements, can reduce counterparty risk and improve operational efficiency. However, managing systemic and liquidity risks unique to tokenised assets, such as unpredictable liability flows and spillovers, requires banks to incorporate these considerations into their risk frameworks.
Banks must establish clear risk tolerances for proximity-based exposure to sanctioned entities through multiple transaction hops. This requires banks to learn to work with new ways of measuring crypto, such as tracking wallet addresses instead of account numbers and understanding transaction "hops" that can occur in minutes across dozens of intermediary addresses. Real-time monitoring and automated decision-making processes are essential to keep pace with blockchain transaction speeds while maintaining appropriate human oversight.
Regulatory sandboxes are valuable for banks to test crypto services under relaxed regulatory requirements and learn how to work with regulators. Approximately 70% of traditional risk management principles apply directly to digital assets, but the interoperability of the crypto ecosystem creates significant additional complexity, requiring banks to understand entire ecosystems, including DeFi protocols, NFT marketplaces, and mixing services.
Sanctions compliance screening mechanisms must expand to include the screening of specific wallet addresses and tokens that may appear on sanctions lists. Successfully changing risk frameworks requires almost unprecedented coordination across banking departments. Our brand name works with banks worldwide to bridge the gap between traditional risk management and digital asset requirements, providing crypto-specific tools and insights.
In summary, banks should transform their risk management frameworks by integrating crypto-specific controls, governance, custody practices, cybersecurity protocols, and data analytics, all aligned with evolving regulatory guidance. This holistic approach enables banks to safely and effectively manage the risks inherent in blockchain-based assets and digital currencies as part of their broader financial operations.
Banks should develop risk and control frameworks specifically designed for blockchain processes, incorporating transaction processing adapted to blockchain networks, advanced cryptography, decentralised infrastructure considerations, and comprehensive third-party due diligence to manage unique risks within the crypto ecosystem. To enhance compliance, fraud detection, and overall risk assessment, banks can leverage blockchain analytics tools, employing smart contracts and real-time monitoring. Clear governance structures and oversight mechanisms are essential for effective monitoring of crypto-related activities, including sanctions compliance screening of specific wallet addresses and tokens on sanctions lists. Regulatory sandboxes provide a valuable opportunity for banks to test crypto services under relaxed regulatory requirements and learn how to work with regulators. By implementing a holistic approach that integrates crypto-specific controls, governance, custody practices, cybersecurity protocols, and data analytics, banks can safely and effectively manage the risks inherent in blockchain-based assets and digital currencies as part of their broader financial operations.
