Cautious about the volatility of crypto-assets, Luxembourg banks are staying away from this market for retail customers. However, faced with growing demand and rapid developments in the sector, this caution could become a strategic risk. Some are exploring white-label partnerships, an option that poses challenges in terms of control and accountability.
Patrick Augustin, an associate professor of finance at McGill University in Montreal, understands this restraint. The Luxembourgish economist draws a parallel between the sale of crypto products that are misunderstood by customers and that of the white-label Lehman products distributed by German banks before the 2008 crisis.
Paperjam: What are the main types of risks that a traditional Luxembourg bank is exposed to when offering products linked to crypto funds to its clients?
Patrick Augustin: Banks offering white-label crypto-linked investment products face reputational and legal risks. For investors, on the other hand, the main concerns are price volatility and counterparty risk. People often believe [misleading truisms like] “this time is different,” but it is hard not to think back to Citibank and other German banks that sold Lehman Brothers products to retail investors--many of whom lost money. Clear risk disclosures and strong investor education are critical in order to avoid repeating past mistakes.
How should a bank that is traditionally conservative in its risk management adapt its existing risk frameworks to account for the volatility and specific nature of crypto assets?
Banks have a fiduciary duty to act in their clients’ best interests, making it essential to assess both counterparty risk and custody risks--especially given historical examples of lapses in custodial responsibility. Regulatory approval in jurisdictions like Luxembourg or the UK may help, but it does not replace the need for independent monitoring. In terms of price volatility, cryptocurrencies resemble other asset classes. What truly sets them apart are their unique technological and protocol risks--such as private key loss and infrastructure vulnerabilities--which have no direct parallels in traditional financial instruments.
Even sophisticated institutional investors are not immune to risk.
Regulatory uncertainty is cited as a real obstacle to the adoption of crypto assets. How do the Markets in Crypto-Assets (MiCA) regulation and Luxembourg’s laws on blockchain and crypto assets concretely affect the risk management approach for traditional banks?
MiCA represents meaningful progress in clarifying the regulatory landscape for digital assets. Still, regulation often lags fast-moving innovation, especially in crypto. Its scope is limited--it does not yet address areas like decentralised finance. While counterparty, operational and governance risks remain central, investors and banks must also build technical literacy, especially around private key management and custody.
The white-label solutions allow banks to offer crypto funds without necessarily developing the entire infrastructure internally. What are the risks in outsourcing this function?
Banks must prioritise acting in their clients’ best interests, especially when dealing with vulnerable retail investors. The collapses of FTX and the $150m write-off by Canada’s second-largest pension fund following its investment in Celsius highlight that even sophisticated institutional investors are not immune to risk. Counterparty and custody risks require continuous monitoring. To keep pace with the crypto space, banks need to invest in training and stay current with technological and regulatory developments.
What are the risks related to the custody of crypto assets (e.g. via partners like Zodia Custody) from the perspective of a traditional bank? How can those risks be mitigated?
Partnering with a custodian that is licensed and regulated across multiple established regulatory jurisdictions is a positive first step, but banks must continuously monitor the custodian’s financial strength, operations and compliance. It is also wise to update internal risk frameworks to include crypto-specific issues--and to keep clients and staff well-informed through regular education.
The traditional clientele of a bank may have a different risk tolerance than crypto investors. How should a bank approach issues of suitability and investment advice for these new types of products?
High-return, high-risk financial products often attract unsophisticated investors who may not grasp the complexity of the assets--TerraUSD and Luna’s collapse in 2022 is a recent example. Banks offering white-label crypto products must ensure their clients understand the risks, including asset volatility, custody and counterparty exposure. In many jurisdictions, retail investors must pass a suitability test before they are permitted to trade options. A similar approach could be considered to introduce investor safeguards for cryptocurrency products.
Demand and liquidity are key drivers of price and risk.
The development of talent and internal expertise has been identified as a weak spot. How can traditional banks develop the necessary skills in risk management related to crypto assets?
Traditional banks should invest in specialised training on crypto-asset risk--covering blockchain technology, valuation methods and regulation--while also hiring talent with firsthand experience in the sector. But this should not come at the expense of core financial skills: strong foundations in traditional risk management remain just as critical in navigating the evolving landscape.
Despite the momentum for crypto adoption, scepticism persists. What are the risks associated with hesitation by traditional bank clients after their initial investment?
Theory tells us that the value and volatility of crypto-assets are heavily influenced by network effects--meaning that user adoption plays a vital role. In simpler terms, demand and liquidity are key drivers of price and risk, just as they are for traditional asset classes. So, while slow client adoption could create challenges, the underlying risk dynamics are not fundamentally different from those in other markets banks already know how to navigate.
Beyond quantifiable risks, what are the long-term strategic risks for a traditional bank that decides to engage in offering products related to crypto assets, considering the rapid evolution of this market and potential future disruptions?
While it is hard to predict the future, reputational risk and brand positioning are long-term strategic concerns. In 2017, Jamie Dimon threatened to fire traders dealing in bitcoin. Today, JP Morgan is actively building crypto infrastructure. That dramatic shift shows how public stances and strategy can evolve--and why banks need to be thoughtful in how they approach crypto now.