Traditional banks may still dominate the financial sector in terms of assets held, but credit unions are becoming an increasingly popular option for Americans who qualify.
Recent the data shows that there are approximately 4,600 credit unions in the United States. A September 2023 report from The National Credit Union Administration (NCUA) also notes that nearly 139 million Americans were members of federally insured credit unions, up 20% from five years earlier.
Also, the credit union market size measured by revenue, it was $126.2 billion last year.
Credit unions are ripe for the tokenization of real-world assets
John Wingate, CEO of financial platform BankSocial, told Cryptonews that a credit union is a member-owned bank.
“Unlike for-profit banks which are owned by shareholders, credit unions are owned by members, one member, one share, one vote,” Wingate said. “Given this, the ethics of credit unions and the ethics of decentralized finance (DeFi) are perfectly aligned.”
While this may be true, credit unions face a number of challenges that could hinder future growth.
Source: mx.com
Kyle Hauptman, vice president of the NCUA – an independent US government agency that regulates federal credit unions – told Cryptonews that credit unions buy and sell loans.
“It’s a complicated process called ‘loan participation,’” Hauptman said.
A compliance blog of the National Association of Federally Insured Credit Unions explained that loan participation occurs whenever ownership interests in a loan are divided and sold.
“Under section 701.22, federally insured credit unions (FICUs) may purchase participation interests in loans under certain conditions,” the blog states.
Hauptman pointed out that the current loan participation process can be complex. For example, he explained that if one credit union makes a loan and another credit union purchases a 20% stake, it will receive 20% of each loan payment.
However, Hauptman notes that the credit union that purchases the loan participation does not know whether the payment has actually been made. Additionally, the credit union is unsure whether the selling credit union will pay the required 20%.
“This makes planning difficult for the purchasing credit union and creates unnecessary uncertainty,” Hauptman said.
Tokenization use cases
Considering the challenge, Hauptman believes that tokenizing loans that aren’t large enough to be securitized in a bond offering could be helpful.
“A smart contract would automatically pay the purchasing credit union 20%,” Hauptman said. “That credit union will never have to ask ‘did they make a payment?’ or ‘when will I get my piece?’”
Ravi de Silva, managing partner at compliance risk management firm Risk Partners, told Cryptonews that tokenization could also help manage compliance risk by providing greater transparency, security and efficiency.
For example, de Silva believes tokenization would be useful for credit unions and Anti-Money Laundering (AML) use cases.
“Transaction monitoring is a key control requirement in anti-money laundering, which involves analyzing customer transactional data to identify potential suspicious or fraudulent activity,” de Silva said. “Tokenization can enable efficient analysis of transactional data.”
For example, de Silva observed this tokens can be used as a unique identifier to track transactional patterns and detect anomalies. He added that credit unions can analyze token data to detect large cash transactions, structuring or unusual transaction patterns.
“Anti-money laundering regulations also require that financial institutions, including credit unions, perform thorough due diligence on customers and maintain accurate records of their customers’ identities,” de Silva said.
Therefore, he believes that tokenization can further help securely store and reference customer identification data.
Credit unions embrace tokenization
Given the benefits that tokenization can bring to credit unions, it should come as no surprise that some have begun implementing these solutions.
According to Wingate, BankSocial is working with several credit unions for use cases such as identity tokenization.
“Credit unions are using our ‘verified product’ for interoperable use between systems and fintech, deposits for interoperability between bank accounts, other banks and for DeFi use cases,” he said.
Wingate explained that BankSocial’s verified product tokenizes transactional data via hashing.
“This is done in a quantum manner, on-chain, to ensure the immutability of records and results for regulators and third-party audits,” he said. “We have future cases in the pipeline for merchant payments, treasury management and lending/borrowing.”
Wingate added that Great Lakes Credit Union recently implemented BankSocial’s real-time payment solution. The solution uses Hedera Hashgraph’s distributed ledger technology (DLT). to tokenize payments and deposits for peer-to-peer transactions made on the Hedera network.
He added that BankSocial uses the immutable ledger on Hedera as transaction resilience for traditional financial binaries.
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Marshall Hayner, chief operating officer of Metallicus, told Cryptonews that Metallicus is also working with credit unions on blockchain solutions.
“Metallicus built the Metal blockchain, which is a layer-zero blockchain to enable banks, credit unions, financial institutions and fintechs to create interoperable ledgers that can communicate seamlessly,” Hayner said.
A recent one Forbes article noted that Metallicus is working with three credit unions, Vibrant, Meritrust Credit Union and Fairwinds, to enable blockchain-based solutions.
Credit unions embrace tokenization, but concerns remain
While it is notable that some credit unions have begun exploring tokenization use cases, regulatory concerns represent an ongoing challenge.
According to Hauptman, the big question facing credit unions is whether or not tokens are securities.
“Credit unions worry about whether that participation can be considered a security,” he said. “We at NCUA have pioneered the use of tokenization, but we can’t really alleviate other concerns about the tokens themselves.”
Hauptman added that KYC processes, along with platforms’ custodial tokens, are a concern for credit unions.
“And then within the platform the concern is ‘who are the node operators?’” Hauptman pointed out. “There have already been political questions about a node in North Korea or Iran. No one needs an OFAC investigation for violating sanctions.”
On a positive note, Hauptman shared that credit unions are moving forward with blockchain projects that enable identification.
“This is where any token is clearly not something ‘bought or sold,’” he said. “But tokenization for real-world assets remains a problem.”
However, all things considered, Hauptman believes that US credit unions are still better off implementing tokenization use cases rather than American banks. He believes this is because the NCUA has provided guidance that provides positive clarity on regulations for credit unions.
For example, Hauptman noted that in July 2021 the NCUA released a report “Request for Information and Comment on Digital Assets and Related Technologies.” That same year, the NCUA released a report called “Guidance on relationships with third parties providing digital asset services.” Additionally, in May 2022, the NCUA released another document called “Guidance on Federally Insured Credit Unions’ Use of Distributed Ledger Technologies.”
Credit unions should work with compliance teams
In addition to providing clear guidance, de Silva believes that regulatory challenges related to token implementation can be resolved by demonstrating how tokenization is implemented, monitored and verified.
“Credit unions must continuously monitor their tokenization processes and conduct periodic risk assessments to identify and address any emerging vulnerabilities or threats,” he said. “This includes staying current on the evolving regulatory landscape and making changes as necessary to ensure compliance.”
That said, de Silva emphasized that credit unions should work closely with compliance teams to adopt industry best practices for tokenization.
“It is essential to establish a robust framework that aligns tokenization practices with applicable regulations, prioritizing the security and privacy of customer data,” he said.
