Cryptocurrency continues to grow as an asset class. Bitcoin's surge beyond 50,000 USD in March 2021 means that the total market capitalization of Bitcoin comes to $1 billion, with the total market capitalization of the cryptocurrency market at nearly $2 billion. How will banks survive when cryptocurrency becomes mainstream?
How Cryptocurrency Disrupts Traditional Banking
Cryptocurrency provides an alternative to the fiat currencies that presently dominate the world. Financial institutions that deal with fiat currencies are heavily regulated by the same governments that print these fiat currencies. Let’s look at some of the defining features of cryptocurrency and how they affect the traditional banking system.
Decentralization
Most cryptocurrencies are designed to be decentralized, meaning that there is no central authority over them. This prevents the manipulation and debasement that is often found in fiat currencies and allows cryptocurrencies to function better as a store of value. Fiat currencies are routinely the subject of interventions such as quantitative easing and interest rate adjustments that manipulate both the supply and demand of these currencies.
Decentralization removes all middlemen, including central banks, from the equation. Transactions become a direct exchange between the buyer and seller. Since central banks are essentially the link between government and a country’s banks, the mainstream growth of cryptocurrency foreshadows a dramatic change to the financial system.
Immutability
Cryptocurrencies are also designed in such a way that transactions are permanent. While a traditional financial transaction could be reversed by a financial institution, there are no such chargebacks in the world of cryptocurrency. Once a transaction is made and one party is unhappy, it is solely up to both parties to agree to a resolution. This removes one of the roles traditional banks have as referees in the financial system today.
Without Borders
There are hundreds of fiat currencies in the world. This is because they are operated by the governments of the world and almost every government wants to have control over its own currency. Their national economies are tied to this currency and when they manipulate the currency, they can manipulate the economy that depends upon it. Central banks increase the supply of currency when they believe the economy is growing too slowly, diluting its value to stimulate more economic activity. They decrease the supply of currency when they feel the economy is overheating. The central banks of the world will often parrot each other's actions as well because if currency X gains value with currency Y, it means that it will take more currency Y to buy goods from country X because the goods will be priced in terms of currency X.
Large national banks and smaller banks along the borders with other countries make a lot of money through currency exchange. Wiring money from one currency to another can not only be very expensive but can also take a ridiculously long time. This is one reason why Ripple exists and why it has gained a lot of serious consideration from the banking community, especially in Asia.
Resistance to Cryptocurrency
In any institution, there will be those who are threatened when the current way of doing things is challenged. The rise of cryptocurrency is no exception. Banks and governments are among those who are understandably nervous about a currency that has no central authority and no need for a middleman. We will dig more into why do banks and governments resist cryptocurrency so much. How do they attempt to undermine cryptocurrency and is there any hope that they will change their minds?
Why Banks Resist Cryptocurrency
Governments and the banks that borrow from central banks are naturally hostile to cryptocurrency. This is why the legality of cryptocurrency has been subject to debate in much of the world since it was created. Since governments have a virtual monopoly over currency, their hostility to an alternative currency is no surprise. Since these same governments also issue treasuries and regulate the stock market, governments favor these asset classes over cryptocurrencies as well. This explains why the legality of cryptocurrencies has been such a hard-fought battle and one that is still underway as it is still illegal in several parts of the world.
Central banks argue that digital currency undermines the financial stability of an economy that relies upon it. The Bank of England has even said this would be the case if a central bank issued digital currency. However, they have been studying whether such a currency would be feasible. This doublespeak seems to pervade the financial sector’s response to cryptocurrency. As we will see, they say one thing, yet do another.
How Banks Undermine Cryptocurrency
Regulation of ICOs was one way that governments were able to put the brakes on cryptocurrency’s growth. In 2017, the Chinese government banned initial coin offerings or ICOs. They called them an unauthorized fundraising tool and warned that they could be associated with financial scams. While this may seem a backward and draconian stance indicative of China's Communist policies and authoritarian government, the United States also considered increased regulation of ICOs during the same period.
In 2017, big banks like J.P Morgan Chase and Bank of America labeled cryptocurrency as a “fraud” or “scam.” J.P. Morgan Chase & Co. CEO Jamie Dimon called Bitcoin a "tulip bulb”, a reference to the tulip craze that led to soaring tulip prices in the Netherlands in the 1600s. With comments like these, the big banks labeled cryptocurrency with the same broad brush that they have done to Forex and stocks in the past. These big banks have an ally in this battle—the governments who print the money they borrow and lend. Losing control of the currency that people use daily means giving up control over manipulating the economy, which in turn constitutes relinquishing control over the economy itself.
Are Banks Softening on Cryptocurrency?
Banks and other financial institutions have only recently taken an interest in cryptocurrency as an investment vehicle for themselves. Before recently, only lip service was paid to customer-facing cryptocurrency investment, while many banks have dissuaded their clients from investing in cryptocurrency for various reasons, the most popular excuse being its volatility.
Fast-forward to 2021 and a blockchain network called Spunta is being used by a large part of Italy’s banking sector. J.P Morgan Chase, whose CEO cast serious doubts about Bitcoin’s valuation in 2017, has developed its own in-house cryptocurrency called JPM Coin. Many central bank digital currency projects exist in countries like France, Australia, and Thailand. The People's Bank of China is testing a digital version of its national currency, the yuan.
Adapting to Cryptocurrency
With cryptocurrency being described as “the people’s currency,” the benefits of cryptocurrency are hard to overcome. Despite long-standing attempts to discredit or heavily regulate cryptocurrency, its growing popularity is reaching a point where increasing its regulation would cause significant blowback from a large number of people. With the popularity of cryptocurrency seeing no end in sight, many banks are beginning to come to terms with cryptocurrency.
Why Banks Are Slow to Change
Banks are large entities that generally have been in operation for many decades, if not centuries. They tend to be extremely slow to adapt to change. When the Internet first appeared, it took banks years to implement online banking. When they did, you often had to pay a fee for it. Only now with the advent of smartphones, banks are taking online banking seriously. The barriers that banks must clear to adapt to cryptocurrency are more substantial. The first of them is that there is currently not much demand to offer it among traditional banking customers.
The technology at the center of many banks dates back to as early as the 1970s. These systems are still being used today, only now they are connected to the modern world of online banking. These legacy systems are increasingly growing harder and more expensive to maintain.
Some banks continue to market themselves as places where you can “speak to a person.” Some older customers who grew up in a time when technology was much less pervasive in all aspects of life, may prefer this approach. However, this type of service is becoming more and more costly to maintain. As face-to-face customer service loses value as a skill, it becomes harder to find employees who do it well. The increasing cost of old systems and old ways of doing things could be a catalyst for change.
Efforts of Banks to Embrace Cryptocurrency
There are niches within the traditional financial system where cryptocurrency is making a real difference. Ripple has been taken seriously by the financial system for some time due to its potential for enabling cross-currency transactions faster and with less effort than conversion between two different fiat currencies. Converting fiat to Ripple and then from Ripple to the destination fiat currency vastly decreases the cost and length of time of these transactions. It is therefore seen as a way to serve the customer better.
In the summer of 2020, decentralized finance took off. The lack of regulation within cryptocurrency allows for all the derivatives that make decentralized finance so exciting and profitable. Banks must necessarily look upon these developments licking their chops. The fact is that they are missing out. There was once a time decades ago when people who needed to borrow money would patiently wait in line at the bank and humbly state their case for a loan. With decentralized finance, technology has the potential to sweep away this antiquated process.
Since the adoption of cryptocurrency as a payment method is still in its infancy, there is not a lot of demand for banks to deal with cryptocurrency if they don’t already use it. Those who already use cryptocurrency don’t see much reason to use a traditional bank to do so. In other words, the lack of a middleman in cryptocurrency transactions means that no bank is necessary. That is another reason why banks are generally hostile to cryptocurrency. Unless banks can find some way to insert themselves as a necessary middleman in cryptocurrency transactions, it is difficult to see how they can benefit from it.
Proprietary Blockchains
One way for banks to benefit from cryptocurrency is to create a different kind of cryptocurrency—one that is not decentralized but has the traditional banking system tied into it as a middleman. China has been working on a digital currency for some time. Banks are also looking at integrating blockchain technology into their financial platforms.
Conclusion
Cryptocurrencies are heavily disruptive to the traditional finance system. Their decentralized design removes the necessity of a central authority, thus giving banks little opportunity to provide value. Immutability removes their ability to intervene in transactions that are judged or even proven to be fraudulent. Also, cryptocurrency’s lack of borders removes the opportunity for arbitrage between the myriad fiat currencies of the world.
Due to their complete irrelevance to cryptocurrency, central banks and banks are resistant to cryptocurrency. Threats of bans or heavier regulations, and public statements by financial experts and bank CEOs to discredit cryptocurrency or its valuation are some examples of the ways the traditional financial system attempts to sidetrack cryptocurrency. However, these same financial entities are beginning to sense a budding opportunity.
Banks are very old institutions, with roots that are very deep in society. Due to this, they have some liabilities that more lithe and nimble technology projects don’t have. Banks and other financial institutions are thus very hesitant to change. Countries like France and China are working on or testing digital versions of their fiat currencies. Big banks in the U.S. are investing in and even funding their cryptocurrency projects. These proprietary blockchains attempt to give the benefits of cryptocurrency, but with the bank firmly implanted as a middleman. Whether this fundamental contradiction to the founding principles of cryptocurrency succeeds is something that only time will tell.
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