Digital Currencies and Crypto Currencies
An area that has engendered a lot of discussion is the use of cryptocurrencies by Central Banks. This has generated significant challenges for banks, politicians, as well as regulators.
“Virtual currencies, perhaps most notably Bitcoin, have captured the imagination of some, struck fear among others, and confused the heck out of the rest of us”
Thomas Carper US-Senator
This is a good summary of the general response to cryptocurrencies from politicians and regulators. There are however exceptions, and notably some jurisdictions are looking to embrace cryptocurrencies or a central bank authorized version of them.
A very recent example is from Turkey where a former industry minister and the current Deputy Prime Minister are talking about a national ‘digital’ cryptocurrency. Whatever people’s views on cryptocurrencies, I believe that they will not go away so therefore cannot be ignored. The Peoples Bank of China has been testing a cryptocurrency based on blockchain technology, since early 2017. Venezuela has announced an oil backed cryptocurrency. Sweden is exploring introducing the EKrona in 2019, having started work on the project last year.
Many other institutions and governments are also looking at cryptocurrencies. The implications are that there will be centrally controlled cryptocurrencies that will flow around the digital world, and that they will potentially have a significant impact on business and traditional banking, as they can work quite differently to Bank ledger based money.
That being said, as things have progressed, a better description would be Central Bank issued ‘Digital Currencies’ – CBDC, a truly digital form of a fiat currency, which although different from Cryptocurrencies, have many similar concepts.
Cryptocurrency is a blockchain asset and not the liability of anyone, in most cases and often not linked to any asset. A key differentiator is that Cryptocurrencies are not usually nation state backed, but created by businesses, individuals or Organisations outside the governmental controls. Central Bank issued Digital Currency, however is based on a fractional reserve banking system based on debt – FIAT Currency and nation state central banks’ ability support the currency, the same as its current physical and ledger based money.
A good link for information about Central Bank Digital Currencies (CBDC) is in the article on Wikipedia
Banks cannot ignore cryptocurrencies, no matter how much they try to block or inhibit them. Many banks are rejecting transactions on credit cards for cryptocurrency purchases or blocking cryptocurrency exchanges for banking services.
A leading global bank has indicated, in a report filed with the US Securities Exchange Commission (SEC) that cryptocurrencies are a risk. They mention the risk in three areas that may impact them, Know Your Customer (KYC) and Anti-Money Laundering (AML), as well as customer loss to cryptocurrencies for trading or business uses. The third area the bank indicated in the risks, is that it may have to lower margins and spend significantly on technology to address the threat that cryptocurrencies create.
That leads to a third contention, that banks’ complex and layered ‘plumbing’ is inflexible, highly complicated and not suited to agility, as well as the completely different technology concept of cryptocurrencies. Ignoring the technology behind cryptocurrencies, as well as the use of them, is not really an option. The challenge facing the established banks is what to do. The banks currently have a complex range of systems to support their traditional businesses as well as the myriad of regulatory and compliance requirements. Cryptocurrency is actually designed to remove intermediaries, which is where banks operate. Cryptocurrencies also introduce a new technology paradigm for storing and exchanging value. This does not lend itself to minor changes or tweaks, or adding another layer on to already complex systems.
This move to cryptocurrencies does however offer opportunity for ‘Fintechs’ as well as emerging challenger banks. The dilemma that established banks or financial institutions have is that they will eventually have to operate with cryptocurrencies, which means spending money on technology, systems, people and processes, as well as potentially reducing margins. On the flip side there are opportunities for new products and services based around cryptocurrencies, which can be implemented with modern technologies to deliver competitive services.
This leads to the last related observation, which is taken from a consumer perspective; the convenience aspect of cryptocurrencies. The New York Times had a recent opinion piece on the tyranny of convenience, basically saying that convenience drives decisions rather than other more rational drivers such as privacy or stability. In short, this means from a consumer perspective, even if cryptocurrencies are volatile or unstable, if they are convenient then they will be utilized. This has been seen mainly by early adopters, however the adoption wave is growing. A significant driver is convenience from an end-user point of view to exchange value with lower cost, immediacy, less intrusion and scrutiny. Some are also seeing cryptocurrencies as a convenient store of value, often ignoring the volatility, but rather the ease of exchanging and storing value in comparison to traditional equities as an example. This will have an impact on a range of traditional intermediaries such as banks and financial markets, as well as business as cryptocurrency is here to stay, and it does change the way things are done or can be done.