How can banking survive in an age of cryptocurrency?

One of the most disruptive and promising technologies of our time, blockchain is often called Web 3.0 for its ability to democratize the web and decentralize finance. This is evident in the blockchain-powered cryptocurrencies, which have forced the business world to take notice and evaluate their impact on various sectors, the most prominent being banking and finance.

There is a growing concern about the future of banks, given cryptocurrency’s ability to enable new business models and challenge traditional finance practices. But to know whether these concerns are valid or just hype, let’s understand how cryptocurrency works and why it has everyone’s attention.

​What is cryptocurrency?

Cryptocurrency is a digital asset or digital currency secured by cryptography. It is based on a network that is distributed across a vast array of computers. No single entity has ownership or control over cryptocurrency owing to its decentralized structure. This means it is outside the control of central authorities, regulatory bodies or government. The underlying technology that cryptocurrency uses is called blockchain. This is a distributed ledger secured by a set of computers on a network. As a result, cryptocurrency transactions occur online without third-party intermediaries. There are many types of cryptocurrencies, some of the most popular types being Bitcoin, Ethereum, XRP, Tether, Binance Coin, USD Coin etc. 

Some of the apparent benefits of crypto are ease and speed of transfer, automatic execution of transactions without third-party involvement, privacy, accessibility and transparency. 

Rising interest from banks and financial sector in cryptocurrency

Industry experts predict a strong inflow of attention and buy-in. Gartner’s September 2021 survey of CFOs and financial leaders showed that nearly half of the leaders plan to evaluate the use of digital currencies for business in 2022. Several mainstream organizations across diverse industries too invested in cryptocurrency and blockchain technology in 2021. For example, AMC announced that it would accept Bitcoin payments soon. Fintech companies such as PayPal and Square have announced support by enabling users to buy crypto on their platforms. 

Banks and financial institutions have started to accept and launch their own entries in the blockchain ecosystem. Some banks have launched their own cryptocurrency to be used for fund transfers and faster settlements, while others have launched blockchain-based investment products. Many banks are using the Ripple network and XRP for instant payments, cross border payments and multiple other use cases. 

Revelio Labs estimates that some of the most prominent banks have added over 1000 new cryptocurrency-related roles since 2018. Many banks are offering cryptocurrency investments to select clients, while others are considering trading desks for Bitcoin. Another way in which banks are embracing crypto is by providing custodial services to clients - to hold their Bitcoin. Crypto custody firm NYDIG says that Bitcoin is soon coming to hundreds of U.S banks, which will allow these banks’ customers to buy, hold, and sell bitcoin using their existing accounts. 

Ushering in a digital-first culture

Challenger banks are, however, moving in rapidly to gain the first-mover advantage by investing in the right crypto offerings. There are many opportunities and use cases to choose from as banks embrace the digital-first culture. In addition to the currencies themselves, the underlying distributed-ledger technologies (DLT) can help banks accelerate innovation.  For instance, blockchain and DLT can disintermediate some of the key services that banks provide, including below.

1. Payments
 

A decentralized ledger for payments can facilitate faster payments at lower fees than banks.

2. Clearance
 

Distributed ledgers can lower operational overheads and enable real-time transactions between financial institutions. The technology can allow transactions to be settled directly and track transactions better than existing methods. 

3. ICOs
 

With Initial Coin Offerings (ICOs), entrepreneurs are trying a new model of financing that unbundles access to funds from traditional capital-raising services and firms. 

4. Securities
 

Blockchain can essentially remove the intermediaries from asset rights transfer, lowering the cost of operations, enabling access to wider markets and reducing some of the instability of traditional markets. Additionally, by moving securities on blockchains, financial markets could dramatically reduce the costs of trade processing operations and time. 

5. Trade Finance
 

Similarly, blockchain could replace the paper-heavy and tedious bills of the lading process in trade finance, leading to enhanced security, transparency, and trust among trade parties.

The case for regulation

Despite this rapid adoption and interest in cryptocurrency, there is still much uncertainty around these currencies. How can banks and their customers avoid the challenges associated with cryptocurrencies? For example, one of the main risks arising from this widespread adoption is that money laundering and fraud practices have crept into the crypto exchange market. Cryptocurrency can also lead to financial and operating risks because of price volatility. The absence of an overarching regulatory framework results in market uncertainty, with any change in regulations impacting the value of a currency.

Regulatory bodies in almost all countries are trying to write new rules governing the use of cryptocurrencies and building awareness. However, while regulation may protect the interests of investors, it goes against the core tenet of decentralization, the reason why cryptocurrencies gained popularity. 

The future of banks in the face of disruption
 

While bitcoin and cryptocurrencies are exciting for their promise of decentralizing wealth and democratizing control, fiat money is here to stay. Banking services continue to remain the most stable and accessible financing method for the vast majority. Additionally, with concerns around regulation and volatility, it will be a while before cryptocurrency gains acceptance as a mainstream financing model. Thus, it is safe to say that the banking sector will continue to play an essential role in the economy, aided by blockchain and other emerging technologies.

Disclaimer

The contents of this article/infographic/picture/video are meant solely for information purposes. The contents are generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. The information is subject to updation, completion, revision, verification and amendment and the same may change materially. The information is not intended for distribution or use by any person in any jurisdiction where such distribution or use would be contrary to law or regulation or would subject IDFC FIRST Bank or its affiliates to any licensing or registration requirements. IDFC FIRST Bank shall not be responsible for any direct/indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information mentioned. Please consult your financial advisor before making any financial decision.