October 9, 2017    5 minute read

Cryptocurrency: The Future of Banking?

New Era?    October 9, 2017    5 minute read

Cryptocurrency: The Future of Banking?

When Bitcoin was created in 2009, it was an anti-establishmentarian backlash to the Global Financial Crisis. Bitcoin’s libertarian founder, Satoshi Nakamoto, would hardly have envisioned that cryptocurrency, and the distributed ledger technology that it adopts, would now represent the greatest opportunity for financial intermediaries to take advantage of. Cryptocurrencies are steadily changing the way we not only facilitate transactions, but also the way that we view money altogether. Banks who neglect the value of this technology, or those who are too slow to adopt it, will ultimately pay the price.

Distributed ledger technology (DLT) is the operating system that facilitates transactions between devices located in different areas, subsequently updating a record of transactions, known as a ledger, in a synchronised fashion across a network. Decentralised cryptocurrencies, such as Bitcoin and Ethereum, are designed so that the ledgers are not in control of a central authority which has access to the database of transactions and those making them. The database for these cryptocurrencies is kept decentralised as a result of using a consensus-based validation procedure and cryptographic signatures.

In such a system, transactions take place between two individuals, after which the details of the transaction are verified by other participants on the platform. The validation of transactions by participants on the platform is done in batches, known as “blocks” and is incentivised through a commission. Since the ledger of activity is organised into separate but connected blocks, this type of DLT is often referred to as “blockchain technology”.

Does Bitcoin Have a Future?

J.P. Morgan CEO, Jamie Dimon, has taken a leading position in questioning the credibility of Bitcoin, which he labelled as being “worse than tulip bulbs” – a bubble waiting to collapse. Bitcoin is a cryptocurrency controlled by no central authority, such as a central bank, which can validate the creation of the currency. As well as this, there is no regulatory body overseeing activity in the Bitcoin space. Therefore, if countries start to restrict cryptocurrency exchanges, as seen in China with a regulatory clampdown on Initial Coin Offerings (ICOs), it may spell the end for the likes of Bitcoin which could see its market value collapse. The volatility of the cryptocurrency was aptly demonstrated following Dimon’s damning comments, with Bitcoin’s value dropping 10%, from around $4200 to $3800 in the space of a day of trading.

Much has been made of Dimon’s remarks, with many commentators dismissing his claims on the credibility of Bitcoin and some even stating that the CEO of the world’s largest banking group does not understand the power of “blockchain” technology. This, however, is not true. Dimon was not dismissing the technology that Bitcoin utilises, but the premise of a currency that is able to function without the control of a regulatory authority.

One problem that it unintentionally creates is the facilitation of illicit activities, such as the purchase of drugs or weapons, which can be anonymously purchased and therefore left untraced on the digital ledger. There is then the issue of value: the value of all sovereign currency is guaranteed by the currency’s central bank, but for cryptocurrencies like Bitcoin this is not the case. Whilst the cryptocurrency’s origins were anti-establishmentarian and alternative, its inherent failure to adhere to traditional financial practices could eventually hinder the longevity of the venture.

The Alternative to the Alternative

This does not spell the end for “blockchain” technology – far from it. It is important to understand that this technology is not limited to the transaction of cryptocurrencies, but the transaction of any currency in the digital space; it is simply the case that cryptocurrencies were the first to implement DLT. The emergence of Bitcoin and alternative cryptocurrencies put in motion a wave of technological disruption and a race has now begun for financial intermediaries to get to the crest. Among a long list of benefits, using “blockchain” technology reduces costs, increases transaction speeds, transparency and security. Firms who are successful in innovating within this space could assert control over the use of those new concepts in new trading platforms through patent rights.

Led by UBS, six of the world’s largest banks are collaborating to create and accept a new cryptocurrency, called Utility Settlement Coin (USC). Backed and promoted by Barclays, Credit Suisse, Canadian Imperial Bank of Commerce, HSBC, MUFG, along with UBS, it will use the USC to settle securities transactions – paying each other for buying and selling securities without any waiting period for traditional money transfers.

The project is paving the way towards the design of central bank cryptocurrencies, making it simpler for global banks to conduct a wide variety of transactions with each other using collateralized assets on a custom-built “blockchain”.  According to the Reuters, “the USC would be convertible at parity with a bank deposit in the corresponding currency, making it fully backed by cash assets at a central bank”.

What Comes Next?

The success of decentralized cryptocurrencies cannot be understated. Bitcoin’s value is continuing to soar, despite its volatile price swings, proving that the demand for it is still stronger than it ever has been. Jamie Dimon was cautious in stating that the value of the cryptocurrency may eventually reach $20,000 before it eventually crashes. The price of Bitcoin will continue to rise, so long as investors still see value in purchasing and using it. However, with no inherent value backed by a real asset or central authority, once demand and confidence in Bitcoin disappear, so will the currency itself.

It seems likely that, as firms bridge the gap between the “blockchain” and central banks, the demand for decentralized cryptocurrencies will be called into question. The greatest benefits to using the likes of Bitcoin is that transactions are quick, transparent and anonymous. Whether all of these can be guaranteed through a centralized authority remains unclear, but if they are then Bitcoin will likely become obsolete. Even if they are not guaranteed, Bitcoin may become forcibly obsolete through the clampdown of regulatory authorities across the globe. If one is still looking to invest in Bitcoin, they should do so with caution.

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