Bitcoin and other cryptocurrencies had a fantastic year in 2017. The market for cryptocurrencies grew tremendously, hundreds of blockchain projects received funding though ICOs, and blockchain technology became mainstream news. Much of the public has now heard of Bitcoin and blockchain technology thanks to the success of 2017.
2017 also saw rising interest from businesses, institutions, and governments in blockchain and cryptocurrency’s potential applications. Of those institutions, the finance industry has the most to lose from the rise of digital currency. With value backed by a decentralized blockchain, banks are wondering how to respond to the current cryptocurrency craze.
Gone are the days when banks could safely ignore cryptocurrency as a fad or fringe movement. Cryptocurrency is now a market worth hundreds of billions of dollars. Now, banks and other financial institutions have to decide how they’ll handle customers, investors, and internal voices calling for increased institutional investment in blockchain assets.
Of course, the financial industry’s responses to cryptocurrency have varied across a wide spectrum and over time. In this article, we’ll take a look at the various responses banks have had to the current cryptocurrency craze. Since banks control so much institutional capital and leverage, it’s important to understand how banks will interact with cryptocurrency, now and in the future.
- Response #1: “It’s bogus and a fraud”
- Response #2: “This should be regulated like stocks and other securities”
- Response #3: “Maybe we can find a way to implement blockchain ourselves…”
- Response #4: “We have a lot of capital under investment. Should we get involved in the cryptocurrency market?”
- Response #5: “Let’s create Bitcoin-tracking commodities, futures, and ETFs for cryptocurrencies”
- Response #6: “Cryptocurrency can’t really replace us, can it?”
Response #1: “It’s bogus and a fraud”
In the early days of Bitcoin, this was the initial response from nearly everyone in the finance industry. Bitcoin was a scam. Or, at best, it had no inherent value and would soon fall out of use. The early days also saw Bitcoin branded as a currency for illicit transactions and buying drugs on the darkweb. Very few in the finance industry grasped the early implications of blockchain technology for value transfer.
Still today, many leaders in finance see Bitcoin and other cryptocurrencies as a fraud. 25% of U.S. CFOs believe that Bitcoin is a fraud. Another 25% believe it’s founded on real technology, but it’s overvalued. Taken together, that’s half of U.S. executives who are skeptical of Bitcoin and cryptocurrency’s current value.
It’s easy for crypto-enthusiasts to dismiss these claims out of hand. However, it’s worth paying attention to the opinions of these smart financial minds. Sure, calling Bitcoin an outright fraud is probably a response that comes out of fear. If Bitcoin fundamentally changes financial markets, these CFOs’ jobs could be on the line.
Keep in mind, however, that Bitcoin has yet to scale its utility as a means of purchase. People don’t currently use Bitcoin to buy many things. Its current high mining fees actually make it not well suited as a payment processor. Bitcoin’s utility right now is as a store of value, but market volatility makes it difficult to predict what that value will be.
For the most part, Bitcoin users are buying and holding the currency, not using it. This buy and hold mentality, combined with more people hearing about Bitcoin, makes the price go higher. While bankers are wrong to doubt Bitcoin as a currency and its underlying technology, its price volatility is still a risk to consumers.
Response #2: “This should be regulated like stocks and other securities”
2017 was the year of the ICO. Projects raised millions off the backs of newly created tokens. However, many token purchasers are not acting like potential users of a new product. Instead, they are speculating on the token and the likelihood it will increase in value.
This speculation looks a lot like stock investing and other types of securitized trading. Securities have strict laws regulating how they can be created, sold, and traded. ICO law and compliance became an important topic over the past year. The United States and European Union have failed to lay out clear guidelines for ICOs. However, The U.S. Securities and Exchange Commission has shut down at least three ICOs over the past few months.
Banks have called for regulation in the cryptocurrency space to level the playing field between stocks and ICOs. Most crypto experts agree that regulation is needed in the cryptocurrency space to protect consumers and prevent scams. The demand for regulation has never been higher.
Since banks want to limit the growth of the cryptocurrency market, it’s in their interest to see regulations that are as restrictive as possible. New cryptocurrencies threaten banks in terms of payment transfers and consumer accounts. However, it also threatens the banks’ investing arm. If anyone can launch a token sale, then they no longer need banks to help launch and back expensive and complicated initial public offerings.
Expect banks to lobby hard for heavy-handed regulations on cryptocurrencies. Perhaps even arguing for restrictive bans like those implemented in China against ICOs and cryptocurrency exchanges. That would almost certainly stifle innovation and be bad for the blockchain community.
Response #3: “Maybe we can find a way to implement blockchain ourselves…”
One side effect of cryptocurrency’s rising tide is banks have begun to take a look at the underlying technology. They deny the legitimacy of these currencies as stores of value. However, they appreciate that blockchain can secure a distributed ledger.
As such, banks are testing blockchain. Internally, blockchain could help banks keep more efficient ledgers. They could make transaction times quicker, especially for cross-border payments. Clearing and settling payments could also be easier using a secured blockchain network, saving banks on overhead and operating costs.
Another area where banks are exploring blockchain solutions is identity. Banks hold a significant amount of personal data about their customers. The blockchain could help secure that data. It could also help with login and identity authentication when a user wants to access their account. A decentralized ledger of identity information doesn’t have a single point of failure, since it exists on many computers across a network. This reduces risk for the bank. Decentralized storage solutions also make a compelling case for secure storage of user data.
Some cryptocurrencies have recognized the need to cooperate with large financial institutions. They argue that these institutions are so powerful that they aren’t going to just disappear. In fact, we probably wouldn’t want them to, since they’re valuable mediators in society. Companies like Ripple are working with banks on blockchain solutions. Ripple is trying to create a 3rd-party standard for cross-border payments.
These are private initiatives to implement blockchain technology. It’s not clear yet how far they’ve gotten in their implementation. However, it’s worth remembering that the current cryptocurrency craze is a function of the effectiveness of the underlying blockchain technology. Many of these ICO companies will likely fail in the next few years, but blockchain will continue to get implemented on public chains and on enterprise chains.
Response #4: “We have a lot of capital under investment. Should we get involved in the cryptocurrency market?”
There has been a lot of speculation that large banks are involved in the cryptocurrency market. Some theorize that they’ve even gone so far as to game the market for their own advantage. There’s no public data to back up that claim. However, banks have been hostile toward cryptocurrency and cryptocurrency investors, while simultaneously looking into ways to make money from crypto’s growth.
Jamie Dimon, the CEO of JP Morgan, called Bitcoin a fraud in September. Shortly thereafter, JP Morgan made a large buy order on Bitcoin. Some theorize that Dimon’s comments drove down the price of Bitcoin, allowing JP Morgan to acquire it at a lower cost. The bank has asserted that Mr. Dimon’s comments were independent and the Bitcoin order came from a private customer, not from JP Morgan’s institutional funds.
So far, however, this is the first openly reported case of potential conflict of interest when banks are investing in cryptocurrency.
Customers of some Australian banks had a different issue when they tried to purchase cryptocurrency. Banks began closing accounts of cryptocurrency investors based on wire transfers to exchanges. While the banks were within their rights to do so, as part of the terms of service, it nonetheless caused a PR nightmare for the banks as crypto enthusiasts took to social media. They derided the banks for not giving their customers control over their own money.
On a positive note, some banks are looking into investing in Bitcoin and other cryptocurrencies. Getting institutional investment like this could be an important step in stabilizing the cryptocurrency market. Goldman Sachs is the largest bank so far to announce they’re looking into investing in Bitcoin.
Response #5: “Let’s create Bitcoin-tracking commodities, futures, and ETFs for cryptocurrencies”
Financial institutions have also grown eager to create investment products around cryptocurrencies. Bitcoin futures allow you to buy a future amount of Bitcoin at today’s price. If you believe Bitcoin will be more valuable in the future, then you could invest in Bitcoin futures to secure your investment.
The trouble with Bitcoin futures is they’re likely to be settled in cash. Nobody will actually be purchasing Bitcoins on your behalf if you purchase a Bitcoin futures contract. Instead, you’ll just be issued an IOU that basically amounts to a bet on the Bitcoin market. This means institutional money doesn’t actually get invested in the Bitcoin ecosystem, and the rewards all go to fiat based institutions and investors.
Tons of brokerages want to offer cryptocurrency mutual funds and ETFs, but US SEC has dragged its feet approving them. In France, TOBAM launched the first cryptocurrency fund for European investors. However, the number of available funds is still limited.
Response #6: “Cryptocurrency can’t really replace us, can it?”
The big debate going on in the world of finance over cryptocurrency is whether digital cash can replace fiat. And if so, will blockchain DAOs replace the financial industry?
Many have argued that blockchain does to finance what the internet did to the media industry. The internet didn’t totally destroy the media industry but it did grant more people access to cheaper products. It also forced media companies to change the way they do business and offer their customers more compelling deals.
Still the debate is split. International Monetary Fund Head Christine Lagarde says cryptocurrency could replace banks. On the other hand, European Central Bank Head Mario Draghi says fiat will never go away. It’s not likely that countries and central banks will relinquish control over the monetary supply, and the financial industry certainly won’t go away quietly.
As such, moving to a completely decentralized currency system raises a lot of economic questions. Since most cryptocurrencies have limited supply, they will almost certainly become deflationary currencies as tokens exit the supply when people lose their private keys or initiate mistyped transaction requests. This may not matter though, since most cryptocurrencies are infinitely divisible. In a deflationary model, we could theoretically keep dividing tokens into smaller and smaller units, instead of needing a central bank to increase the money supply.
While this sounds feasible, the truth is nobody knows what would happen in a completely decentralized, deflationary monetary system. Because of this uncertainty, most consumers and major corporations will continue to use fiat and trust central banks to keep the economy stable.