Current and future state of crypto
The future of money and what it implies has for the past decade come to be discussed due to the increasing growth of innovation in technology. Increased innovation in technology has not only come to change how we communicate and interact but has also initiated a globalization process now on the verge of disrupting the traditional ways of financial transactions. The uprising of blockchain technology and cryptocurrencies as a result of this process have come to offer opportunities and challenges for financial institutions, businesses and customers alike. The implications of blockchain technology is perhaps not only an important subject to discuss for the current generation, but also for generations to come.
Whether described as an asset, currency or technology, the traditional definition of a currency does not necessary apply in the case of currently available cryptocurrencies. Due to high price volatility and a hardship of getting widely accepted as a payment method, current cryptocurrencies like Bitcoin, Ripple or Litecoin perhaps share more similarities with that of a speculative security.
The short term speculation in cryptocurrencies is likely to continue due to the fast pace of changes to the underlying technology. Just like with the introduction of the internet, many of the first movers reaped rewards by creating new businesses and products. Yet, costly mistakes were made and many businesses that initially soared, failed not long thereafter. The internet brought a wave of change too swift for anyone to predict, and in the short term it brought speculation and market volatility most notably during the dot-com bubble, but in the long run the internet was here to stay.
Similarly, one must make the distinction between current cryptocurrencies and the blockchain technology underlying these currencies. While it is possible that many of the cryptocurrencies in the markets today will be looked back upon as bubbles, some are perhaps here to stay or at least be the stepping blocks of future currencies.
The risk of cryptocurrencies infiltrating the financial system, exposing institutions to a potential bubble and the fact that they are independent of central banks have made regulators rightfully aware. At the moment a big drop in value would more likely be a risk to retail investors, and the systemic risk of a potential collapse in wealth seems limited due to insulated exposure of the globally rated banks. Nonetheless, today the reality is that the speculative and unregulated nature of currently available cryptocurrencies makes them unreliable as an effective store of value.
Altogether, speculation drives innovation, and many of the currently hyped ICOs are likely to be forgotten in a few years. Current speculation is proof of the uncertainties regarding blockchain and one must not be hesitant to make conclusions as to what to expect in the coming years. In the end, time will tell if the utility of cryptocurrencies might usurp their speculative nature.
Effects on traditional models
Even though an increase in the use of cryptocurrencies over the past years is a fact, the implementation of these currencies has seen and may continue to see many setbacks and challenges. But the implementation of decentralized currencies, just like with the first decade of computers, may show exponential potential and opportunities.
A decentralized currency would, if widely adopted, mean that the cost of mediation or transaction cost is circumvented by the customer, something that would otherwise put limitations on the minimum size and agility of transactions. A hindrance making small transactions impractical.
Furthermore, the potential impact on traceability and swiftness of transactions possible with blockchain is also substantial. The possibility of creating a digital ledger of transactions would open up potentials in a wide range of financial value chains. Firstly it could change how transparency and privacy would work. Blockchain would prevent identity theft and enable secure identification of customers, potentially making internet transactions unfraudulent. Because of the digital ledger, transactions would be impossible to delete and therefore impossible to forge by automation. Transactions could however remain anonymous to anyone outside the peer-to-peer transaction. Payment transparency and optimization of data could among other things simplify and reshape financial reporting, KYC processes and the management of company data.
“Blockchain technology could reduce infrastructure costs for eight of the world’s 10 largest investment banks by an average of 30%, translating to $8B to $12B in annual cost savings for those banks.” Accenture plc, Banking on bitcoin
Secondly, the so-called smart contracts or digital contracts that are made available through the shared digital ledger are potentially applicable in various situations, not only in B2B. The possibility of exchanging value, contracts or agreements in a transparent but conflict-free way that is both safer and faster than systems implemented today may change the reality for customers, businesses and everyday people alike. Eventually, due to their adaptability, digital contracts may not only be used to replace middlemen in industries such as law, real estate, consulting, automobile, financial services or insurance. In a far enough time horizon, political elections would potentially be performed via blockchain, increasing voter turnout by avoiding the necessity of physical attendance and struggle surrounding identification.
Despite the many opportunities that come with blockchain technology, cryptocurrencies face many challenges. The future impact of cryptocurrencies in financial markets seem to be highly dependent on the integration and coordination of regulations and laws between markets. Regulation could affirm the legality and proof of trust with centralized exchanges and custodial crypto storages, ensuring the confidence of investors. Because of the process of gradual integration it is highly likely that cryptocurrencies’ significance to financial services will also be progressive. Since legislation may only be effective if applied in uniformity between markets, and the extent of required regulation ranges across different regulatory levels with incentives to prevent tax evasion, market manipulation, money laundering and the possibility of use in illegal activities, the speculative nature of cryptocurrencies might endure in the near foreseeable future. From a risk perspective banks and institutional investor would meanwhile be inclined to avoid cryptocurrencies, not to be accused of aiding in any of the above mentioned.
Apart from regulation. A challenge towards the wide implementation of cryptocurrency is the implementation process itself. Since the technology works better the more widely it is adopted, the more users that embrace the technology will also increase its usability. This will be an initial barrier, slowing implementation. Ironically, scalability has also proved to be a problem for cryptocurrencies like bitcoin due to maximum processing capacity of number of transactions per second. This has resulted in a debate surrounding development and coordination of blockchain.
The Future of Banking
The internet of money refers to a future where we find transactions and agreements relied on decentralized digital ledgers, a system potentially nondependent of intermediaries. This would seem far reached to many, however, there is good reason to believe that as long as the technology is evolving and becomes cost-effective, it is only a matter of time before implementation. The digitalization of society today is characterized by exponential growth. We have seen a shift in how communication is conducted and the diminishing importance of physical location, due to society moving online. So how will this affect the financial system and banks of today?
Still to this day there are over a billion people globally that are unbanked, and many of those who could open an account, choose not to due to the centralized governance in place. This gap in the market for potential new customers and revenue is mostly contributed to emerging markets. Markets change constantly, and while there are flaws restricting people in the current system of capitalism, this might change because of emerging virtual markets. The opportunity encapsulated with the financial inclusion of these market is contributable to two major trends: the rise of income in the low-income populations, and the revolution of digital technology and its application to financial services. The convergence and financial inclusion of these markets will affect the banks’ customer base, changing the income models and posing challenges to the traditional business model of banking.
Due to the decentralized nature of blockchain technology, it is often described as a disruptor and a threat to the traditional banking system. Traditional commerce is founded on the reliance of financial institutions serving as a third party middleman. This model based on trust between customers and agencies would be threatened by a transactional system based on cryptographic proof. Though new products such as futures or contracts based on cryptocurrencies may reap profits in the medium to short term, still more profound than the impact of currently available cryptocurrencies to the banking system, will possibly be that of the technology underlying these assets.
A financial system where the users become the owners opens up unlimited possibilities of innovation and the possibility of peer-to-peer transactions could potentially be a threat to the industry of banking. Firstly, central banks lose the power to control money supply if a decentralized currency would be issued, changing the reality of effective monetary policy. Contrarily, a cryptocurrency backed by the central bank might be the necessary reinforcement to restore the credibility of blockchain.
Smaller financial institutions are both more adept and exposed to the uprising of new technology than the conservative banks. Initially, it is likely that new business will be coming out of ICOs and the opportunities that come with bitcoin and similar assets. Investment banks and crypto exchanges that are adaptable will be able to profit and possibly steal market shares from existing banks.
Nonetheless, for banks there are also great opportunities that come with blockchain technology. Apart from new income-generating products, blockchain presents the opportunity to financial institutions and banks to streamline much of their back-office operations. This would imply the time shortening and cost-cutting of clearances, settlements, accounting and transactions. Moreover, blockchain would enable the creation of intranet between banks, positively affecting trade finance, cross-border transactions, post-trade processing and money transferring. This would remove ineffective processes requiring man-power, and cut costs.
Banking for The Generations
The role of the bank has always been to ensure security between transactions. However, after the credit default bubble of 2008, we have seen the tendency to distrust with authoritative governance. The desire for change has been noticeable and the internet has in many ways shifted the governance of social networks from a totalitarian system to a market-driven force were power is given to anyone willing to add value to the network. Millennials who were born into this permissionless digital society will be the ones who push innovation forward, putting strain on restrictive traditional systems.
Some may argue that blockchain offers a payment solution to fix an already solved problem. And the problems faced by the technology in the near future will determine how fast and to what degree it will be implemented. Even if none of the currently available cryptocurrencies would replace credit cards as the predominant way of making online payments, the blockchain technology could provide the platform for future payment systems. Banks that are fastest to act stand most probable to establish themselves, and the global banks currently operating will either have to develop new systems or acquire the necessary technology to remain competitive.
Depending on regulation, it is possible we will see a hybrid system between centralized and decentralized currencies, where central banks are backing and controlling demand of cryptocurrencies. It is possible that the established banks’ role in the markets will be offering a combination of banking, support and compliance. The same way hedge funds are specialized in offering advice on diversification of portfolios even though investors could actively buy and sell themselves, banks would grasp the role of the advisor rather than that of the necessary third party. Banks would be providers of familiar interfaces, e-wallets and smart solutions, but primarily offer specialized services in tax planning, capital management and corporate solutions.
In the long run the majority of branches will likely disappear due to the likelihood of societies moving online and becoming cash-free. It is more likely that e-wallets will replace the cash system, and generation z has never visited a bank office in person except for the one time when they needed to upgrade their account as they came of age. It goes without saying that the same generation never had to walk physical invoices to a bank office instead of signing an e-invoice over their smartphones. The business of the bank is quickly becoming automated, and banks today that are managed by generation x for generation x must quickly realize that the needs of the current generation might be drastically different.
In the long term, banks will have the opportunity to restructure essential operational and financial systems to shared data platforms. Data reconciliation is a crucial part of financial business models. Yet, because of the problem of individual parties having to maintain their own data, and relying on a sequential dialogue between parties, these models feature inefficiencies. Contrarily, blockchain would make data reconciliation an integral part of the transactional system, transforming the sequential models of today to efficient transactional systems where reconciliation is a part of the process of transactions.
Finally, there is reason to believe that we could see potential shifts in the financial landscape and changes to how transactions are made in the markets. The role of banking in the payment industry and as a whole is likely to change in the next decade to come. Immersed in a digital world, the youth of today will be the market participants of tomorrow, and the conservative attitude of banking will be challenged by agile new contenders offering slim lined financial services in a quick moving climate of technologic change.
References
Accenture plc – Banking on blockchain: A Value Analysis for Investment Banks
The World bank – The Global Findex database