The Strategist

Are blockchain and cryptocurrencies a danger to banks?

04/03/2018 - 10:15

Blockchain and cryptocurrencies are changing the global financial system, making it more international and less centralized.

Nobody knows how this will affect such traditional economic institutions as banks, pension funds, exchanges, public financial authorities. Some of them will take advantage of new opportunities and will succeed, but some may find themselves out of the job.

If we talk about traditional exchanges, their situation seems to be lasting. Since December 2017, the Chicago Mercantile Exchange and the Chicago Stock Exchange have been trading bitcoin futures. This is an example of successful cooperation of old exchanges and a new asset. Stock exchanges do not yet sell such assets, but they have their own solid niche. This is trading in shares of companies and other securities with high guarantees of investment protection of the investor.

On the other hand, cryptocurrency is extremely volatile and generally prone to growth, but risky. Shares are more conservative, but reliable investment. They give the investor the right for a stake in a company, and their acquisition requires complex legal procedures that are best provided on stock exchanges. The cryptocurrency market does not yet provide such an opportunity.

The situation of banks was less certain in the new situation. After all, their work is tied to the movement of money, and crypto-currencies pretend to be the role of new money.

Crypto-currency transfers have no boundaries and their commissions are sometimes radically lower than banking ones. They are easier to use faster, no legal formalities are required from the transfer participant, no need to report on the appointment, etc.

Development of new technologies such as smart contracts allows transferring one-time payments and complex financial flows between large companies to cryptocurrency. Many people still associate smart contracts with the Ethereum currency, but now they are being introduced in other crypto-currencies including Bitcoin (RSK project). 

The situation is already changing. Some countries such as Japan have already recognized crypto currency as a means of payment. In many other countries, more and more services accept crypto currency. The market of exchangers is also expanding, the competition between them is reducing commissions and raising reliability. Sooner or later, crypto-currency transfers will be preferable to modern banking ones.

How can banks stay afloat in this situation? They should radically simplify and speed up operations, reduce bureaucracy, and lower commissions. To compete with crypto-currencies in the future, the main difference between banks should be reduced to the formula: "Not anonymous, but as reliable and convenient and cheap as possible". And competitor's weapon, the blockchain technology, would be very useful for this to happen.

Already 10 large banks - Barclays, Credit Suisse, Deutsche Bank, Santander, etc. - are actively experimenting with blockchain and even developing their own USC (utility settlement coin). This currency will radically differ from Bitcoin and other classical crypto-currencies by its centrality. However, it will retain most of the technical advantages of the crypto currency.

In addition, some of the already existing crypto-currencies can already be integrated into the banking system. For example, Ripple and Stellar, which can work as "cryptorails" not only for their XRP and XLM tokens, but also for other currencies including national ones. The main disadvantage of Ripple is centralization and opacity: the system is developed by a private company Ripple Labs, and it is unlikely that banks will be comfortable to depend on it. Stellar is a decentralized analog of Ripple with open source. But, perhaps, USC will satisfy the needs of banks more fully than all existing analogues.

Of course, this transition will not be easy, and success is not guaranteed. Many banks are pessimistic. JPMorgan Chase, Bank of America and Goldman Sachs openly acknowledge that crypto-currencies threaten their competitiveness. And, for example, Barclays promised to start accepting Bitcoin back in 2015, but in reality is threatening to close accounts of those who uses bitcoin. This highlights uncertainty of banks in the future victory.

By and large, the challenges of blocking banks are not new. Any new invention encroaches on old technologies. In some cases, old companies fail to compete and are replaced by new ones. In other cases, they are modernized and move to new track. For example, appearance of cars drove the majority of horse-drawn carriages out of the market, but turned out to be more humane to the manufacturers of coaches and other wheeled vehicles. For example, the Hungarian bus giant of the XX century Icarus began its work in 1895 as a coach-blacksmith workshop. Boeing and IBM also implemented a lot of innovations for their age-old activities, although there is almost nothing in common between their first products and modern models.

If the blockchain technology is similar to an internal combustion engine, what are banks like - equestrian plants or manufacturers of carriages? Is it enough for them to insert new engines or they have to reinvent their business? That is the question.