It’s Time For Banks To Prepare For Crypto … And Beyond

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Cryptocurrencies are in the spotlight in the media. So what is it… and how should banks prepare? Marc Kenigsberg, founder of Bitcoin Chaser gives us a clue: “Blockchain is technology. Bitcoin is just the first mainstream manifestation of its potential. This blog examines the origins of crypto, why banks should take it seriously, and how to prepare for the next phase of digital currencies to come.

Bitcoin was the original cryptocurrency. Launched in the wake of the global financial crisis, its origin story is often described as a reaction to the ensuing global upheaval, a general distrust of banks and a desire (by some) to avoid them. While that makes a good story, it’s not the complete picture. Although Bitcoin was first introduced in 2009, the writing of the seminal Blockchain tome “The White Paper” by Satoshi Nakamoto began in early 2007, a year before the World Bank fell into freefall. To assume that Bitcoin was a reaction to the crisis both misses the point and diminishes technical achievement.

The challenge of double spending

So how did the whole history of cryptocurrency begin?

Bitcoin emerged as a solution to the “double spending” challenge inherent in digital currency. For decades, cryptographers have searched for ways to avoid the duplication of money held in digital format. A secure and tamper-proof centralized ledger was needed to display individual account holdings and to facilitate transactions over a private network.

The first practical solution was the Bitcoin blockchain, a cryptographically secure public ledger that records transactions anonymously on each member’s computer. In this way, all participants have access to the same data and the general ledger simultaneously belongs to everyone and no one. From a bank’s perspective, this distributed ledger (blockchain) technology is far more important than any individual cryptocurrency.

From theory to practice

One of my previous blogs explored the disruptive potential of distributed ledger (DLT) technology in the banking industry.[1] But the discussion quickly moves from behind the scenes to the boardroom. Many banks have already invested in DLT as a platform for new payment processing services, facilitating international cash transactions and providing customer loans and cryptocurrency investments.

Some banks have gone further, for example JPMorgan Chase introduced JPM Coin, its own cryptocurrency, which it mainly uses for faster money transfers and transaction settlements between customers. Specialty exchanges, such as Coinbase and Diginex, have made investing in crypto easier. With growing interest in crypto as an investment, banks need to – at a minimum – make it easy for customers to buy, sell, or hold cryptocurrencies.

Recently, two European central banks (Banca d’Italia and Deutsche Bundesbank) joined forces to work on the central bank money settlements of asset swaps based on DLT. Although the proposed solution would work in tandem with conventional systems, the scope of the project is significant: “DLT has the potential to introduce new products and services, generate additional revenue streams, reduce operating costs and to make organizational structures more efficient, said Italian central bank governor Ignazio Visco.[2]

With big banks investing heavily in DLT, banks without a plan need to consider this: start soon, or risk being left behind.

Central bank digital currencies are on the horizon

Bitcoin is just one example of a cryptocurrency, but the underlying technology is similar for all digital currencies. In the coming years, we can expect all major economies to have a central bank digital currency (CBDC) – a virtual form of the country’s fiat currency – that will work alongside physical currency. Countries around the world are at various stages of researching, piloting and launching their CBDCs. For example:

Europe already has a framework to regulate digital money US and UK are in research phase Canada is piloting digital currency Bahamas launched Bahamas Sand Dollar digital currency

CBDCs have the ability to revolutionize the speed, cost and efficiency of payments and transfers. With such incentives to succeed, investing in DLT should be a strategic priority for all banks.

An architecture for digital currency

Every bank needs an architecture for digital money. Although the standards evolve, a new blockchain protocol is available that relies on the attributes inherent in the blockchain: decentralized, encrypted, immutable and tokenized. However, the new protocol includes additional logic to facilitate regulatory compliance, including Know Your Customer (KYC), Anti Money Laundering (AML), and various privacy and data protection rules.

Banks should welcome the arrival of digital money, which heralds a new era of processing efficiency. Regulated digital money is a revolutionary architecture that is expected to be at least 40% cheaper than cryptocurrency. But the main beneficiaries are bank customers who can transact money and data directly in near real time without friction, while business users can streamline processes and reinvent the customer experience.

In this new paradigm, banks may be called upon to issue and redeem digital money, oversee governance and regulatory compliance, and protect funds. The important point is that regulated digital money is much simpler and more profitable than cryptocurrency and is quickly moving from theory to practice.

The next phase of digitization

At a time when many banks are undertaking fundamental transformations, it is essential that new platforms can adapt to the continued maturity and stored value of cryptocurrencies and CBDCs. It doesn’t require a big speculative investment now in the hope of a return later. What is needed is choosing the right component architecture that can incorporate additional cryptocurrency functionality and integration with specialized exchanges.

[1] https://www.finextra.com/blogposting/20469/distributed-ledger-technology-in-banking-friend-or-foe

[2] https://cointelegraph.com/news/eu-central-banks-work-on-dlt-based-asset-settlement

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