The Effect of Cryptocurrency on the Banking System

Abstract

What implications will cryptocurrency have on current banking systems?  The invention of cryptocurrency and its subsequent adoption may have a significant impact on banks and financial systems.  Cryptocurrency adoption has grown significantly since the creation of bitcoin in 2009.  Today, cryptocurrency adoption is substantial, and many reputable companies are involved in cryptocurrency.  Government regulation may mitigate some of the effects of cryptocurrency on the current banking system.  The adoption of Central Bank Digital Currencies may change and minimize the impact of cryptocurrencies on the current system.  Banks may adopt the new technology and offer cryptocurrency products and services.  In an extreme scenario, cryptocurrencies may completely disrupt traditional banks and banking systems.

Cryptocurrency and the Banking System

Cryptocurrency was invented in 2009 with the creation of bitcoin by an unknown engineer with the pseudonym Satoshi Nakamoto.  Cryptocurrencies are entirely digital and decentralized – no state or central authority supports cryptocurrencies (Burlacu, 2021).  The decentralized nature of cryptocurrencies is made possible through the innovation known as the blockchain.  The blockchain is a public database (or ledger) that contains records and details about cryptocurrency transactions (Nicoleta, 2021).  The blockchain database is copied and updated on all of the computers on the cryptocurrency’s network.  This distributed network creates both trust and redundancy.  Most cryptocurrencies are open source, so anyone can become part of the blockchain network by running software on their computer or other devices (Raj, 2019).  Since the blockchain database has so many copies that are the same, it is nearly impossible to introduce a false version of the database without detection.  Also, the distributive nature of the blockchain database means that it does not rely on any central authority, and it does not have any single point of failure.  What implications will cryptocurrency have on current banking systems?

A Brief History of Cryptocurrency and the Current State of Adoption

Cryptocurrency adoption has evolved since the recording of the first bitcoin transaction was made on January 12, 2009 (Raj, 2019).  Bitcoin, being the first mover, has the highest adoption rate of any cryptocurrency.  Bitcoin accounts for a substantial percentage of the entire cryptocurrency market.  Early adopters of bitcoin included tech-savvy individuals who were able to see potential early on.  Later, bitcoin became popular with libertarians who viewed cryptocurrency as a possible method to avoid central government and corporate power.  Today, bitcoin and other cryptocurrencies are seen by many as a method to store value and a valid alternative to traditional fiat currency.  The financial press routinely reports on bitcoin’s value, and many high-profile public companies use cryptocurrencies as a basis for innovation and profitability. Approximately 2% of financial institutions are currently interested in offering crypto-related services (Shelvin, 2021).

Cryptocurrency Regulation can Mitigate the Impact

The nature of cryptocurrencies puts it at odds with the traditional, centralized banking system.  Traditional banking systems rely heavily on banks and on a central government that can control fiscal policy.   Since cryptocurrency is outside of the control of any single entity, there has been speculation that governments will heavily regulate or even outlaw the use of cryptocurrency.  These concerns have eased somewhat because governing bodies like the US Security and Exchange Commission (SEC) have indicated that they intend to enact regulations to protect investors (Gura, 2021) instead of implementing laws that severely restrict cryptocurrencies.  If heavy regulation is enacted, however, the adoption of cryptocurrencies could be hampered, minimizing the impact of cryptocurrency on the existing financial system. 

Central Bank Digital Currency Implementation

Government-sponsored alternatives to cryptocurrencies are called Central Bank Digital Currencies (CBDCs) (Broby, 2021).  The digital nature of CBDCs gives them some of the advantages of cryptocurrency while avoiding decentralization and anonymity.  There are privacy concerns with CBDCs since the currencies can be programmed to track all transitions and gather consumer purchasing data.  CBDCs could be programmed to restrict purchases to certain items and even collect taxes automatically during transactions. Some governments are attracted to the potential for enhanced power over financial systems and consumers.  Government adoption of CBDCs could ensure that an evolved form of banks and the central banking systems remain strong.

Acceptance of Cryptocurrency within the Traditional Banking Industry

As stated previously, approximately 2% of financial institutions are investigating cryptocurrency services.  Large financial institutions like Fidelity and Bank of America are facilitating the trade of financial instruments that mirror the value of bitcoin and other cryptocurrencies.  The banking industry is accustomed to change and has been evolving since 1472 (Broby, 2021). To date, however, most large and small baking institutions have not fully embraced cryptocurrency.  Some companies such as Coinbase, PayPal, Square, and others are capitalizing on the need for cryptocurrency exchanges and services such as crypto credit cards (Forbes, 2021).  The demand for these services will likely increase if the cryptocurrency adoption rate trend continues.  The existing banking industry may capitalize on its strengths and financial stability to profit from cryptocurrencies.  Offerings could range from trading and lending cryptocurrencies to enhanced services and rewards (Forbes, 2021).

Complete Disruption of Traditional Banking

Since the original intent of bitcoin and other cryptocurrencies is to remove the need for banks and a centralized financial system, the impact on the existing systems could be severe.  In the extreme, traditional banking systems might collapse if consumers avoid using fiat currency in mass and rely solely on cryptocurrency for purchases and as a store of value.  Cryptocurrencies can be sent, received, and traded directly without the need for a third party.  Cryptocurrency users can store the currency locally in cold wallets without the need for banks to provide security. Mass adoption of cryptocurrency could significantly impact financial institutions because many of the traditional banking services they provide will become obsolete. 

Conclusion

The invention and adoption of cryptocurrency and blockchain technology have the potential to disrupt the current banking system.  The adoption rate of bitcoin and other cryptocurrencies is increasing.  Stringent regulation of the cryptocurrency could slow its adoption and mitigate any disruptive effect on banking.  The creation and implementation of Central Bank Digital Currency might also reduce the impact of cryptocurrency.  Banks may offer new crypto services and products that will allow them to profit from cryptocurrency.  An extreme scenario is that cryptocurrency could entirely disrupt the banking system by rendering it obsolete.

References

Broby, D. (2021, June). Financial technology and the future of banking. Financial Innovation, (7,1), 1-19

Gura, D. (2021, August 20). Tougher rules are coming for bitcoin and other cryptocurrencies.  Here’s what to know. NPR. https://www.npr.org/2021/08/20/1029436872/tougher-rules-are-coming-for-bitcoin-and-other-cryptocurrencies-heres-what-to-kn

Nicoleta, V. B. (2021, June) Cryptocurrencies, money of the future or the future of money. EIRP Proceedings, 6(1), 286-290

Raj, K. (2019) Foundations of blockchain: The pathway to cryptocurrencies and decentralized blockchain applications Packt Publishing. https://web-b-ebscohost-com.libauth.purdueglobal.edu/ehost/ebookviewer/ebook/bmxlYmtfXzIwMTM4NzJfX0FO0?sid=9d1347c9-006a-4919-ba45-9ad5db39bdbf

Shelvin, R. (2021, April 19). The coming bank bitcoin boom: Americans want cryptocurrency from their banks?Forbes. https://www.forbes.com/sites/ronshevlin/2021/04/19/the-coming-bank-bitcoin-boom-americans-want-cryptocurrency-from-their-banks/?sh=236702a24908

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