Are Cryptocurrencies a Threat to Banks?

In this post I want to talk about an extremely popular topic, at least in the crypto space- and that’s whether or not cryptocurrencies pose a threat to banking institutions.

Even though our current financial system has many flaws and they need to be fixed, it’s an extremely complicated process and as banks play a vital role in this system, they cannot be easily replaced.

Sadly, a huge number of crypto-enthusiasts cannot see objective reality and many of them are confident that decentralized currencies alone can make major banking institutions obsolete, and in a short amount of time. And by decentralized cryptocurrencies I mean only those, that first of all, should be transferring value. So, they must be usable as a medium of exchange, store of value and unit of account. Note that it’s different from other comparisons like blockchain vs banks, which is a much wider topic , or decentralized currencies against fiat currencies. I’m going to talk specifically about the impact that truly decentralized cryptocurrencies may have on traditional banking.

When talking about banks , it’s important to distinguish the difference between two different groups of banking institutions: central banks, such as Federal reserve and private banks, such as JP Morgan or bank of America.

In order to replace or at least compete with them, the alternative solution must be able to fight with the same problems that current banking system is trying to solve, but in a more efficient way.

Let’s begin with Central banks. Structure of central banks differs from to country to country, but their job is pretty much the same. A good central bank should be able to:

Avoid hyperinflation

Avoid economic depression

Sustain a steady economic growth with a low rate of inflation

Of course, it’s much easier said than done, and central banks have failed to do their job many times, even in the most developed countries, and even when they were trying to do their best. Not to mention some of the obviously corrupt ones in 3rd world countries, that use their power only for personal financial interests.

Countries with exceptionally incompetent and corrupt central banks are places where using decentralized cryptocurrencies really makes sense. If people lose trust in their national currency, crypto begins to look very appealing, as it’s not controlled by their corrupt government and is a relatively better store of value than available fiat options. Hyperinflation in Venezuela is the most famous example of how a cryptocurrency can be very useful.

But can it really compete with more or less effective central banks of developed countries? Well, hyperinflation is not a big threat as cryptocurrencies have either a finite supply, or an unlimited supply with a predefined inflation rate that significantly lowers with time.

On the other hand, a deflationary currency is not capable of stimulating a steady economic growth, as it encourages saving instead of spending. A monetary policy that can’t adjust to specific economic conditions is quite problematic.

Of course, one day, we might have a decentralized cryptocurrency with proper decentralized governance that effectively adjusts the monetary policy to different economic conditions, or in a more distant future we will do well even with a fixed supply without any intervention. But until that point, central banks are still needed. What’s really great about cryptocurrencies is that they offer an alternative, for anyone who doesn’t want to rely on policies of central banking institutions.

Hopefully, the blockchain infrastructure will make central banks as decentralized as possible, but that’s a different subject for discussion.

Now about private banks, are they threatened by cryptocurrencies? Well, privately held banks offer a huge variety of complex financial services, and cryptocurrencies can compete with only several of them: mainly deposit accounts and wire transfers.

I don’t think many people from developed countries prefer to store wealth in volatile cryptocurrencies rather than in tried and tested bank accounts. It’s much more likely to gain popularity in developing countries, and it’s already doing that.

Surely, the ability to have complete control over your funds is revolutionary , but stability is more important for almost everyone. So, until crypto is much less volatile, it’s unlikely to be a big threat to deposit accounts.

Wire transfers, on the other hand, are certainly a thing of the past, and for transferring value, cryptocurrencies are already better than existing intermediaries in many ways.

Anyway, private banking institutions can just trade cryptocurrencies as they are currency agnostic. Basically, the only category that would be in serious danger are commercial banks that mainly rely on deposits.

A much, much more interesting topic to discuss would be whether or not a blockchain-based economy can make current banking obsolete , and I think that it has a fairly big chance of doing that in the long run.

Thanks for reading!