It’s been a weird, passive-aggressive relationship. Crypto markets have been, from the outset, designed specifically to bypass the necessity of banks and any sort of financial supervision. In turn, banks initially regarded crypto as a geeky fad, then as a questionable platform for dealing in illicit activity, and, more recently, as a more direct threat to their supremacy in handling financial transactions.
Crypto was, indeed, all of those things. It still is, unfortunately, a platform for illicit activities. However, precisely because it no longer is a geeky fad, it has more recently grown to represent an increased threat to banking institutions around the world. For the past couple of years, it seems these banking institutions have been taking notes, building defenses, even sometimes hedging their bets. It will soon become imperious that they take a stand. So far, though, all signs indicate the banking system loves to hate crypto markets as much as crypto markets hates them.
The problem with banks
Banks have always been mythologized as evil, while at the same time remaining the trusted guardian of individual, corporate, national and international entities. Some of the mythology stems from 17th century early banking prejudice, or late 19th century attempts at portraying them as soulless institutions working against the common man. However, in contemporary society there are a number of very real and immediate problems plaguing financial institutions in general, and banks especially.
Accountability. This is one of the customer-facing problems that anyone will pinpoint. There are countless cases of insider trading, corrupt bankers, irresponsible financial investments and myriads of acts of misdemeanor or criminal activity connected with high-ranking banking officials. Most of them emerge with little in the way of penalties, since the system is not really designed for personal accountability.
Integrations. In an increasingly complex world, increasingly interconnected and increasingly reliant on technology, integration is key. This comes with high costs for product development, implementation etc. Failure to integrate on a single node can cascade to the next ones and affect the system. This is an issue of both cost and usability.
Homogeneity. Banking institutions all perform the same primary functions. Financial instruments are increasingly homogeneous, as are the marketing and PR associated with the banks. For customers, this translates in little incentive to shop the market themselves, instead relying on questionable third parties.
Compliance. As more and more banking institutions are now international, and as threats and levels of responsibility rise, there is more compliance work to be done. Dozens of norms, laws, regulations are in place. Bank secrecy acts, anti-money laundering regulations, all kinds of customer laws and national/international rules and guidance papers need to be minded at every step. To compound the difficulty, new technologies and participants constantly come up in gray areas of regulation.
Security. One of the more visible problems of the banking system is the constant risk of a data breach incident that would either compromise personal identification data or individuals’ financial records. Cybercrime is cheap, but the costs to the institution and the individual are incommensurate.
Third-party risk management. This is loosely connected to the topic of security, as banks are accountable for third-party vendor risk assessments and often find themselves liable for operational disruptions and/or financial damage caused by them.
Innovation Financial technology, or FinTech, describes a multitude of firms, activities, and capabilities for financial services. From the automated teller machines (ATMs) of the 1960s through today’s online lending platforms with unique algorithms for underwriting, FinTech has represented, and continues to represent, great challenges and opportunities for financial institutions
Politics. However loosely, the banking industry is connected to, and dependent on, politics. Regulations change, penalties do or do not apply, the law is not equal for all. Fluctuations in fiscal policy, data regulations, and more can greatly influence everything from data collection to interest rates and lending policy.
High, opaque fees. That the banking system is “ripping off” its customers is an old refrain. Transaction fees are not merely high; they are, in fact, very seldom clear and fair, and customers often have to conclude a transaction to be 100% percent sure of what the commission on it actually is. It is a deliberately opaque system.
What crypto has that banks don’t
With the advent of blockchain technology, transactions eliminate the need for a trusted third party, combining digital signatures with the power of P2P real-time networks to create an anonymous, irreversible ledger maintained simultaneously on all network nodes. No central authority monitors and ok’s transactions.
For the merchants, this is a godsent. The records cannot be falsified or reversed in any way, whether to forge a transaction or reverse it. On the one hand, you cannot fool the system on the factual nature of a transaction. On the other hand, if you’ve mistyped a wallet address, there is no way to get your money back by asking the vendor for a refund.
While the gold standard was in place, however relative it was, you could still claim there was a certain limited supply backed by real-world assets. With the increasingly digital character of financial transactions, there is very little in the real world to support currency creation. With cryptocurrency, there is usually a fixed circulating supply, in amounts that everyone is aware of, and a healthy combination of buying, trading and investing, supplemented by transaction fees, that maintain currency circulation outside of new currency mining.
Crypto security is not great. Digital keys get stolen, bugs get out undetected, code is insecure, wallets and exchanges get hacked. And yet, with proper security in place and with users learning what security looks like in the realm of crypto, this remains one of the more secure areas of digital trading. Aside from that, another kind of security is owner-facing: if you own crypto assets, they are, so to speak, unseizable.
Borderless transaction settlement, with efficient payment clearance and speed increased by the lack of a need for trusted third part approval, bring great immediate benefits to users, compounded by non-regulated transactions. For banks, this could chip away at their $32 trillion offshore banking market.
Because everyone operates at the same level of authority, there is no delay other than the technically-imposed restrictions of the blockchain. Banking holidays, system failure, time-zone differences between banks, transaction authorization are literally nonsensical on the blockchain. It is as if all crypto users were banking with the same bank, on the same network, in the same location.
Banking institutions, by their very nature, as well as by force of regulations, rely on user identification and authorization. It is one of the security mechanisms that allow it to prevent fraud, track transactions and ownership, monitor various indexes, localize services etc. Blockchain technology allows for transaction visibility, but not owner visibility. It takes very sophisticated digital policing mechanisms to untangle crypto ownership. While institutions dislike that level of transparency, often with good reason, users may find it useful, whether their concern is criminality, censorship, moral issues or anything else.
No fractional reserve banking
A disputed, but common practice of contemporary banking institutions, fractional reserve banking allows financial institutions to hold only a fraction of their deposit liabilities, or only have a fraction of their deposits backed by cash. This allows banks to lend well beyond what they actually hold and enables an insecure system that perpetrates risk while admittedly encouraging business and innovation. Crypto, on the other hand, only relies on currency that actually exists.
Crypto is speculative, volatile, non-transparent. Certain regimes are attempting to ban it altogether. And yet, it is a serious concern to banks, some of which seem to be already buying into the potential not just of blockchain, but of cryptocurrency itself (think only of Circle). The success of PayPal and Venmo shows users are desperate for alternatives, even when they are not cheap and not fast. Fintech is pushing for more radical change in how financial transactions are conducted.
However, most of these solutions are so far still relying on banks as middle men, as the more established, better insured actors on the market. But crypto is gaining in visibility, market cap, and overall potential. What’s more, retail mammoths are potentially the next big thing that might happen to crypto. It is not in the realm of impossibility that Amazon decides to allow crypto payments, or even create their own digital currency. The riskier traditional markets prove to be, the more credible the alternative.