With the rise of cryptocurrency in the global consumer finance world, it is increasingly important to identify the benefits and risks that cryptocurrency can pose to the commercial banking and finance world.
What is ‘cryptocurrency’?
If you are like me, odds are you have heard that word “cryptocurrency” through around a lot, but never really had the time or patience to do the research and fully understand what it is. Let’s break this down, the ‘crypto’ portion of the term is in reference to cryptography—the study of secure communications techniques—and currency is simply a system of money. Put these together and you’re left with a secured system of exchanging money. The current usage of cryptocurrency, however, is more toward investment purposes. Currently, you can exchange cryptocurrencies (i.e., Bitcoin, Ethereum, etc.) on either cryptocurrency exchanges, payment services, or brokerages.
Where does cryptocurrency come from?
The history of cryptocurrency is rather cryptic—no pun intended. The first cryptocurrency, Bitcoin, was created by Satoshi Nakamoto, simple enough. However, Satoshi Nakamoto is actually a pseudonym used by the person or persons who created this crypto, wrote the bitcoin white paper, and deployed all original reference information. From there, Bitcoin mining gained great popularity among computer science aficionados. Eventually, once it had attained a certain degree of popularity and valuation, investors—recognizing the potential—began entering the market which only increased its value.
What is cryptocurrency ‘mining’?
The ‘mining’ of crypto is often where most people get confused and lose interest, but I’ll do my best to explain this. Each coin of Bitcoin, for example, has a hash, a 64-digit hexadecimal number, associated with it. All you really need to understand about hashes is that they can be randomly generated by computer programs and that Nakamoto stated there were 21 billion hashes to be mined. So, where the ‘mining’ comes in is through the generation of these hashes. Essentially, in order for a Bitcoin transaction to be verified, someone has to verify the hash. So, combining these, the miners try to randomly generate the hashes of different Bitcoin transactions in order to verify them. Once that hash is verified, it is then uploaded to the blockchain (a sort of distributed ledger). For sake of simplicity, these are the basics of crypto mining.
At this point, we have mainly been focused on Bitcoin, but there are other cryptos (or coins) that exist on exchanges. The most popular coins are Ethereum (ETH), Tether (USDT), Dogecoin (DOGE), and Bitcoin Cash (BCH). With new emerging coins, it can be tempting to blow these off and think that they are the same, so why waste your time with a new one. An example of how this thinking is wrong is the valuation systems that each crypto uses. There are certain coins marketed as stablecoins, these are usually tied to fiat currencies (government-issued currency that is not backed by a commodity). As of early 2021, nearly 57% of crypto trading was using Tether (a stablecoin). Volatility is often an important consideration when investing in crypto and can certainly affect which crypto you choose.
Crypto v. Fiat Currency
So, with the rising popularity of things like cryptocurrency and non-fungible tokens (NFTs), we are left with the question on everyone’s minds, will crypto ever replace fiat money? As with our current valuation methods, maybe. As established, there are stablecoins that have proven to—as the name implies—much more stable than coins that exist. For the original crypto, Bitcoin, we very likely won’t see it being used for anything other than investment for quite some time. (Though El Salvador did make Bitcoin an official currency form several months ago.) More abstractly, should we work to replace fiat money with crypto? Realistically, we may not have a choice. Even now, most of our money, we never actually see. For individuals, it is deposited into their checking account, and they go about using their card or buying things online, without ever even seeing the physical form. On the other side of the [bit-]coin, we see that having many different decentralized, digital forms of currency may present some hardships for government systems all around the world.
Using the information and assumptions made in the previous section, we will now carefully look at the implications that the growth of cryptocurrency could have on different areas of banking, including consumer, investment, and commercial.
For those who realized it earlier, cryptocurrencies are decentralized, that’s most of their appeal. Cryptos aren’t meant to rely on a centralized bank, government, or other intermediaries. Rather, cryptocurrencies rely on the distributed nature of blockchain. This, in particular, makes many banks skeptical to get involved. The potential growth of cryptocurrencies seems to imply the end of modern banks. Or does it? There are many crypto exchange services that are starting to emerge, so perhaps the bank as we understand it will just need to switch gears a little. Similar to now, the crypto banks will hold the crypto wallets of individuals (imagine a portfolio for all your varying cryptos). That’s from a consumer banking standpoint, looking at commercial banking, it all seems to be up in the air—no one seems to have a plan of attack.
If, after all, we cannot prevent the eventual conversion of all fiat currency-based exchange systems to some sort of cryptocurrency exchange system, then maybe it’s time to stop thinking about what might happen and start thinking about what will happen and find ways to start preparing ourselves for it.