By Ronald Salmond Jr
Cryptocurrency is the latest stage in monetary evolution. Even without a legal and enforceable definition as money, digital currencies are at the center of what could constitute a revolution in the financial space as we know it. The growth of a worldwide cashless society is driven by digitalization of consumption and is a major force to be reckoned with. From commodities to precious metals, paper currency and credit, cryptocurrencies cannot be ignored as money continues to shapeshift and mutate along its evolutionary path.
When bitcoin was created a decade ago, it was easy to dismiss it’s potential. Since then there have been several write-offs on the future of cryptocurrencies as their volatility leads to continual catastrophic crashes. In fact, the current record holds ‘Bitcoin deaths’ at 326. However, cryptocurrencies have proven staunchly resolute in the face of open opposition from traditional finance moguls like Jamie Dimon and Warren Buffett. It is therefore understandable why cryptocurrencies pose an inherent threat to the current financial set up.
Crypto Vs Fiat
There is no doubt that fiat is also susceptible to unpredictable volatility. Yes, it is true that cryptocurrency prices can drop by half their face value in a matter of days or even hours in a worst case scenario, but this is a totally different form of instability than that of fiat. The cryptocurrency market is still a rapidly developing sector and with the implementation of proper security measures and strategies to manage volatility, this recurring flaw can be fixed.
Throughout time, the means of exchange were typically backed by some tangible item with real life value, but the same cannot be said for fiat as we know it today. Technically, fiat are as strong as the faith that people have in them. In simple terms, they are ‘backed’ by a country’s debt. This means that when a country is unable to repay its debt and takes the recourse of printing more money, it can lead to hyperinflation and a devaluation of the actual currency. Venezuela, post-war Hungary and Zimbabwe, which just had its 58th inflation crisis on record are fantastic case studies of untethered fiat gone wrong.
A look at global financial crises over the last 40 years exposes a critical flaw within fiat that could collapse the world economy all together. The centralization of money appears to expose fiat currency to the abuse of corruption and malpractice that has been demonstrated to have far-reaching effects on citizens reliant on sovereign currency as a way of obtaining essential goods. As many will recall, the 2008 global financial crisis was triggered by a series of US government pro-bank regulatory policies which allowed banks to play fast and loose with cash and debt. The party came to a crashing halt Wolf of Wall Street style when Lehman Brothers kicked off a global meltdown and liquidity crisis which ended up being what is considered the worst financial crisis since the great depression in 1930.
Thanks to blockchain’s immutable distributed ledger, cryptocurrencies are safe from the issues described above. Naturally, cryptocurrencies are not subject to inflation as the number of tokens released to the market are always fixed. Bitcoin for example, intends to create only 21 million tokens and the total supply will be complete once the last token is mined. The implication of this is that eventually, through high demand and fixed supply, bitcoin should retain its value better than fiat currencies.
Bitcoins are also generated through a democratized process of solving complex computational tasks. As such, there is no entity holding or distributing them. This decentralized of currency creation ideally should make bitcoin, as a currency, free from manipulation. Of course, there are some kinks in this ideology. Take for example, the fact that an overwhelming number of bitcoins are mined in China, or the fact that a handful of powerful mining pools are behind the mining of bitcoin, validation of blocks, and collection of rewards for the effort of supporting the network.
These all sound quite centralized and similar to the production cycle of fiat currency but cryptocurrency does carry the promise of providing a shift in the financial system by knitting a strong fabric whose backdrop can provide for the development of strong, universally accepted, global currencies that are agnostic to nationality, borders and capital controls levied by partisan financial regulators.
Crypto-banking could be the future
The unique form in which cryptocurrency exists (as encrypted algorithms) allows the assets to be generated and kept online. Cryptocurrency users create wallets which are allocated unique, anonymous addresses to store coins. Alternatively, cryptocurrency exchanges also allow users to trade and store their assets in the exchange's hot wallet or cold storage. When transacting and trading dominated as the main use case for cryptocurrency use cases, cold, hard, and hot wallets were sufficient. However, the continual growth and evolution of the cryptocurrency industry has created a need for increased functionality. Hence, the requirement for crypto-banks.
Crypto-banking could revolutionize the crypto-sector as its secure wallets, smart contracts, dApps, and distributed ledger technology provide features that go above and beyond basic wallet services. These banks are essentially decentralized versions of traditional banks and are powered by blockchain technology. Dedicated blockchains built for crypto-banks act as the point of ‘authority’ and this means crypto-institutions like Datarius, Crypterium or the European Crypto-bank are able to self-execute a range of functions through the blockchain.
An immutable blockchain-based bank account with unlimited access
The same technology that underpins bitcoin is now being utilized by crypto-banks to solve some of the long-standing financial problems that plague the traditional banking sector. In fact, one of the most upsetting aspects of traditional banking is the the inability of bank account holders to truly exercise full control over their funds.
Yes, banks provide account statements to members but there are heaps of stories highlighting how difficult it can be for customers to retrieve their funds under certain extenuating circumstances. For example, in some cases of claiming an inheritance left by a deceased, it could take months if not years of costly bureaucratic processes to access assets held in banks and often times lawyers are required to mediate conflicts between account holders and financial institutions. Add to this the fact that banks lend out depositors' money in order to generate profits, a practice that would quickly be shut down by the U.S. Securities and Exchange Commission and labelled as "wash trading" in equities markets.
Contrast these frustrating experiences with cryptocurrency and one will begin to see the advantage and necessity of crypto-banks. Cryptocurrencies are kept in wallets owned and controlled by users and when left on an exchange, the exchange has no access or authority over coins on the platform. Their job is to simply facilitate crypto-to-fiat and crypto-to-crypto exchanges and provide secure wallets for users to deposit their coins.
Crypto-bank users have absolute control of their digital assets and they can conduct transactions at any time. Crypto-banks also have a high cap on transactions. Users can send relatively high transaction amounts which provides the the convenience to conduct large transactions that would attract the attention of the FBI and other regulators in the traditional sector.
The World Bank reported that remittance of funds to low and middle income countries reached an all-time high in 2017, which equates to an 8.5% increase from $429 billion in 2016 to $466 billion in 2017. Overall global remittances including high income countries also improved by 7% from $573 to $613 billion in the same period. The World Bank also projected additional increases of 4.1% and 4.6% in the respective categories in 2018.
These statistics show that with the appropriate infrastructure, an increasing amount of funds could be sent across borders, but the current issue is that traditional banking limitations hinder scaling to cater for rapid growth of remittances.
Traditional banks generate a great deal of income through bank fees. Every single transaction has fees attached to it from overdrafts to ATM withdrawals, domestic and international transfers and even account maintenance come with a fee. Users have become accustomed to incurring fees but it also seems that each year the fees are becoming ridiculously high! There also is the aspect of hidden fees which are covertly levied against account holders as there is little transparency to the various processes used by banks. This could further raise the involved fees significantly.
Blockchain networks usually set base transaction fees which are often minimal. This is because payments are direct and do not have long processes that incur costs. Blockchain transactions through crypto-banks are published on the public ledger and anyone is able to scrutinize transactions as they are 100% transparent which eliminates fraud and any hidden charges.
It is worthwhile to note that banks themselves verify and audit processes. This generates costs on their end and these are passed on to the customer. Blockchain on the other hand keeps records and conducts audits of on-chain activity at no extra cost.
Long transaction times
Everyone loves it when banks notify them that their accounts have been credited, especially after long fidgety days of uncertainty. Everything could be a lot easier and less stressful if funds could make it to the account as soon as they were approved by the sender. At the moment, this is technically difficult for traditional banks which may not have yet piloted Ripple’s blockchain products.
When making traditional wire transfers, users don’t hand out cash directly. Customers make requests to their bank to transfer funds to users in another banks or the same bank in different locations. The bank approves transactions once checked against the issuing account then make a back-end settlement with the recipient bank. This normally takes about 2 business days.
This demonstrates that traditional banks do not provide users with absolute access to and control of their funds. On the other hand, owners of cryptocurrency always retain full possession of their funds and can directly send funds to desired wallets whereby transactions are instantly completed. In a matter of seconds, at most a few minutes, funds are deposited to recipient accounts.
As technology grows, bad actors get better. Hackers have developed an arsenal of weapons that they deploy against unsuspecting users and vulnerable computers, mobile phones, websites, email accounts, and corporate user databases. Hard hacks, phishing, ransomware and DDoS attacks and exploits of vulnerabilities in various code allow hackers to deftly compromise systems and steal user identities, funds, and other valuable personal and financial details that can sold for a profit on the dark web. Also, third parties, such as bank personnel who have access to personal data can sell or criminally use account data to their own benefit. This vulnerability and high risk is a result of accessible personal data that openly identifies customers.
Cryptocurrencies use encryption methods that ensure wallet addresses cannot be linked to users. Even better, wallet addresses change after every transaction. This is a further security implementation from two-factor authentication (2FA) on wallets which help secure them to make wallets impossible to hack into.
Not long ago, traditional banks were more alluring because of loan services which сryptocurrencies couldn’t offer. However, сrypto-backed loans are steadily on track to become a more mainstream and disruptive form or raising capital.
Loans issued from crypto-banks are often faster to process and come with much lower interest rates. More importantly, Crypto-banks are objective in their criteria for loan issuance as opposed to their subjective counterparts. Customers seeking loans from traditional banks could face alienation, variable rates based a series of subjective factors and international financial regulations could also prevent some applicants from being considered as loan candidates.
As сrypto loans are a relatively new service, there are few entities in the market who offer them. BlockFi allows crypto owners enjoy liquidity while ‘hodling’ coins to reap gains from future price appreciation. BlockFi borrowers have to stake their assets in holding wallets which they are unable to withdraw from before they receive a loan. This comes as a double benefit as digital currencies that use Proof of Stake (PoS) consensus to mine coins reward users who hold a given number of coins.
Other early bird startups making headways into the сrypto-lending field are FotonBank and Aurora. Similar to BlockFi, each offers loans which require the staking of digital assets as collateral. Foton employs a personal credit system which gauges and underscores individual credit worth through user activity. Credit ratings are also complemented by a reward system which scales up ratings for users who participate in the improvement of the network.
Furthermore, this process of impartial lending allows users to progressively build their reputations and credit worthiness as they borrow more and pay back their balances. This objective method of issuing loans is also replicated in Aurora’s approach as the company uses identity services such as uPort, KYC attestations, and risk algorithms to come up with impartial customer credit ratings. The benefit of these processes being integrated into the lending process is the removal of human influence which creates bias in traditional banking. Crypto-banks could truly function as fair lenders that securely and quickly get money to those who need it.
Generally, crypto-banks offer a suite of services which eliminate the issues that have become endemic to traditional banks. Among them are payment gateways, currency exchange, and virtual bank services. Crypto-banks like Aurora and Foton offer a combination of these three services. One operates a single decentralized capital that offers loans via a platform specific stablecoin called Boreals whereas the other offers more diversification in its banking functions.
Accounts can be configured as either personal or business accounts and users have the unique choice of operating a white or black account. Black accounts are anonymous with daily transaction limits to comply with the EU Anti Money Laundering (AML) laws. White accounts on the other hand are subject to know-your-client (KYC) verification which provides for lower commissions and unlimited transactions.
The unique thing about crypto-banks is they can run open source blockchains which integrate with other networks through decentralized applications (dApps) and there is also the option to connect to the platform exclusively through smart contracts.
Heavyweights leading the pack
While crypto-bank startups like BlockFi, Foton, and Aurora show great promise, the crypto and traditional financial sector old timers are not just watching from the rafters. Coinbase, the biggest cryptocurrency exchange by trading volume in the US, is reportedly seeking a federal banking charter to enable it increase its banking features to become the cryptobank standard. Other powerful crypto establishments on the road to becoming crypto-banks and crypto-lenders include Binance and Litecoin Foundation.
Japanese financial giant SBI Holdings also recently developed the world’s first bank-backed crypto exchange and on July 17, 2018, the bank opened its doors to Japanese nationals aged 20 to 70 years. Less than a month later the bank began accepting members over 71 due to what it described as ‘high demand.’ A host of other financial institutions have also taken notice of consumer desire for such products by beginning to develop regulatory frameworks that will broker greater cooperation with cryptocurrency exchanges.
Research throws its weight behind the need for crypto banking
According to a research project conducted by Deep Knowledge Analytics, Big Innovation Center, and DAG Global on ‘Blockchain in UK Industry Landscape Overview 2018’, the UK is positioned to become a major blockchain hub by 2022. DAG Global CEO Sean Kiernan personally believes that “the gap between the two worlds of traditional finance and crypto economy remains, but in the coming years we can expect this to lessen and eventually disappear.”
Another study dubbed ‘Cryptocurrencies: Overcoming Barriers to Trust and Adoption’, commissioned by eToro and authored by Professor William Knottenbelt found that “Bitcoin and blockchain technology could do to banks what cell phones did to telephone poles.” Ultimately, it is Deutsche Bank analyst Jim Reid who doesn't mince his words by firing a fully loaded shot across the bow by criticising the inherent instability of fiat. Reid comments on the relationship between central banks, governments and the traditional financial system by saying,
“[governments)] are forced to prioritize low interest rates and nominal growth over inflation control which could herald in the beginning of the end of the global fiat currency system that began with the abandonment of Bretton Woods back in 1971."
As blockchain technology continues to develop and cryptocurrencies become a more familiar part of every consumer's day to day activities, the need and available space for their use will continue to increase. Given the multiple shortcomings of the traditional banking system, it’s safe to assume that today's banks work only because are the only option available. However, with the entry of the far more efficient and equitable customer-oriented banking options offered by crypto-banking if presented properly, could become the future financial model for banking.
About Ronald Salmond Jr: Educator by day, crypto zealot at night. I scour charts, swing trade and ponder blockchain’s ability to transform cities, commerce and the entire banking system as we know it!