How would the Financial Industry adopt Cryptocurrencies?

The concept of cryptocurrencies and blockchains was first introduced in 2008, by Satoshi Nakamoto’s white paper, indicating the requirement for a neutral peer-to-peer electronic currency system. Shortly after Bitcoin was introduced along with blockchain technology, supposedly eliminating the need for a third party during digital transactions.

Why banks defy the rise of cryptocurrency

Cryptocurrency enthusiasts claim that fiat currencies will be replaced by cryptocurrencies in the recent future. Banks and financial authorities are wary of such claims. Consequently, the financial services sector’s general overview of cryptocurrencies is not a very positive one. Cryptocurrencies affect the core business of commercial banks because customers are liquidating savings & deposits to invest in cryptocurrencies. Some governments such as China have even banned crypto usage & mining. Many other governments have enforced some limitations for cryptocurrencies. However, regulation of cryptocurrency is an extremely complex task due to its decentralized nature.

KYC procedures and other regulations surrounding the financial services sector have helped identify & terminate many illegal activities. However, the inherent properties of cryptocurrencies have enabled a tool for money-laundering.

The price volatility within the crypto market also discourages traditional FSPs to endorse cryptocurrencies as a reliable tender, investment vehicle, and general store of value.

Still, no one can deny that blockchain, the underlying technology of cryptocurrencies is a significant milestone in the history of Fintech. Blockchains provide top-level security for cryptographic assets such as Cryptocurrencies, Smart Contracts, Non-Fungible Tokens (NFTs), Utility & Security tokens, etc.

Nevertheless, in 2021 more than a decade later, it is abundantly clear that both banks and cryptocurrencies could co-exist in a digital economy. Some banks and a few governments around the world are working to regulate and make better use of cryptocurrencies.

Banks as a custodian for cryptocurrency-related services

In the absence of a regulatory body, crypto consumers are responsible for the storage and safety of the cryptographic assets in their possession. Cryptocurrency holders usually store their coins in exchange platforms or digital wallets. Crypto exchanges have been reportedly hacked from time to time which casts doubt on their security. On the other hand, wallets offer the user much more control in maintaining their assets. But, theft or loss of passwords & cryptographic keys could mean the loss of their assets.

Banks could offer custodian services such as holding cryptographic keys on behalf of customers and provide wallets & storage services. This could mitigate security risks for customers and add a new revenue-generating business model for banks. A 2020 report in the World Economic Forum (WEF) unveiled Deutsche bank’s plan to develop a fully integrated custodian platform for digital assets bridging the gap between conventional banking and cryptocurrency.

Banks & financial institutions could use their existing channels to educate and onboard new cryptocurrency investors. Banks can offer brokerage services to advise new & less experienced investors who would otherwise incur losses. The endorsement of cryptocurrency by reputed banks and financial institutions may enhance its legitimacy in the clients’ mind.

Banks can offer financial instruments and securities based on cryptocurrencies. In doing so, a customer can indirectly invest in cryptocurrencies as the bank would also share a portion of the risk.

Banks could partner with crypto exchanges and add certain restrictions and KYC checks, especially before trading fiat currencies to cryptocurrency. If an industry standard is developed and adopted by a few big exchanges, most others will follow suit.

Banks could invest a slice of their balance sheet in cryptocurrencies as a hedge against inflation & devaluation of fiat currencies and further diversify their portfolios with this new asset class.

The creation of cryptocurrency is a significant breakthrough in the evolution of Fintech. The idea that fiat currencies and the current financial system are at risk due to cryptocurrency & blockchain technology is a misconception. If banks continue to avoid new Fintech developments, it will drive a wedge between a bank and its customers. Several banks have already accepted the significance of cryptocurrencies, including reputable banks such as Barclays, Goldman Sachs, & Deutsche bank. Many other financial/non-financial institutions in different parts of the world are adopting cryptocurrencies as well. The combination of the highly regulated & centralized banking sector and the decentralized & diverse crypto world will soon bring forth a new era of banking.

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