Banking Article, Banking Finance 2020, Banking Finance April 2020

Blockchain Technology: Will it change the way we Bank?

Block Chain is a computer program that carries time specific data which is distinct and cannot be modified. This data is controlled by a cluster of computers and is not owned by any single entity. The data is carried in blocks and is linked to each other using cryptographic principles (Chain). The salient points of Block Chain is that the data is not central, is transparent and is open for everyone to see. A blockchain has no transaction cost (although infrastructure is required to support the functioning of Block Chain) also block chains can be used for carrying any kind of data may be financial or non financial. Of all the purposes for which the block chain has found uses, the impact on financial domain has been the most effective. The concept of block chain is such that the data on any block cannot be modified on an standalone basis and if the data on any block is modified than the data on all the blocks gets changed and since the data is verifiable on many systems such a change would easily be detected hence for all practical purposes the integrity of data on a block cannot be tempered with.

Block Chain has the potential to disrupt the way we do business and it could practically lead to the elimination of third parties and connect the seller directly with the buyer and with the transaction costs being negligible the overall costs could come down drastically and lead to better efficiency. The scope of block chains is enormous however we would limit ourselves with the study of impact and potential of blockchains on financial sector which is the scope of this reading.

The phenomenal rise of Bitcoin with its peak at $20000 had had everyone including Investors and Regulators astounded alike. The investors were exposed to the huge potential offered by the these investments  and regulators suddenly woke up to the challenges and opportunities posed by these new form of virtual currencies which had the potential to uproot the authority of the central banks as the issuer of  currency and overhaul the financial system.

The advent of disruptive technology and its acceptance has thrown many challenges and opportunities in so far as the financial ecosystem is concerned. In hindsight we know that in the digital age we need to embrace technology and work with it to develop a more inclusive and efficient financial system but the sudden surge of crypto currencies and their acceptance has caught the government agencies napping and like all the good initiatives the use of virtual currencies is now associated more with the grey market, terrorism and crime. The end result is that instead of focusing on developing the crypto currencies and harnessing its potential we are more focused on how to prevent its misuse.

In recent years after the initial success of Bitcoin there has been a number of virtual currencies like Dodgecoin, Etherum and others however all of them seem to derive their value through Bitcoins. Blockchain Technology or Virtual currencies or crypto currencies are mined though a computer program through the use of high capacity computers and the quantity of the virtual currency that can be mined is dependent on the underlying computer program. The most valued currency of all Bitcoin is limited in numbers and can be mined only upto a specific quantity which is the reason why there has been such an increase in its value. The more bitcoin is minded the more difficult it becomes to mine the subsequent unit of it. Some other currencies that can be mined unlimited number of times limits the appreciation that can be gained because the currency is unlimited.

Beginning with the largest, the top 10 crypto currencies are currently Bitcoin ($BTC), Ethereum ($ETH), XRP ($XRP), Bitcoin Cash ($BCH), Tether ($USDT), Litecoin ($LTC), EOS ($EOS), Binance Coin ($BNB), Bitcoin SV ($BSV) and Stellar ($XLM). The aggregate value of the top 10 crypto currencies (as of 8th October 2019, 14:00) is $194bn which is a decrease of $88bn since 8th July 2019.

  1. Bitcoin (BTC) $147.3bn
  2. Ethereum (ETH) $19.4bn
  3. XRP (XRP) $11.7bn
  4. Bitcoin Cash (BCH) $4.1bn
  5. Tether (USDT) $4.1bn
  6. Litecoin (LTC) $3.6bn
  7. EOS (EOS) $2.9bn
  8. Binance Coin (BNB) $2.4bn
  9. Bitcoin SV (BSV) $1.5bn
  10. Stellar (XLM) $1.2bn

The benefits of virtual currencies are many including ending the dispute of artificial promotion of exports by some countries by devaluing their currencies. The world could become one financial nation with the same currency and it could solve the problem of exchange rate fluctuations and could facilitate inter movement of goods between countries and reduce tariffs.

Bank’s earn their income by the net interest margin between the cost of deposits and the rate on advances. Though there are many other streams of revenue of banks the primary source of income is by way of commission be it in core activity or in ancillary activities like cross selling. The use of blockchain technology with its zero transaction costs could change the financial landscape forcing banks to adapt to the new reality or let go the business. Each borrower could borrow directly from the public although the credit risk could limit its use however many of the creditworthy borrowers may try to take the direct route and save on the cost of borrowing, also with the borrowing and lending in retail segment being on the path of largely technology driven with the credit score and online footprint of an individual deciding his credit worthiness the credit risk of an individual could easily be assessed by a lending entity on a blockchain network.

We must also bear in mind that what was considered impossible earlier in the field of banking is a reality today like mobile banking and so there is high probability that if and when the blockchain network gains traction there would be advent of technologies that could make banking plausible with blockchain.

The realm of possibilities is huge however the use of a common currency also poses multiple challenges due to difference in socio economic parameters, inflation and political uncertainty. Also the supervision of such a virtual currency could become a bone of contention among countries. The concept of one currency could be considered an extension of Euro which is a common currency of nineteen nations. Even Euro has been facing problems when the economy of any one nation is not performing well and which in turn exerts downwards pressure on Euro. A common virtual currency could be seen as an extension of Euro including all the nations. Now if one nation is not performing well it would exert pressure on the other nations to support it to as eventually support the common currency. These are some of the challenges that make the adoption of a common virtual currency difficult however the adoption of virtual currency in general and bitcoin in particular has been rapid in the international grey markets as this currency is not controlled by any sovereign nation and so is not subject to their laws also it does not require any trace of the origination of currency issued. The virtual currency could be used by anyone for purchase of any goods and at the same time remain anonymous also such transaction are outside the purview of tax authorities of any jurisdiction. It has been increasingly found that payment for majority of the illegal transactions is now being made through bitcoins which has posed multiple challenges for the enforcement agencies to choke the supply of money to illegal activities.

What is pertinent is the fact that a virtual currency which is common to all nations and is supported and endorsed by the central banks and governments around the world is not feasible at least for now due to the multiple challenges mentioned above however a virtual currency could become the defacto payment currency of the world as has been the case of bitcon, a concept which again is poised with multiple challenges. Since such a crypto currency is not under the purview of any nation or government agency which is accountable to the public there is no mechanism for addressing any dispute associated with the currency which could lead to the unsuspecting gullible investors incurring huge losses. This alone explains the reason why many countries have decided to ban all cryptocurrencies other than the cryptocurrency floated by the sovereign.

Block Chain Technology poses multiple opportunities to improve the financial ecosystem and make it more effective however its use for illegal activities has posed many questions regarding its commercial viability. Many believe that investment in cryptocurrency is just long term speculation without any underlying fundamentals and the fizz will soon fade out also countries like China have since banned the use of Bitcoins and introduced its owned cryptocurrency to keep track of movement of funds and this trend of state owned cryptocurrencies is expected to gain traction as many more countries could ban bitcoins forcing the cryptocurrency users to invest in state promoted cryptocurrencies

Many countries like Ecuador, China, Senegal, Singapore and Tunisia have launched their own cryptocurrency and major technology companies  have started to explore the idea of launching their own virtual currency based on blockchain technology. It may not sound too big a thing but if the virtual currency floated by these countries / or  fintech companies gains a foothold then they will be in a position to command the financial ecosystem and thereby gain huge socio economic influence. Even in India RBI had undertaken a study on the feasibility of the use of blockchain technology and so far the central bank has decided against the use of it. The lost opportunity can also be gauged by the fact that we are just exploring the limited use of  blockchain technology whereas other countries have started the study on launching their own virtual  currency. Ofcourse  in India the per Capita Income is low  and so is the risk taking capacity however a complete ban on  the use of blockchain means a lost opportunity. The financial sector is a dynamically evolving sector and the kind of transformation that the financial sector has undergone in the last few years in unprecedented. In this backdrop it is imperative that we allow the research and use of blockchain technology in a limited way under strict supervision however a complete ban on virtual currencies means ceding ground on an otherwise level playing field.

Crypto currencies are a perfect preclude to a cashless economy and major financial institutions of the world like HSBC, Barclays, UBS are working on developing a Universal Settlement Coin to facilitate trade.

It is often said that the geographical boundaries of the world are becoming increasingly irrelevant and the same is being replaced by economic boundaries. Facebook and Amazon  are at advanced stages of launching their own virtual currency based on blockchain technology and based on their vast customer base it can be safely assumed that the acceptance of such a technology will be huge. Many countries have already launched their own crypto currencies to take control of the crypto financial ecosystem.

Inspite of the numerous challenges posed by virtual currencies we cannot deny that the potential of such currencies is enormous and it’s just a matter of time before which virtual currencies take over the financial ecosystem and whether or not virtual currencies will change the way be bank will only be known in future but based on the current trend there is a strong probability that it will.

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