Bitcoin: banks are beginning to believe the hype
The emergence of cryptocurrencies such as Bitcoin is beginning to pose a real threat to banks’ dominance of the multi-billion global payments business. Banks are still trying to figure out how best to respond. Some are a bit further ahead than others.
JPMorgan is one financial institution that has seemingly attempted to take advantage of the digital craze. The US bank recently filed for a patent for an online payment system - though it was ultimately rejected - that had a strong whiff of Bitcoin about it. JPMorgan has since dismissed the idea that its patent application was in any way inspired by Bitcoin, saying that its original patent application was made 13 years ago, before Bitcoin even took off.
That JPMorgan filed for a patent at all does nevertheless signify how serious big banks are about the evolution of online payment systems, an importance no doubt enhanced by customer demand and the meteoric, if speculative, rise of Bitcoin.
“The emergence of Bitcoin lit a fire under JPMorgan and pushed it to do the things its customers have been calling for it to do for years,” says Chris Odom, chief technology officer at Monetas, a financial and legal transactions system designed to be integrated into the Bitcoin economy.
“The big revolution we are witnessing is the emergence of the internet for value,” says Chris Larsen, CEO of Ripple Labs, the creator of the Ripple payments network, which is online and global. “The world has learned how to build value exchange systems without a central operator.” He adds that JPMorgan’s patent suggests that it is now under way in designing its own payments system suited to the internet age.
Indeed, JPMorgan’s patent application said that although credit cards dominate the market for online payments – and are likely to continue to do so for at least five years – their high processing costs and risks limit their use. The bank says what the internet needs is something that is a quick, cheap and simple way of transferring value.
What they propose is a means of making anonymous payments “without provision of an account number or name from the payer”. Their system would make internet shopping safer by withholding information from merchants that allow them to withdraw money from customer accounts, the demand for which has existed for years.
Odom says: “They were under pressure to do something so they tackled the insecurity of credit cards, from which you can take money if you have a number. But this isn’t a new problem, people have complained about this for years. It just took Bitcoin to make a bank do something about it.”
Whatever JPMorgan is now contemplating, banks are certainly thinking hard about how to profit from the growth of Bitcoin, although for now they are keeping their own counsel. Naturally there is concern that the growth of payments on new, non-bank systems such as Ripple and Monetas will divert flow away from banks and therefore undermine bank profitability. However, the opposite might actually happen.
Skype, for example, did not adversely affect the communications companies – it increased the overall level of communication – and maths-based currency systems will do the same with payments, says Larsen. Ripple’s vision of the future envisages banks acting as gateways to the payments network. Although they might have to accept smaller margins per transaction, they will generate revenues on increased traffic, says Larsen.
At this early stage of development the Bitcoin economy is to some extent dominated by libertarians who love the currency in part precisely because of its separateness from existing financial infrastructure. But banks are already starting to take notice.
However, Steven Englander, head of G10 FX strategy at Citi, is extremely sceptical about the prospects for Bitcoin. The proliferation of many cryptocurrencies will undermine the success of any one of them, he says. But the very fact that Citi, and Bank of America Merrill Lynch, put out research notes on Bitcoin tacitly recognizes its emergence as a currency. And not all bankers are so sceptical.
Acknowledging the currency as tamper-proof, divisible and finite, David Woo, head of global rates and currencies research at BAML, says: “We believe Bitcoin can become a major means of payment for e-commerce and may emerge as a serious competitor to traditional money transfer providers. As a medium of exchange, Bitcoin has clear potential for growth, in our view.”
The stage is therefore set for Bitcoin’s arrival in the mainstream, which should switch the emphasis on the currency's anonymity and potential for tax avoidance and illegal activities towards an interest in resolving outstanding issues concerning security and excessive complexity. This creates an opening for banks.
Recent developments suggest some banks might develop proprietary systems to meet the demands Bitcoin has exposed. Banks would still have some key advantages if they adjusted their businesses to remain competitive in the new environment. They remain universally recognized, enjoying a certain level of trust when it comes to money, even if they are not liked. They have the capital to develop systems and the reach to roll them out globally.
Having a more centralized system might also be advantageous. “Centralized exchange platforms argue that a decentralized exchange technology can never match a centralized system in terms of the number of orders per second it will process,” says Nicolas Genko, a Bitcoin consultant. “Certainly it is much easier for a machine working alone to match orders, but I believe the technology and performance for decentralized networks will catch up.”
Certainly its advocates view its decentralization as among its most important assets, as Citi itself acknowledged: “Some also argue that its decentralization is an advantage. The ‘ledger’ that keeps track of Bitcoin transaction seems resistant to fraud, but there have been issues with Bitcoin exchanges and other elements of the transactions process.”
So instead of developing their own systems, banks might opt to acquire companies that harness the power of Bitcoin to make quick and cheap payments, once their market share in the business has been eroded to the point they have to take action. Either way, ignoring the issue and expecting people to remain loyal to legacy payments systems designed for the pre-internet age does not appear to be a viable option.
“I believe that banks should get more involved with Bitcoin, to provide that extra layer of security to give confidence to people to use the currency,” says Genko. “I think people would feel more secure holding Bitcoin if they could hold it in a wallet offered by a well-known bank.”
As cryptocurrency trading increases there will also be an opportunity for banks to act as market makers. Bitcoin does not automatically mean trading will all be peer to peer, says Ripple Lab’s Larsen, and the financial institutions that today dominate global capital flows will remain the biggest players.
|Chris Odom, CTO at Monetas|
At the extreme, banks’ embrace of Bitcoins might extend beyond payments and into the bread and butter of deposit-taking and loans. “I see no reason why banks cannot take deposits in Bitcoins and make loans in Bitcoins using fractional reserve,” says Genko. “This is what banks are for and what they are best at. But they need to manage their risk in order to avoid bankruptcy, the same way when banks were issuing banknotes backed by gold deposits.”
Larsen is more sceptical here. “I am not sure people would want to use a deflationary currency to borrow against; that is why central banks will not tolerate deflation,” he says. It may have its uses in some specific instances, but as a rule national currencies will be more suited to this business, he says.
“Banks will continue to be major players in the payments space, but they will be one among many more than we have now,” says Odom.