In the past 20 years, a kind of financial revolution has been quietly taking place right under our noses. The revolution in digital money is now moving into banking, as cryptocurrency starts to reshape the way people borrow, save and invest. The development of Bitcoin and thousands of other cryptocurrencies have changed the definition of money. Creating an entirely new universe of alternative financial services, allowing crypto businesses to move into traditional banking territory. Here’s what’s happening in the fast-growing crypto finance industry. A sector that has officials all over the world sounding their alarm bells.
How does cryptocurrency offer banking services?
Crypto banks are now offering a lot of the main services that traditional banks have been offering for centuries. Most notable are lending and borrowing. It has come to the point where investors can easily earn interest on their holdings of digital currency. No matter what the type and that interest are often a lot more than they can earn through traditional banks. They can also borrow money with crypto with collateral to back a loan. These loans generally involve no credit checks since the money exchanged is backed by digital assets.
Who are the parties actually involved in this emerging sector?
This new market of crypto banking has offered an opportunity for a lot of parties. To start offering blockchain-based financial services. They usually use BlockFi, which offers interest-bearing accounts like a bank and has state lender licenses, and Kraken Bank. Which was granted a Wyoming bank charter and hopes to soon take retail deposits. To markets controlled by computer code and devised to be governed by users through a token distribution structure. A good example of exactly how big this sector already is might be Compound, which is a decentralized, automated lending and borrowing system that has more than 18$ billion dollars in assets earning interest, despite only having started in 2018.
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Cryptocurrency vs. traditional banking, what’s the difference?
On the surface, some of these banking services might look quite similar to one another. Using the BlockFi interest account as an example. Consumers deposit cash or crypto and earn monthly interest like they would at any bank. The major difference is that the interest rate can earn a yield more than 100 times higher on BlockFi than on an average bank account. These deposits do carry some risks though. As they are not guaranteed under the FDIC or the Federal Deposit Insurance Corporation.
They can also suffer from a temporary or even permanent halt on all withdrawal or transfers. Because of factors like cyberattacks, extreme market conditions, or other operational or technical difficulties. This still begs the question though, why such high yields? Well, traditional banks lend out part of their customer’s deposits and pay them a slice of the interest they receive from lending it out.
Crypto banks take a similar approach, they pool deposits to offer loans and give interest to depositors just like any bank would. The difference is that crypto banks don’t have the requirement to keep reserves. In case the outcome of the loans they give out isn’t good, the law requires traditional banks to have such a reserve. This makes them way more profitable, as well as way riskier.
A form of crypto that’s slightly less volatile than that is Stablecoin, which means cryptocurrencies that are pegged to stable, “real” assets, most notably the U.S dollar. They are meant to provide the best of both worlds, creating steady government-issued money in digital form for blockchain transactions. Popular dollar-tied tokens include Tether and U.S.D. Coin. The number of stable coins in circulation globally has jumped from $29 billion in January to $117 billion as of early September, according to The Block, a publication dedicated to cryptocurrency.
Central bank digital currencies
Recently, there has been talking in the financial world about a potential form of government-issued cryptocurrencies. Countries like the U.S and the UK are considering this development. Because Stablecoin aims to perform the same function as a regular government-issued bill – provide a stable value -. A U.S digital dollar could undermine the private money minters of the crypto sphere just like the original dollar disrupted the many forms of currency that private banks issued them centuries ago.
“You wouldn’t need stable coins, you wouldn’t need cryptocurrencies if you had a digital U.S. currency. I think that’s one of the stronger arguments in its favor.” The chair of the Federal Reserve, Jerome H. Powell, said in July.
Regulator response to the alternative banking sector
After years and years of lagging behind the private sector, banking officials are finally attempting to catch up with the many developments in cryptocurrency. While simultaneously trying to slow down the industry’s momentum. Gary Gensler, the chairman of the Securities and Exchange Commission, is calling for Congress to give regulators more authority to oversee new entities. In the Senate, crypto drew massive attention during negotiations. Over the 1$ trillion bipartisan infrastructure bill. Which included a tax-reporting clause that defined the word “broker” in crypto transactions. People in the industry had a negative response to this, arguing that the language was too vague. That brought focus to many players in the sector who elude traditional definitions.
It’s probably safe to assume that it will be many years before congress addressed the many questions raised by blockchain’s alternative banking services. Representative Don Beyer, Democrat of Virginia, introduced comprehensive legislation this summer that would tackle the range of issues raised by digital assets.
what’s the way forward?
Some Industry folks and regulators are arguing that this new technology requires a new approach. That these novel risks don’t necessarily have to be addressed in a way that stifles innovation and puts the country at risk of being overtaken by the rest of the world. Code audits and risk parameters for example seem to be a good alternative to demanding that cryptocurrency banks keep reserves and collect customer information.
J. Christopher Giancarlo, a former chairman of the Commodity Futures Trading Commission, has said that law enforcement can combat issues like financial fraud by flipping the old script. So instead of collecting customer data at first, they could take the broad view, Also use AI and data analysis to monitor suspicious activity and work back to track identity. This will all undoubtedly will come with many challenges and difficulties, but so do all good things. Whether we like it or not, cryptocurrency seems to be the future. And it’s our opportunity as a community to either seize that future or it will leave us behind.