Trade in cryptocurrencies and banking – part II

Until recently, if you wanted to buy a cryptocurrency, you needed to use a bureau de change for digital money or a cryptocurrency exchange, as most traditional banks ignored the potential of virtual coins. However, this has changed and an increasing number of financial institutions are interested in this new technology. What may the future of independent cryptocurrency trade look like in terms of banking?

Cryptocurrencies – are they a good solution and why?

According to a new report released by KPMG, central banks in Asia and Europe are in the final stages of launching digital currencies for future payment systems and cross-border transactions. It means that governments view the launch of central bank digital currencies (CBDC) as a method of realising advantages within the global trade system in future. This is connected with the stance of the International Monetary Fund (IMF), which expressed its support for developing cryptocurrencies secured with fiat money and claimed that they may reduce dependence on government-issued money. Dong He, the Deputy Director of the Monetary and Capital Markets Department (MCM) of the International Monetary Fund, believes that,

unlike bank transfers, crypto asset transactions can be cleared and settled quickly without intermediaries. The advantages are especially apparent in cross-border payments, which are expensive, cumbersome, and not very transparent. New services using distributed ledger technology and cryptographic assets have reduced the time it takes for cross-border payments to reach their destination from days to seconds.

It is worth remembering that stablecoins of this kind have already been issued by private businesses to support exchange, clearance and settlement processes in banking organisations and networks. For instance, JP Morgan Chase announced last year that they developed a means of payment that was viewed as the first cryptocurrency backed by a large bank. JPM Coin, as the bank calls its first digital coin, is linked with a fiat currency because it is secured with American dollars on the JPMorgan Chase N.A. accounts.

Banks use blockchain technology in five main areas: clearance and settlement, trade financing, cross-border payments, handling insurance claims as well as Anti-Money Laundering (AML) and Know Your Customer (KYC) procedures.

Regarding cross-border transactions, a stablecoin may reduce the clearing time from days to minutes as it would bypass the involvement of private organisations, such as the Depository Trust and Clearing Corporation (DTCC) in the United States and Euroclear w the European Union.  As representatives of large banks point out, blockchain-based systems may also streamline the purchase and sale of shares and bonds.

In terms of technology use, blockchain takes the centre stage

Since blockchain offers sure-fire ways to secure services, governments across the world have recognised its potential in security and begun working on applying this technology in a number of fields.

Australia Post has announced a plan to use blockchain in election voting. The system will be “tamper-proof”, providing traceability, anonymity and security in voting records. The ballot would be integrated cryptographically within the blockchain, and citizens would use voting credits to attribute their preferences and receive unique digital access keys to verify their identity. Once cast, votes cannot be changed; election counts can then be easily done by gathering data from the platform.

Estonia, in turn, is one of the most digitally advanced nations in the world. The government is already using blockchain in its tax and business registration systems, and has secured citizens’ electronic health records with the same approach this year. As a result, these records are no longer vulnerable to cyber attacks and various forms of internet fraud. Estonian citizens hold cards that allow them to access over 1000 state services online, including their medical records.

Residents of Moscow may soon be able to use blockchain for voting in referendums. City authorities want to use it to record citizen votes on laws and projects under its “Active Citizen” scheme. They are also investigating other uses of the technology and planning a wider implementation in service delivery.

The government of Singapore is exploring the blockchain technology to prevent export and import companies from committing bank fraud. Trade invoices will be recorded in a digital ledger, and any duplicate entries will raise alerts across banks. The system will improve coordination between the trade and finance sector and help authenticate invoices for banks.

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Cryptocurrency fully developed by a bank

Bloomberg has recently been informed that the Federal Reserve System (FED), the central bank of the United States, is working with the Massachusetts Institute of Technology (MIT) to investigate the possibility of issuing a digital currency.

In a webcast for the Federal Reserve Board, Governor Lael Brainard said that the Federal Reserve Bank of Boston is collaborating with MIT researchers in a joint effort to build and test a hypothetical digital currency oriented to central bank uses. According to Brainard, this effort is intended to assess the potential as well as the risks associated with the digital currency to be developed, known also as the central bank digital currency (CBDC), and possible consequences that new technology may present in the payments area.

In May 2020, 80% of 66 central banks declared that they were working on CBDC. Especially China is making progress; owing to the efforts of its central bank, the country is developing and testing a national digital currency. Members of the United States Congress also called for the creation of a digital currency that would be a balance value expressed in American dollars, consisting of digital ledger entries recorded as liabilities in the accounts of any Federal Reserve bank.

However, there is no shortage of problems associated with building such a currency. Since financial and payments systems have extensive cross-border connections, a poorly designed CBDC issued in one jurisdiction could produce financial stability issues in another jurisdiction, Lael Brainard said. The speed in clearing transactions has been the main area of interest. Bloomberg informed that James Cunha, the senior vice president at the Boston FED overseeing the digital dollar projects, said that the efforts of FED and MIT are directed towards building an engine and the software that can support issuing digital currencies.

 

A chance for the future?

Many consumers are hoping that “cryptographic banking” will soon become an integral part of the financial sector. This, however, cannot happen without prior changes.

Development of cryptocurrencies that may be used in traditional financial institutions in the same way as conventional money seems of key importance for ensuring stable use of crypto assets. These new “currencies” must not function like speculation bubbles or securities. Instead, software developers need to seek to ensure that tokens function as a means of payment in the same way as fiat currencies do. Moreover, banks may start using digital currencies in future to buy, sell and trade in commodities, securing tokens with conventional assets. Asset-backed tokens offer a wide range of benefits, such as securitisation of assets, liquidity, ownership rights, or reduced volatility of cryptographic assets.

Consequently, if banks launch their own cryptocurrencies or blockchain-based systems, these will be probably digital currencies developed at the request of financial institutions or governments and secured by adequate amounts of assets: fiat money or precious metals. Existing, independent e-coins, such as Bitcoin or Ethereum, are unlikely to be used for such purposes.

It looks like both banks and governments will introduce fully digitized currencies sooner or later – at least to gain an advantage over competitors. Questions may only be asked about what this process will look like and what it results will be.

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