Cryptocurrencies & The Banking Industry

Despite the concept of Crypto-currencies being increasingly expanding and gaining popularity, the traditional banking sector is hesitant to adopt the use of digital assets, believing that its inherent risks outweigh potential benefits. The main concerns for such thinking could be depicted as the decentralized nature of transactions, AML/KYC concerns and the high volatility of crypto-currency values. However the regulatory agencies such as the Office of the Comptroller of the Currency (OCC) are working towards changing bank’s perception on digital currencies believing that such assets would positively drive finance/banking sector in to a new era of innovation and efficiency.

Main reasons why banks are wary of digital currencies

Decentralized Nature

One of the main reasons why banks are reluctant to engage in digital currencies is its decentralized nature. Cryptocurrencies have been developed as an alternative to the traditional banking system; hence they do not require any intermediary or do not linked to the capacity of a centralized government, bank or any other agency. Instead cryptocurrencies tend to rely on related blockchains in performing transactions. It is believed that a cryptocurrency that is managed by a central bank is likely to reduce the appeal of the asset.

AML/KYC Concerns

Crypto currency transactions are simply linked to the particular blockchain and avoid the engagement of any regulated intermediary. This gives the user the ability to perform transactions efficiently and easily. However the banks are worried about crypto transactions as this could lead to increase the number of financial crimes due to lack of AML (Anti Money Laundering) and KYC (Know Your Customer) considerations.

Volatility

It is observed that the prices of crypto currencies are highly volatile mainly due to the market size, liquidity and the number of market participants etc.  As such the banks tend to see this as a risk and not a stable investment. 

How Banks Could Engage with the industry of Digital Currencies

In order to avoid being left behind, the banking sector has been striving to find new ways to embrace this technology. As such several initiatives have been taken with the intention of adapting to this new technology such as custody services, AML/KYC regulations, enhanced security concerns and smart contracts relating to digital currencies.

Custody Services

The OCC has stated that the banks could provide customers with crypto custody services such as holding unique cryptographic keys associated with the ability to access private wallets. Through this the OCC expects the banks to hold either the cryptocurrency itself or the key to access crypto on private digital wallets for its customers.

AML/KYC Concerns

In 2019, the Financial Crimes Enforcement Network determined that any cryptocurrency transaction or custody services conducted through crypto entities must comply with AML/KYC regulations. This has been implemented in order to avoid fraudulent transactions, illegal activities and other financial crimes using these platforms. This has given the banks and the other financial institutions to conduct due diligence ensuring the genuineness of the transactions performed. Further it has been identified that there a possibility of automating AML and KYC verifications using blockchain technologies.

 

Enhanced security concerns

The cryptocurrency holders are much worried about hacking of personal wallets and exchanges. In this scenario the banks could involve in improving security aspects of such transactions by bringing crypto currencies under bank’s supervision.

 

Smart contracts

When you enter in to an agreement with a smart contract, the level of trust among parties is less. This is mainly due to the transaction being relied on computer code instead of the behavior of an individual. Therefore the banks could strengthen the trust by being a reliable intermediary which utilizes such smart contracts for mortgages, loans, LCs and other transactions. 

In conclusion it could be stated that the banks could perform a significant role with regard to digital currencies/assets while introducing regulations and such initiatives could take the banking industry to a new era of innovation and efficiency.

  

References

Scicchitano, M., n.d. How Cryptocurrencies May Impact the Banking Industry. [online] www.wolfandco.com. Available at: <https://www.wolfandco.com/resources/insights/how-cryptocurrencies-may-impact-the-banking-industry/> [Accessed 4 July 2022].