Banks Should Remain Skeptical of Crypto

Banks Should Remain Skeptical of CryptoCryptocurrency has hit a crisis point unusual in its short but bright history. Rather than listening to tech evangelists' opinions on the matter, banks need to look at the fundamentals. While price bubbles and market corrections have happened many times since bitcoin launched in 2009, this latest pricing drop—triggered by the unpegging of the Tether and Terra stablecoins—suggests that the problems with cryptocurrency run deeper than many may be willing to admit.

With an estimated 16% of Americans now owning some form of cryptocurrency, the fallout from this latest bubble burst could serve as a turning point in the market and how banks treat cryptocurrency. Cryptocurrency is likely to rebound from these latest crises, but it is imperative that banks begin to ask the emperor exactly what he is wearing.

The Rise of Crypto

Interest in cryptocurrency-related technologies hit record highs in 2021; KPMG estimates that US$210 billion worth of private equity and venture capital investments were made into crypto-related firms last year across 5,684 deals.

This comes against a backdrop of growing marketing toward consumers to invest in cryptocurrency, with notable cultural markers such as Super Bowl ads, the renaming of sports arenas, and high-profile celebrities such as Matt Damon and Larry David giving the technology a familiar face, even if they remain vague on what the technology is or what it does.

Adding fuel to the fire has been the sharp rise of NFT hype—and the subsequent collapse against much public mockery—as well as emerging promises from tech giants that the future of the internet resides in building blockchains tied to everything, financializing all aspects of life and driving us toward a Web3, decentralized Metaverse future. 2021 even saw El Salvador become the world’s first country to accept bitcoin as legal tender.

With Great Growth Comes Great Volatility

But the challenge with the bold proposals, hype, and huge levels of investment pouring into cryptocurrency is that it remains a horrible form of currency that offers no benefits over existing payment mechanisms. The volatility of cryptocurrency is already well noted and understood, but more crucially, the transactions per second rate (TPS) remains ludicrously poor. Bitcoin averages 7 TPS, Ethereum perhaps double that. Visa holds an average TPS of 1,700, while Mastercard claims a maximum TPS of over 5,000.

Furthermore, the immutability of the blockchain under almost any cryptocurrency means that reversing payments or solving disputes are usually impossible and at best extremely difficult. If users are hit by scams, they often have little recourse or potential for redress. These challenges have notably increased, with total crypto-crime levels reaching US$14 billion in 2021, almost doubling from 2020 levels according to research from Chainalysis.

While cards globally saw losses of nearly US$28 billion in fraud in 2020, this is against a backdrop of enormously higher transaction numbers along with regulations and security measures. Furthermore, while Decentralised Finance, aka DeFI, is aimed at liberalising financial services for end users, it also places all risk squarely on said users, an outcome most consumers and businesses are unlikely to find acceptable.

Ironically, the best way to help combat crypto-crime is through more centralization and regulation, precisely the sort of approach decentralized cryptocurrency is supposed to avoid.

Behind the Hype

While the hype for cryptocurrency has undoubtedly gone mainstream, the average number of bitcoin transactions per day has declined slightly in recent years. The bitcoin blockchain recorded a global average of 245,000 transactions per day in January 2022, down from over 350,000 per day in early 2019. This should come as no surprise since most cryptocurrencies are not treated or used as a payment mechanism; they’re treated as an investment asset.

The promise to consumers and even most crypto-enthusiasts isn’t to ease payment challenges, it’s to get rich and get in on this investment opportunity early. The details of how they will get rich or what the cryptocurrency actually does are frequently buried under technical jargon that means little to most people.

Many of the initiatives from the thousands of cryptocurrency fintech startups out there are essentially “blue sky security”—that is, security based on little more than the rising value of said security. Many initial coin offerings in these crypto-launches are a means to pump up the value of their own cryptocurrency assets.

Blue sky laws have been in place for decades. As regulators finally come to grips with cryptocurrency, it is likely that either regulations will become stricter and provide more guidance, thus ensuring the protection of both retail and commercial investors, or the decentralized, Wild West nature of most crypto-initiatives will be rife with scam artists and grifters, scaring off most mainstream participants.

What Banks Should Avoid

The latest challenges to the market—the recent near collapse of stablecoins Tether and Terra, as well as the freezing up of the Ethereum blockchain due to the latest Bored Ape Yacht Club NFT release, which at one point saw “gas” transaction fees rise to thousands of dollars—all point to the severe technical challenges facing the broader cryptocurrency space.  

Many of these systems are not as stable, or as neutral, as they appear. As the financial impact of cryptocurrency becomes more tangible, it’s unclear just how beneficial it is to have protocols that are censorship-proof, that avoid regulated centralization, or that use automated contracts with no guarantee of being any better than a standard contract. While avoiding censorship sounds good on paper, breaking anti-money-laundering restrictions or funding nefarious activities are not capabilities that most banks want to enable.

The enormous ecological impact of blockchain technologies can also no longer be ignored. While some cryptocurrencies, such as Ethereum, claim to be moving to a more ecofriendly proof-of-stake model, these promises are constantly on the horizon and have yet to actually occur. Banks are rightly wary of vaporware from vendors, and they should be wary of vague promises that don’t go beyond greenwashing by cryptocurrency firms.

Building a Better Crypto Future

Despite the enormous, and increasingly visible, challenges posed by cryptocurrency and the broader related distributed ledger space, there are potential uses for the technology. This includes traceability of authenticity on items linked to a blockchain, creating networks of networks through linked chains, or even basic cross-border capabilities.

As with many new innovations, the actual problems solved by blockchain and cryptocurrency remain unclear. Much of the conversation around these technologies is overfocused on putting everything on a blockchain without asking, “What is the benefit of putting this on a blockchain?” In most instances, aside from being a speculative asset, cryptocurrency and related technologies are not yet the best solution to any actual existing problems.

Banks should not ignore cryptocurrency or its related technologies. However, it is time to be realistic and ask outright: What problem does this actually solve? Are there better ways to do this? Rather than jumping on the hype bandwagon and accepting bold promises of future capabilities, now is the time for banks to ask the most important question of all: What does this technology actually do?

To discuss this topic further, please contact me at [email protected].

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