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13 March 2014

Bitcoin and Banks, Part II: Here to Stay?

In the previous instalment of this series we looked at some of the ways in which digital currency differs from traditional currencies, and the mixed response that it has received to-date.  We now look forward to consider whether they will pose a long term threat to financial institutions, and what they can do to best respond.

Long term future?

Bitcoin presents a sizeable threat to current operations and will have a marked impact, particularly their transaction / payment fees revenue structure. Ultimately, however, we believe that there are key reasons why Bitcoin will beat a hasty retreat and remain a niche instrument:

The Bitcoin commodity bubble

Regulators and governments are concerned that unsuspecting individuals are being sucked into a bubble in an asset that has no intrinsic value or legal framework to guarantee it as a medium of exchange.Bitcoin is only as good as the confidence the community has in it, and for us, the inevitability of a confidence shock (much like the recent insolvency filing of the Mt. Gox exchange) relating to Bitcoin security, exacerbated by the lack of inherent value, will be the primary reason for its retrenchment 


Even with widespread and comprehensive insurance in place, hacking and security threats (targeting both individuals and exchanges) force the entrusting of Bitcoins by their owners to other intermediaries. This reintroduces to the system the very trust that it sought to remove in the first instance, limiting Bitcoin's freedom of use.


Jamie Dimon of JP Morgan has predicted that regulation will be a primary stumbling block, stating that “the (key) question is do we even participate with people who facilitate Bitcoin?". The US Treasury declared last year that Bitcoin businesses must register as money services businesses and impose anti-money-laundering checks on customers, demonstrating that Bitcoin can even at this early stage be at least partially regulated. All of this suggests that with a concerted effort, individual jurisdictions can and are taking steps to regulate the players in the Bitcoin market

Constraints on growth

There are limitations using Bitcoin for lending and, should it gain sufficient market share, on economic growth. Lending requires a trusted middleman in order to clear the lending transactions (even P2P) which, again, builds the need for trust and fixed costs back into the system. Also, on the assumption of continued volatility in Bitcoin prices, both lending and borrowing in Bitcoin becomes a high risk, speculative activity as the proceeds ultimately need to be converted back into fiat currencies.

How banks can respond

The rise of Bitcoin is yet another indicator that consumers are becoming increasingly savvy and sensitive to invasions of privacy and are actively looking for alternatives to traditional financial systems. It demonstrates demand for a medium of exchange that can be policed and transferred more securely and cheaply than the financial services industry currently does. Both retail and commercial banking operations will see Bitcoin claim a material portion of such revenues, particularly cross-border payments. Banks of all sizes need to ready themselves for this in two ways:

  • by continuing to reduce existing transaction costs, particularly cross-border, and passing savings onto their customers. This will be achieved through continued infrastructure investment and by creating more efficient partnership networks – essential also to compete with large global corporates, such as Apple, Amazon and EBay who are moving aggressively into the payments arena, and a host of start-ups who have seen the opportunities in the market for low-cost international transfers (such as the crowd-sourced currency exchange service, TransferWise)
  • by offering innovative and competitive products that meet customer needs to generate revenue from alternative sources to take the place of the revenue that will be lost.

Trust, too, is critical. The banking industry, subject to a seemingly endless series of misconduct issues, must restore its integrity in the eyes of customers. Further issues will only increase the potency of the digital currency threat.

The industry response

We can expect to see more specific, affirmative action from the industry as a whole. As a result of the contrasting outlooks on the future of digital currencies, we will see a mix of both:

  • banks and central banks/governments increasingly working together to regulate digital currencies, and

  • banks themselves taking further steps (such as the JPM patent, discussed in part one of this series) to exploit market share from digital currencies themselves, attempting to shape the digital currencies of the future to complement their existing business models.

We believe that it is unlikely that Bitcoin will impact other sources of bank revenue e.g. those from credit. The provision of P2P Bitcoin lending will be suppressed by the volatility in the price and larger scale lending has its own challenges. Bitcoin P2P lending will pale into insignificance compared to the threat which P2P lending in regular currencies poses to banks (along with payday lenders and other market entrants).

The verdict

In conclusion, Bitcoin is a sign of changing consumer demands. It is the manifestation of inefficiencies in the global financial services industry and a somewhat extremist view held by some that centralised monetary control is damaging to the economy. The seeds of banking revolution have been planted and even though the Bitcoin experiment is ultimately unlikely to take root, it will not be the last challenger or most successful of its type - the next generation of digital currencies will not be far away.

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