1 Nov

Are Cryptocurrencies and PayPal a Risk for Banking?

WRITTEN BY Rekha Khandelwal, CFA

Alternative options, such as cryptocurrencies or payment platforms like PayPal (PYPL), may impact banks in the long term. Technological advances have changed the way we bank. From cash and checks, the transactions have moved to online and mobile systems. While advances in Fintech (financial technology) have made the lives of consumers easy, it could pose some serious threat to traditional banks.

Whether cryptocurrencies are the ‘next big thing’ or not is a topic of ongoing debate. However, one point is now widely accepted: cryptocurrencies are here to stay.

Blockchain: the technology behind cryptocurrencies

Blockchain has the potential to make banking transactions easier and faster. BitPay, a pioneer in Blockchain payments, processed more than $1 billion in payments in 2018. Also, top tech and banking players understand the potential benefits of Blockchain technology. So, they have started investing in the technology to develop it.

JPMorgan Chase’s (JPM) CEO Jamie Dimon feels that the threat of Blockchain to banking is real. Dimon’s change in stance on cryptocurrencies and Blockchain is well-known. Though he suggested cryptocurrencies were a “fraud” in 2017, he believes in Blockchain technology. The bank launched its own cryptocurrency—JPM Coin—this year. However, with its limited application, it’s not truly a cryptocurrency, at least not yet. However, the bank may expand its JPM Coin userbase.

Jamie Dimon on cryptocurrency

While Dimon’s stand on the topic seems to be ever-changing, it does offer some perspective. Recently, Dimon said that Facebook’s (FB) Libra cryptocurrency isn’t a near-term threat. He said, “To put it in perspective, we’ve been talking about Blockchain for 7 years and very little has happened.”

While the technology is promising, it’ll take time to evolve, get regulatory support, and become a mainstream channel for transactions. With its JPM Coin, JPMorgan Chase hopes to stay a frontrunner in Blockchain’s evolution. Through this, the bank also aims to keep itself equipped to face future competition head-on.

Facebook’s Libra project

Facebook’s (FB) Libra project highlights the importance that cryptocurrencies may have in the future.  The project had serious setbacks with few prominent initial participants, including PayPal Holdings (PYPL), MasterCard Inc. (MA), and Visa Inc. (V) opting out of the project.

At the same time, Apple’s (AAPL) CEO Tim Cook said that private companies shouldn’t try to set currencies, which should remain with countries. “A private company shouldn’t be looking to gain power this way,” noted Cook. Libra has faced opposition from France and Germany, too. Also, JPM’s Dimon has reservations for the project. He said, “It was a neat idea that’ll never happen.”

Similar to JPM Coin, Libra is intended to be a stablecoin. A stablecoin is pegged to fiat currencies like the dollar. While JPM Coin is pegged to US dollar, Facebook plans to peg Libra to a basket of currencies. Facebook’s Libra project highlights the challenges that cryptocurrencies may face.

China on cryptocurrency

While Facebook’s Libra project is suffering setbacks, China is looking to gain a lead in this evolving area. Chinese President Xi Jinping said in October that China should focus on Blockchain to promote economic growth. Major cryptocurrencies, including Bitcoin (BTC-USD), surged following the backing by China.

However, according to a report in the Express, Jinping’s support is for the Blockchain technology, not for cryptocurrencies. Back at home, Ohio is the first US state to allow paying taxes through cryptocurrencies.

Cryptocurrency: Issues and challenges

For cryptocurrencies to develop scale, they need to address key concerns relating to financial stability and money laundering. The major concern is that the cryptocurrency transactions are difficult to trace. This may promote its use for illegal activities and terrorism. However, BitPay claims that the transactions on its platform are traceable.

BitPay said, “The biggest misconception is that cryptocurrencies, specifically Bitcoin and Bitcoin Cash, are totally anonymous and untraceable from an AML perspective. By using companies such as Chainalysis and Elliptic, many Blockchains have comprehensive transaction details to remove the layer of ‘anonymity’ that companies perceive as a threat.”

Though cryptocurrencies have been in existence for more than 10 years now, these have gained popularity only recently. With limited transactions, the existing cryptocurrencies didn’t get much attention or scrutiny. However, for a project like Facebook’s Libra, the stakes and potential impacts are very high.

Impact on banking

Like any major tech change, cryptocurrencies will take time to evolve. However, in the long run, there is more than one way for cryptocurrencies to impact traditional banks. First, these may act as a serious competitor to traditional banks. When, and if, fully developed, these may capture a big chunk of banking business mainly relating to money transfers and payments. The biggest risk is that cryptocurrencies may make intermediaries, such as banks, redundant.

However, banks are gearing themselves to embrace Blockchain technology. That means it won’t be a cakewalk for cryptocurrency companies to challenge banks. The Bank of America Corp. (BAC) holds the most patents relating to Blockchain. Similar to JPM, Bank of America intends to be ready if Blockchain and cryptocurrencies become the norm. However, Citigroup Inc. (C) has shelved its plan for a JPM-like cryptocurrency for now.

Second, cryptocurrency and Blockchain technology may make it hard for banks to comply with regulations relating to KYC (Know Your Client) and AML (Anti-Money Laundering). This is because cryptocurrency transactions are difficult to trace. This may raise banks’ compliance costs.

PayPal: a risk to traditional banks

While cryptocurrencies may not pose a serious threat to banks, they may have the potential to be serious competition for banks in the longer term. This is similar to the kind of competition that banks today face from Fintech companies, including payment processors like PayPal.

In addition to business risks, banks face other risks. In a previous post, we discussed the major types of risks that banks face. If you want to learn more about the basics of investing in cryptocurrencies, read How to Invest in Cryptocurrency: A Beginner’s Guide.

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