While the traditional banking system is expanding like a mushroom cloud, gradually, there is a parallel system developing silently, known as the decentralized finance (DeFi) system. However, DeFi is still in its infancy and is passing through a ‘trial and error’ phase.
At the heart of DeFi, digital assets like cryptocurrencies play a pivotal role in keeping this entire system alive. According to CoinGecko, the collective market cap of cryptocurrency is $3.81 trillion at the time of writing. Bitcoin holds a big traction in market capitalization.
Getting to Know Bitcoin
Bitcoin is a digital currency that uses decentralized technology that can be exchanged between users without the interference of a central bank or even other financial organizations. It is the first trillion-dollar market capitalization cryptocurrency. Since its creation, Bitcoin has remained number one in the cryptocurrency leaderboard.
It is money that only exists as code in a peer-to-peer network such as blockchain technology.
Bitcoin transactions are kept on an open, permanent book known as the blockchain. A worldwide network of computers, called miners, holds this distributed ledger.
Computational power is used by miners to verify and authenticate transactions. As part of this process, they also add new Bitcoins to the money supply, but in a controlled, predictable fashion.
Such a design enables value to be exchanged directly person-to-person anywhere on the planet, 24/7. To facilitate this transaction, it also necessitates low fees and without the involvement of a trusted third-party agent, such as a bank or payment processor.
The supply of Bitcoin is algorithmically capped at 21 million coins, making it a digital scarce asset.
But Bitcoin is not just regarded as a new payment system but also as a value store, just like digital gold. This is why many countries and public companies are establishing a Bitcoin reserve to capitalize on its growth.
How Bitcoin is Compelling Conventional Banking to Adapt
The introduction of Bitcoin in 2009 initially encountered dismissive skepticism from financial institutions and governments.
A decade and more after it was dismissed as a “fraud” and a “pet rock,” what started off small has developed into a serious trillion-dollar asset class that cannot be ignored by the mainstream banking industry. The aggregate market capitalization today is at $2.17 trillion as of writing, according to CoinMarketCap.
Bitcoin is not just a new asset, but a technological challenge to the very fabric of centralized finance. Bitcoin is not meant to topple the centralized financial system overnight, but in the long term, it is possible to envision enormous inclusion with the banking industry. But there are some obstacles.
How Bitcoin’s Emergence Threatens Banks’ Domination
For decades, Banks have built their empires by serving as trusted third-party intermediaries. But, Bitcoin and blockchain technology challenge its dominance in numerous areas, including:
1. No Intermediaries for Value Transfer
One of the biggest perks of Bitcoin over traditional finance is in cross-border payments and remittances. The Society for Worldwide Interbank Financial Telecommunication (SWIFT) network, which is an authority that oversees international bank transfers, is often slow. Furthermore, it is quite expensive in its fee structure, which varies from bank to bank.
Also, this digital payment system relies on correspondent banks and the technology it uses (such as Visa and Mastercard. A transfer can take days and cost a high percentage of the total amount.
The Bitcoin network allows peer-to-peer value transfer across borders, anytime, from anywhere. Transactions are broadcast to the blockchain network across different nodes and typically confirmed within minutes.
While transaction fees change with network demand, they are often a fraction of the cost of a traditional wire transfer, especially for larger sums.
2. Sovereignty Over Assets and Identity
Traditional banking is built on a custodial model. You do not “hold” the digital dollars in your account; the bank holds them on your behalf, creating an IOU.
This practice allows the bank immense power, such as freezing accounts, blocking transactions, and being subject to government seizure orders. Furthermore, accessing banking requires permission, including extensive identity checks (KYC) and a credit history.
Bitcoin operates on a non-custodial model. Users hold their private keys, which grant them true ownership of their assets. No central authority can freeze or freeze Bitcoin held in a self-custodied wallet (barring physical coercion). Furthermore, anyone with a smartphone and internet access can download a wallet and participate in the global economy without asking for permission.
3. Monetary Policy
Contemporary central banking is characterized by discretionary monetary policy. Central banks have the ability to print money to spur economies or contain crises such as inflation. In doing so, banks also debase the fiat currency in the hands of citizens, losing its purchasing power.
On the other hand, Bitcoin’s monetary policy is algorithmic, open, and unalterable. Its supply is limited to 21 million coins. Furthermore, the new creation of BTC is reduced by half about every four years in a phenomenon referred to as the “halving.”
This disinflationary model is programmed into the protocol and cannot be altered. This has established Bitcoin’s primary investment product as “digital gold”. It also offers a hedge against inflation.
How Banks are Integrating Bitcoin Into Traditional Finance
Banks and financial institutions are gradually opening the doors to mainstream adoption of Bitcoin. Their adaptation strategy is less about adopting pure Bitcoin for transactions. Their strategy is more about integrating its principles and underlying technology.
1. Providing Bitcoin-Related Services to Customers
Large institutions such as BlackRock, Fidelity, and JPMorgan now offer exposure to Bitcoin in the form of exchange-traded funds (ETFs), custody, and trading desks. This is a major legitimation. Banks are becoming the on-ramps and custodians of the new asset class.
2. Implementation of Distributed Ledger Technology (DLT)
Although banks will avoid Bitcoin’s public, permissionless blockchain, they are investing big in its underlying tech. Private, permissioned DLTs are being created for specific uses, including:
- Interbank Settlement: Major banks like JPMorgan’s JPM Coin utilize blockchain for real-time settlement between institutional accounts. This reduces counterparty risk.
- Trade Finance: Smart contracts can make international trade more automated by allowing users to write code of their desire. Blockchain technology also provides security, which minimizes fraud and processing times from days to weeks.
- Tokenization of Real-World Assets (RWA): Banks are testing putting traditional assets such as stocks, bonds, and property onto blockchains as tokens.
Final Words
Bitcoin is forcing banks to evolve and be quicker and more efficient. Banks will still be necessary for most of their financial transactions and services, but they are slowly embracing Bitcoin and other cryptocurrencies to provide crypto-related services. This acceptance can also assist banks in reaching unbanked individuals.
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