Bitcoin and other crypto protocols are one of the most interesting innovations in payments industry, which are generating enormous buzz as a new currency, commodity or technology. They are a digital representation of value, not issued by a central bank, which can be used as an alternative to make payments at no cost for the users and settled in real time.
Despite the price, Bitcoin ended last year with a 67% decline, making it the worst-performing currency, about 103,000 transactions happen every day and 82,000 merchants in the US accept Bitcoin, including top brands like Overstock, Microsoft, Dell.
Bitcoin: number of daily transactions (Jan 2009 – April 2015)
Crypto-currencies are not backed by a central bank and users are exposed to the risk of frauds and bankruptcy. It may not be realistic to expect a wide adoption but it is clear that there is a place in the economy for crypto-currencies.
What is really innovative is the technology behind crypto-currencies: the block chain technology. It enables settlement in a decentralized way using a network of computers mutually agreeing to validate and record a transaction through a consensus based approach. Depending on how the block chain is applied, transactions may be settled in real time without using independent networks and payments systems running on centralized and proprietary software, which increase cost of processing and time to settlement.
Ripple is a great example of combining the benefits of the block chain technology without exposing payments users to the risk of frauds and bankruptcy. Through its open source protocol it allows banks – and not end users – to exchange values in real time and at almost no cost, when compared to the existing payments networks. While users are protected by the existing local KYC/AML regulations, the applicability and enforceability of these regulations is often difficult to follow as well as the principles of the ‘Travel Rule’.
The potential use of crypto currencies may be seen in areas such as real time payment system for a wide range of user cases, I expect we will see initial adoption for B2B transaction models given the clear value propositions that will be well understood by sophisticated commercial users. Alternatively, I expect initial offerings will shy away from consumer focused business models due to the array of consumer protections around the world. However, the potential opportunities are not limited to payment orientated use cases. The block chain offers the ability to utilise the publicly distributed ledger in a variety of non-payment applications such as the ability to cryptographically secure a legal contract detailing a physical asset’s worth to a bitcoin transaction and be traded among digital wallets or the ability to connect a digital wallet to a smart meter for example, a vending machine.
With payments becoming even more digital, crypto-currencies are opening the era of internet of value, and it will be critical for banks understand benefits and evaluate opportunities. Some banks like the German Fidor Bank, Cross River Bank and CBW Bank in the US have already adopted Ripple’s protocol for real time cross border payments but the benefits for banks could be much more.
1 The Travel Rule requires all financial institutions to pass on certain information to the next financial institution involved in a transaction.