Bitcoin – Progression towards World Acceptance

Bitcoin: From Niche to Potential Mainstream

Please Click to Enlarge
Please Click to Enlarge

The ‘enfant terrible’ of currencies, Bitcoin, has come a long way since sprouting out at a time when the banking world was going through their latest round of turmoil – 2008. From Fintech start-ups to ETFs and finally now jumping the bandwagon, a consortium of Big Banks, have all been putting in their weigh to give the crypto-currency the legitimacy it longed for.

When ‘Satoshi Nakamoto’ invented Bitcoin in 2008, with a possible vision of a global but decentralized money network controlled by end users, many thought that this would revolutionize the way banking works. Now, the digital currency, which set off a frenzy when it broke into public consciousness and peaked over the $1,000 benchmark in 2013, is trying to walk the path it originally set out to follow. However, instead of the crypto-currency in itself, it is the distributed ledger technology behind Bitcoin known as the ‘block chain’ that could bring a sea of change in the banking world. Block Chain is, however, not limited to Bitcoin, but the distributed database behind the crypto-currency is most certainly the most commonly recognized one.

On Tuesday, September 29, 2015, a total of 22 banks including some of the biggest global banks such as JP Morgan Chase & Co. (NYSE: JPM), HSBC Holdings PLC (NYSE: HSBC), Citigroup Inc. (NYSE: C), Bank of America Corp. (NYSE: BAC) and Royal Bank of Canada (NYSE: DB) have joined a group led by financial tech firm R3 to create and establish protocols and standards for the use of block chain technologies to provide financial services. The accord was led by David Rutter, former CEO of electronic trading at ICAP Electronic Trading, one of the world’s largest interdealer brokers. This is the first time that banks, traditionally competitors, are coming together to work, build and check whether a platform based on the technology can be used across the financial markets at a global scale.

Please Click to Enlarge
Please Click to Enlarge

The consortium would try to test and establish whether the platform can handle transactions worth billions of dollars that happen every minute in the banking industry. They would also look forward to learn from the experiments with the technology to understand how they could its optimize usage within financial services.

Mr. Rutter said that banks were mostly interested in the technical architecture underpinning the block chain that could be adapted for their own ends. He added that by adopting the technology, banks could cut the cost of reporting transactions and working out who bought what and when.

Deepening Interest

The creation of the consortium is the latest and strongest move in a long string of forays by start-ups to get banks interested enough to look at how to bring the crypto-currency and the technology behind it to a more mainstream usage. Below is a brief recap of some of the preceding attempts:

In August 2015, Bitcoin start-up Symbiont released its “Smart Securities” platform on Bitcoin’s block chain which allows institutions and investors to efficiently trade and manage a range of financial instruments on decentralized financial networks that are cryptographically secured. Overstock.com launched its own block chain-based trading venture, called t0, at the NASDAQ stock exchange in August 2015. Another startup, ItBit, is preparing to unveil its own version, called BankChain, later in 2015.

In June 2015, NASDAQ announced that it would work with start-up Chain to keep records for its NASDAQ Private Market, which handles trading of shares in the pre-IPO phase.

Barclays also announced in June 2015 that it has signed an agreement with Swedish bitcoin start-up Safello to test traditional banking processes on the block chain to prove they work.

In July 2015, Citigroup Inc. (NYSE: C) announced its Citi Ventures is working on building its own digital currency experimental version called Citicoin.

Deutsche Bank AG (NYSE: DB) is also exploring potential commercial usage of block chain technology in areas including the enforcement and clearing of derivatives contracts, know-your-customer and anti-money laundering registries and surveillance, and securities asset servicing as noted in consultation published by the European Securities and Markets Authority on July 30, 2015.

The surge in interest in Bitcoin and the technology behind it shows that established financial institutions acknowledge and accept the prospect of the technology which can change the way transactions are settled across the globe.

With respected number of big global financial institutions warming up to Bitcoin and/ or the technology behind it, the crypto-currency seems to have undergone a complete transformation from its more geeky background as a black market currency to being the next “It” thing. In its small life cycle of 6 years the digital currency has seen all phases starting from massive hype and speculation which was followed by a crash and loss of goodwill as the system storing the virtual currency got hacked and many of a number of investors lost millions of dollars.

The banking business today works predominantly on trust; trust in the millions of transaction that takes place every second between individuals, institutions and even governments. The trust system is built through the broker and banks who act as intermediaries between the transaction responsible for recording and verifying them.

‘Satoshi Nakamoto’ created Bitcoin as an anti-government or anti-bank currency; he challenged the trust factors of banks in doing the transactions. In his notes in 2009, he wrote “Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve.” The elusive ‘Nakamoto’ further stated that: “We have to trust them with our privacy, trust them not to let identity thieves drain our accounts.”

Banks were one of the most vocal critics of the virtual currency alongside the governments as they feared that this will lead to a parallel economy. They were also concerned that Bitcoin had the potential to replace them, or bring a change in their way of functioning. MIT business professor, Trond Undheim, wrote in an article on November 2014 that: “banks are afraid of Bitcoin because it would force them to innovate.

So what has turned this Untouchable of the banking class into everyone’s project ‘X’? Instead of deriding the currency banks are looking for a means to bring its technology to the service of the banking sphere?

With tougher post-recession regulations and cost-cutting measures being some of the primary reasons behind banks’ new strategy with Bitcoin, they have also acknowledge the need for moving money at a faster rate from one end to another through  a decentralized transaction verification system in a cost efficient manner. Today, if one makes a payment from Africa to Asia it takes around a week for the transaction to be completed; in between the files going through legacy systems to check whether the party making the transaction can be trusted. This also involves a number of intermediaries and the transaction also adds up a heavy cost for moving the money around requiring human intervention. In today’s technologically advanced world where a call over a smartphone takes milliseconds to connect to anyone around the globe, the banking system is lagging far behind. Bitcoin enables a real-time exchange of value on a one-to-one or peer-to-peer basis for virtually no charge; this is the most significant real time benefit of the virtual currency.

Please Click to Enlarge
Please Click to Enlarge

The block chain works like a giant decentralized ledger shared and maintained by a network of computers maintained by users in various location. Transaction occurring between users are encoded and transmitted across to a network of computers known as miners. The miners gather blocks of transactions and compete to verify the transaction first. As soon as one succeeds it shows its work to the others, which double check the transaction, the first computer or network receive monetary incentives in return.

Please Click to Enlarge
Please Click to Enlarge

Once a transaction is approved it is recorded in the block chain, copies of which are maintained separately by computers across the community. Every Bitcoin transaction that has occurred till date is noted in the ledger and can never be erased. The ledgers growing constantly as more transactions are added in chronological order. The computers continually compare their copies of the block chain, checking for discrepancies.

As the online community is constantly checking the work of each other it is considered to be tamper proof. For example, if someone attempts to make a false transaction by spending the same Bitcoin twice, this would not match the records held by the community which will reject the second transaction.

Rules and regulations established after the 2008 financial crisis have forced OTC derivatives to be processed through centralized clearing houses, this has increased the amount of money which acts as a collateral flowing through the financial system that can be then used as insurance for clearing the derivatives trades.

Banks and exchanges believe that a ledger which can be updated in real time will result in the saving of millions in collateral and settlement costs. A report released by Santander InnoVentures, co-authored with Anthemis and Oliver Wymans, in June 2015, estimated that distributed ledger technology could cut $15 billion to $20 billion annually from banks’ costs for cross-border payments, securities trading and regulatory compliance by 2022.

Banks are viewing digital currencies and the block chain technology as a potential game changer to could be integrated into their operating model as opposed to an external threat. Block chain has the unique potential to erode the value of expensive banking infrastructure and boost payment speed and security at par with technological advancements. And these positives will be provided without the need for banking systems which nowadays works on limited hours on a limited number of days during any given week.

However, there may be some inherent issues with the block chain technology as it is currently not optimized to be accepted for banking transactions worldwide. Moreover, environmentalists have criticized the amount of power which is being utilized by computers constantly mining for new blocks of data.

Currently, the decoding work is done by a network of computers, and the cost of running the computers are constantly borne by a group of anonymous users. As the fundamental logic of the block chain lies in consensus where computers agree with each other to verify the transaction, if anyone in those group controls the majority of the network’s computing power even for a small time frame, they could potentially alter the ledger.

Also, unlike the decentralized ledger where all the information about users remains public, banks would need to keep the details private as customers would be wary of their details being available in public domain. Bitcoin has been hit by a series of thefts, where coins which are traded or are held digital wallets, have been hacked by cyber criminals exploiting weaknesses on exchanges.

Digital currencies and the technology powering them may not be the perfect solution to transferring money at a faster and more cost effective manner, but it is a step in the right direction. When money are transferred at the rate messages are sent and received across social media or chat rooms, then the implementation of this technology at a broader level would have achieved its goal partially.

Disclaimer:

The information within this report is provided to its recipients for informational purposes only and shall not be used or considered as an offer or solicitation to trade or subscribe for securities or other financial instruments. Pursuant to WSA’s policy, the author(s) of this report does not own shares in any company he/she covers.

The data contained within this report is based on information derived from selected third party sources our research desk believes to be reliable, but neither its fairness, accuracy nor completeness for retail investors’ purposes can be represented or warranted, expressly or impliedly.

Risks:

The report is intended for WSA’s clients (retail investors) only and it is intended to provide information to assist WSA’s clients in making their own investment decisions. It is, however, not intended to provide investment advice to any specific investor. Specifically, it does not constitute a personal recommendation or take into account the particular investment objectives, financial situation, or individual investor needs. Recipients must exercise their own independent judgment as to the suitability of such investments and recommendations in the light of their own investment objectives, experience, tax and financial position or individual needs. Recipients shall always check with their licensed financial advisor, including their tax advisor, to determine the suitability of any investment.

Past performance should not be taken as an indication or guarantee of future performance. The price, value of and income from, any of the financial instruments featured in this report can rise as well as fall and be affected by changes in economic, financial and political factors. If a financial instrument is denominated in a currency other than the investor’s currency, a change in exchange rates may adversely affect the price or value of, or income derived from, the financial instrument, and such investors effectively assume currency risk. In addition, investors in securities such as ADRs, whose value is affected by the currency of the home market of the underlying security, effectively assume currency risk.

Redistribution of this report without explicit permission from WSA is strictly prohibited. All logos are the copyright property of their respective companies and are used here only to aid the reader in identification of the subject of the article.

Be the first to comment

Leave a Reply

Your email address will not be published.


*