The Impact of Cryptocurrency on Traditional Banking

With virtual currencies only beginning to ripple through the financial system, now the traditional banks are feeling the heat. It is like watching a vintage game of chess, but now there is a rogue pawn (cryptocurrency) making wild moves and causing trouble in ways that bankers are unaware of and attempting to determine how to respond.

Traditional banking has had centuries to build up a robust system, but the rise of cryptocurrency brings a host of new challenges. Whether it’s the disintermediation of banks or the pressure to innovate, cryptocurrency is forcing the entire financial sector to rethink its position.

So, let’s dive into the ways cryptocurrency is making waves in the world of traditional banking—and yes, we’re going to have some fun with it.

Disintermediation

One of the most exciting (and a little scary) aspects of cryptocurrency is the ability to cut out traditional banks and financial middlemen. In simpler terms, it means removing the middleman from the equation.

For example, when you’re trading money (moving money from one individual to another), you must have a bank act as an intermediary. The bank will verify your transaction, make the transfer, and you will pay them for using it as a service. On the other side, with cryptocurrency, you can move money directly from one individual to another without having a bank act as a middleman and charge a fee.

This is a direct threat to the business model at the very foundation of traditional banks, who have flourished for decades marketing these middleman services. 

As more individuals start to use cryptocurrencies such as Bitcoin or Ethereum, banks are grasping at straws in an attempt to try and understand how they can continue to add value within this new peer-to-peer environment.

Increased Competition

Where there’s demand, there’s competition—and cryptocurrency has opened the floodgates. Historically, banks have enjoyed a monopoly on lending, payment, and even saving. But decentralized finance (DeFi) platforms are now taking a cut out of the action, providing the same services—only without the overhead, the branches, and the seemingly endless forms.

DeFi platforms are already offering peer-to-peer lending, insurance, and even decentralized exchanges, where individuals can exchange assets without the intervention of a common authority in between. These services are faster, less expensive, and more convenient than banks, putting the serious squeeze on traditional institutions to remain competitive.

The game is different now, and banks are being compelled to determine how they can play this new game—because, believe me, there’s no turning back the clock.

Pressure to Innovate

With cryptocurrency leading the charge, banks are forced to make modern amendments or become zero. Especially if we consider the emergence of blockchain technology, the foundation of most cryptocurrencies. Blockchain provides an open, secure, and decentralized accounting system for transactions, and it’s finding applications beyond digital currencies.

The truth is, unless banks start to turn towards blockchain and other new technologies, they may find themselves at risk of being left behind. Already, this has prompted a banking slash of innovation, with large institutions looking into blockchain to allow everything from cross-border transactions to online identities.

The dilemma for the banks now is how to mesh these new technologies with existing infrastructure without upsetting their current business. It’s a tightrope—something similar to trying to stuff a square peg into a round hole.

Development of Central Bank Digital Currencies

Enter the Central Bank Digital Currency (CBDC). Whereas cryptocurrencies such as Bitcoin are decentralized and subject to no regulation by any central authority, CBDCs represent how governments all over the world are jumping into the digital currency space. Central banks globally are looking into issuing their own digital currencies to replace or supplement paper money.

For traditional banks, it is a threat and challenge on the potential side. On the other hand, CBDCs can provide a safer, controlled digital alternative to the chaotic space of cryptocurrencies. But with widespread adoption of CBDCs, it may once again nibble at the banks’ stranglehold over money supply and the financial system.

But one thing is sure: Central banks are watching closely how the cryptocurrencies unfold, and they will not simply remain passive while the world goes digital currency-hungry.

New Compliance and Regulatory Challenges

As cryptocurrencies grow, so does regulatory need. Regulators and governments are scrambling to figure out how to manage the risks of digital currencies—money laundering, fraud, and tax evasion.

Old-fashioned banks, which are already regulated, can even face stricter regulation as governments struggle to regulate the digital currencies’ markets. The advent of digital currencies can also unleash a tidal wave of new regulations that will cover both cryptocurrencies and the banks where these are deposited.

For banks, that means higher compliance costs and a constant need to stay one step ahead of evolving regulations. It’s part airplane flight, part airplane construction. Not impossible, but more difficult.

Revenue Threats from Remittances and Fees

Banks have traditionally depended on remittance, transaction fees, and lending interest as primary sources of revenue. But cryptocurrency threatens to upend that revenue model.

For instance, cryptocurrency can give a less expensive, quicker choice to remittance services, which are a tremendous source of profit for banks. Money transfer from one country to another via cryptocurrency can be facilitated in a quarter of the time and expense compared to traditional banking.

The potential of cryptocurrency to reduce the cost of transactions and remove fees can make banks anxious to find other sources of revenue. Banks risk losing customers to lower-fee and quicker digital currencies if they fail to identify ways of maintaining competitive pricing and service.

Custodial Services Expansion

As cryptocurrencies gain more popularity, there is ever-growing demand for custodial services—essentially, a safe place to store your digital money. Although the old banks never had these services in the beginning, they are now starting to get into the crypto space in a bid to capitalize on this new demand.

Cryptocurrency custodial services can protect digital currency from hacking or theft, and banks are eager to diversify and add this as an offering. Although potentially creating a new source of revenue for banks, it makes banks have to change their way of working rapidly into an area where conventional banking skills might not be paramount.

It is a new frontier for banks, and the players who master managing it could be the new heroes of this new economy.

Changes in Consumer Expectations

The current consumers are becoming more and more technologically savvy on a daily basis and wanting services that not only cost less but are faster and more efficient to consume. The rise of cryptocurrencies has merely increased the pace of consumer expectation changes.

For instance, the majority of crypto users are used to low-cost and instant transactions, and they expect the same from traditional banking services. Banks will lose customers to fintech firms and crypto exchanges that provide a more convenient customer experience if they cannot deliver the same.

Older banks have to adapt to digital transformation if they want to survive. From making mobile applications more advanced to enabling quicker payments, customer needs are compelling banks to change their game.

Risk and Volatility Exposure

Whereas cryptocurrency offers innovation, it also offers a lot of risk. Bitcoin’s price, for instance, can fluctuate wildly, and that volatility can be a nightmare for investors as well as banks.

Traditional banks are risk-averse and have strict risk management processes. But price volatility in cryptocurrencies adds a new level of risk. Banks investing in or providing crypto services are exposing themselves to price volatility that may affect their bottom line.

For banks, it involves tightrope-walking the ability to make money from the boom in crypto without taking risk. There will be some who will stay away from the crypto market, and some who will find it as a chance to diversify. It’s a tightrope-walking situation, and there is no silver bullet.

New Investment and Wealth Products

While cryptocurrency becomes more mainstream, banks start to see the investment and wealth management potential. For instance, they might be able to introduce cryptocurrency-based funds, crypto pension accounts, or even investment consulting for clients that want to delve into the arena of digital money.

With crypto-based investment products, banks can access an emerging investor base that is keen to diversify its portfolio through digital assets. This can become a new source of revenue for the banks and be the first choice for clients looking for crypto.

But this also raises a challenge to banks in terms of how exactly they do instruct and advise clients when it comes to the complexities of investing in cryptocurrency. It’s not a simple matter to tell clients to invest in stocks or bonds. 

Conclusion

The effect of cryptocurrency on conventional banking cannot be underestimated. It certainly presents a set of challenges—from disintermediation and enhanced competition to calls for innovation and compliance—but crypto also presents the possibilities for expansion and change.

Banks that can adapt to this new digital age will stand a chance of success. Banks that do not innovate risk being swept away by the tide of change. So, as the world of finance evolves, one thing is certain: the intersection of cryptocurrency and old-school banking is something to watch.

It’s not so much now whether or if cryptocurrencies will supplant banking, but when and how.