For many years, cryptocurrency has been associated with ransomware and the dark web. It has been a speculative investment at best: highly volatile, not traceable and not easily convertible to dollars.
Recently, a new form of cryptocurrency – a digital currency issued by a nation’s central financial institution and tied to a fiat currency (like the dollar, euro or yuan, for example) – emerged to eliminate the volatility and the anonymity, making conversion easier and more cost effective. In fact, Visa’s head of crypto boldly stated that this new form will be the most important payments trend of the next decade.
To date, however, previous types of cryptocurrency have had no impact on other forms of payments. So what makes this one different? And what should financial institutions expect as consumer and merchant acceptance – as well as the proliferation and usability of digital currency wallets – all potentially increase?
First, let’s take a deeper dive into the different types of cryptocurrency. A cryptocurrency’s monetary value is represented by a token held in an individual’s digital wallet. Transactions of that token are registered in a distributed ledger, or blockchain. The most widely known versions of cryptocurrency include Bitcoin, Etherium and XRP.
This category of currency is publicly traded, meaning the value of each coin is determined by supply and demand. Although initially envisioned as a secure, anonymous method of payment independent of any government oversight — hence the categorization of decentralized — these forms of cryptocurrency have all become more speculative investments rather than viable forms of payment. There is little merchant acceptance of this form of currency, except for nefarious purposes, due to the volatility of its value and the difficulty and expense in converting decentralized crypto into dollars or other fungible forms of payment.
Several fintechs, as well as mainstream banking providers, are attempting to make the process of purchasing, holding and selling decentralized crypto more manageable. In June 2018, Square enabled users of its popular Cash App to buy and sell Bitcoin. The Bitcoin could not be used directly for purchases from Square merchants, but rather would need to be sold within the app or transferred to another wallet.
A Growing Trend:
Paypal now allows users to buy, hold and sell several cryptocurrencies, including Bitcoin, Ethereum, Litecoin and Bitcoin Cash, all fee-free.
BNY Mellon joined other established financial services firms including State Street, Fidelity and Northern Trust, enabling their investment clients to buy and sell digital currencies alongside their other investments.
Visa announced a program which will allow any financial institution to offer consumers the ability to purchase and trade digital currencies. While all of these examples are bringing cryptocurrency into the reach of mainstream, none of them enable holders of these assets to purchase goods and services, or to pay or be paid, in decentralized cryptocurrency.
The Stablecoin Option
To solve for the difficulty of spending cryptocurrency or converting funds for payments, a new form of cryptocurrency called stablecoins was developed. The value of a stablecoin is pegged to an asset, such as the fiat currency of a nation. As opposed to Bitcoin, which has no owner, stablecoins are typically issued by a private or public organization.
Stablecoin vs. Bitcoin
Whereas Bitcoin is permission-less — which means anyone can become part of the blockchain for mining and redeeming new coins — stablecoins are permissioned, so there is an entity that acknowledges and allows access to the blockchain for the respective currency.
One example of a stablecoin is the JPM Coin issued by JPMorgan Chase, which recently went live. The goal of the JPM Coin is to reduce cost and friction in interbank transfers, especially cross-border, by moving monetary value on a secure blockchain rather than through intermediary banks and credit unions.
It is currently redeemable by its institutional customers or members at a 1-to-1 ratio to the U.S. dollar, and it is expected to support other fiat currencies in the future.
Another example of a stablecoin is Libra – a previously planned stablecoin announced by Facebook. The original vision of Libra was a stablecoin backed by a reserve of cash and low-risk government securities denominated in a mixture of selected fiat currencies. Facebook has since revamped its plan, renaming Libra as Diem, changing to a single security-backed stablecoin and turning governance over to a consortium called the Diem Association.
Central Bank Digital Currency (CBDC)
The newest type of cryptocurrency, Central Bank Digital Currency (CBDC) is a special category of stablecoin that is issued and controlled by the central financial institution of a country. It is intended to replace paper currency with digital, increasing security and monitoring.
China has moved forward with its widespread trials of digital yuan, or eCNY. China’s state-backed banking providers issue digital wallets to individuals and are responsible for conducting Know Your Customer (KYC) and anti-money laundering compliance.
Major firms such as China’s largest ridesharing company Didi Chuxing and food delivery giant Meituan are included in the trial for acceptance. Although it is a digital currency issued by the central financial institution, it looks more like the digital wallets that already dominate commerce in China to end users and merchants like Alibaba and Tencent.
In the U.S., the Fed is collaborating with MIT to research technologies to build and test a digital currency platform. When it was pointed out to Treasury Secretary Janet Yellen in an interview that “70 countries now have digital currency projects,” she responded: “I think it makes sense for central bank to be looking at it… We do have a problem with financial inclusion.”
“Too many Americans really don’t have access to easy payment systems and bank accounts. This is something that a digital dollar, a central bank digital currency, could help with. I think it could result in faster, safer and cheaper payments.”
— Janet Yellen
Federal Reserve Chairman Jerome Powell, in congressional testimony, called the digital dollar “a high priority project for us.” He added, “We are committed to solving the technology problems, and consulting very broadly with the public and very transparently with all interested constituencies whether we should do this.”
The Anticipated Effects of CBDCs
What does all of this mean for credit unions and banks? A slight increase in card transactions is expected as digital currency platforms such as Coinbase and Fold work with Visa and Mastercard to enable digital currency conversion in real-time and over existing card rails. The biggest anticipated impact will be a quicker elimination of cash and checks, as the unbanked are given the option to store their money digitally without the need for a bank account.
In addition, there is the possibility of a decrease in deposits as more funds are stored in digital wallets as opposed to bank accounts. This may result in a migration from debit card usage associated with a demand deposit account (DDA) to debit card usage associated with a digital wallet. However, any decrease due to this migration will be outweighed by the greater migration from cash to digital, ultimately resulting in a drive to more – not less – debit transactions.
There have also been some projections as to how the introduction of a CBDC might impact banking in general. The Fed produced an abstract comparing means of payments when a CBDC co-exists with other forms of payments. This abstract does not infer that there is a direct influence on transactions, positive nor negative, but it does explore the challenges and benefits to banks and credit unions. The three main impacts, all of which are positive, were identified as:
- Improved accessibly for purchasing by the unbanked, especially where cash is not a viable payment method, such as for online purchases, airline reservations, etc.
- Availability to access funds would increase to anytime, everywhere
- Immediacy will become the new expectation
That being said, since China’s closed environment does not lend itself to direct comparison to other markets, and there are such few active instances of CBDC, there are currently no relevant case studies to reference for actualities.
Overall, while Bitcoin and other permission-less cryptocurrency will likely never be viable payment forms, CBDC – whether blockchain or central-ledger – appears inevitable. While the impact may not be felt for several years, it will only hasten the movement away from paper money and checks to a more fully digital payments ecosystem.
Keep in Mind:
Credit unions and banks should begin preparing for what implications cryptocurrency might have on consumers’ banking activities now and into the future.
Lou Grilli is a Senior Innovation Strategist at PSCU. In this role, Lou is tasked with building and shaping a superior payment and member experience capability for PSCU and its Owner credit unions.