Looking at digital currency world from banking lens

While the cryptocurency market capitalization is soaring and hundreds or new coins are mushrooming from all over the place, it is necessary for financial institutions esp. banks to look at this trend more deeply and identify opportunities, if any. Viewing from banking lens, I believe the cryptocurrency world can be broadly divided into two parts; Friends of the banks, and Challengers to the bank.

But before we go in there, lets look at some latest trends and their trigger points.

The Cryptocurrency rush     

The market capitalization of Cryptocurrency has soared over 200% in 2017 to touch $86 B (May 26, 2017), over 50% of the market capitalization is contributed by Bitcoin (market cap. up by 160% in the last three months), Ethereum takes the second spot with Market capitalization of $18B (up 330% in the last three months), Ripple is close 3rd with $14B market cap (source Coinmarketcap).  

As of now, a single Bitcoin is priced at $2500, while Ethereum is being traded at $225 (source - link). More than 800 coins are being traded on different exchanges across the globe, with new ones are being introduced through ICO mode (Initial Coin Offering).     

Triggers that are leading to this rush     

There are a number of triggers that are leading to this traction in the Crypto Currency space, most notable being; 

• April 2017, Japan legalized Bitcoins, and Russia is on its way to do the same – check this link and for further reading click - "Supply of Yen is unlimited while Bitcoin is limited – why would anyone want to hold depreciating yen when they can hold bitcoin"
  • Russia and South are expected to follow Japan in legalizing digital currency
• May 2017, 47 Banks in Japan successfully ran a pilot implementation of Ripple for instant payment transactions (domestically and internationally)
• May 2017, Enterprise Ethereum alliance getting bigger and bolder with members like Samsung, Toyota, Merck, Broadridge
• Rapid increase in number of companies accepting these coins as mode of payment 
  • Japanese airlines accepting Bitcoins 
  • Russian largest retailer
  • Fidelity is mining Bitcoin and accepting Bitcoins. While accepting Bitcoin in cafeteria wont drive much volumes, but point to note is they are mining Bitcoins too
  • Even UN is planning to adopt Bitcoin/Ethereum as a measure to cut down on intermediaries and bring transparency

Most of the latest developments are from the eastern part of the world and is believed that Korea and Japan and possibly China is heavily buying these currencies even at huge premiums (Source Link)

• Korean markets are buying Bitcoin at over $4000 - a $1400 premium or 50% premium to the USD price. Korean volumes hold 11% of total bitcoin trading. 
• Ethereum is also trading at $316 on Korean markets where the pair dominates trading with a 31% market share
• Bitcoin Trading in Japan is occurring at a  $3100 where the BTC-JPY accounts for 31% of the global market.
• Ethereum is also trading at a 10% premium in Japan in comparison to the JPY markets

Viewing from banking lens

According to my understanding of the market, while viewing from the banking lens, the various companies in the Cryptocurrency space can be divided into two categories

1. Friends of the bank
2. Challengers to the bank

1. Friends of the bank

Example companies: Ripple, Stellar

Key Characteristics

• Fixed amount of Pre-mined coins
• Consensus based transaction 
• Coins have no economic value - means they are less likely to be accepted as mode of payment, but more likely to be used as transfer of payment
• Faster payment execution (~4 sec)

Description

• They view banks as an important institution in the economy 
• These companies places themselves as an important enabler in the instant payment space, potentially replacing SWIFT and other RTP systems 
• These companies are leveraging Blockchain technology as method of transfer of payment/asset but not as store of asset 
• Large number of coins are floated in the market to maintain liquidity and reduce price fluctuation (Ripple plans to float ~100B coins in next 5 years) 
• The coins are used as bridge currency 
• Pace of transaction: It takes ~4 seconds to transfer any payment anywhere

Challenges

• Volatility: Fluctuation in the value of the coin during payment transfer

2. Challengers to the banks

Example companies: Bitcoin, Ethereum, Monero

Key Characteristics

• Coins need to be mined 
• Consensus based transaction 
• Coins are accepted as mode of payment 
• Much slower execution of payment (~800 sec)

Description

• A potential challengers to the banking system since technology can handle most of the regular banking needs 
• Smart contracts to reduce the role of an intermediary 
• The coins are mined in form of blocks by sharing the computing resource and solving complex algorithms (China has established huge mining factories, see here) 
• The coins are limited in number, only 21M Bitcoins to be in circulation (16M mined till now), and the #coins mined slows down as the proportion of mined coins increases 
• Since the transaction has to be confirmed by majority of the connected systems, it usually takes ~800 secs to process any transaction

Challenges

• Scaling: It requires enormous amount of computing power to mine the coins, it would be difficult to rely on present system for large scale adoption

Friends of the banks, Ripple or Stellar, catches my attention as an important and emerging players to partner with and explore opportunites to streamline payments.     

• Ripple (Backed by Google): Aiming banks and large financial institutions as their clients, Ripple is rapidly spreading its network. Ripple claims to have over 75 banks on its network including Bank of America, MUFG, StanC and UBS.  
  • "Ripple announced on Wednesday it has signed 10 new banks from all over the world, including BBVA in Spain; MUFG in Japan; Akbank in Turkey; SEB in Sweden; and Axis Bank and Yes Bank, both in India. Add those 10 to the 47-bank consortium in Japan that implemented Ripple in March. And add those 57 to existing big-name clients like Bank of America, RBC, Standard Chartered and UBS, and Ripple starts to look like it’s gaining traction very quickly link" 
  • Check this link – Ripple’s CTO at Consensus 2017 explaining Ripple Technology and its advantages over Bitcoin and Ethereum    

• Stellar (Backed by Sripe and founded by ex. Ripple Partner) is more focussed on micropayments, Remittances and is working with banks and other financial institutions across the globe to increase its network.  Check this link to scroll over Stellar’s partners and network supporters

Transforming payments (Domestic/ Cross border)

The emergence of new age Fintechs like Ripple or Stellar provides an opportunity to banks to selectively adopt  the merits of blockchain technology (payment processing, record keeping, traceability) while ignoring the demerits (processing time, cumbersome slower netowrk). 

Specifically banks can 

• Re-consider their payment networks and move from T+2 to instant payment modes
• Cut down payment transaction fees
• Maintain traceability and records that cannot by fudged

Obviously, the adoption would be gradual and slow as the banks work under strict confidentiality laws with respect to their clients data.