Cryptocurrency Basics: Blockchain and the Future of Banking for Credit Unions
Cryptocurrency. This is perhaps the hottest topic in the financial services industry right now, and the concept of cryptocurrency has become a bit of a buzzword that everyone seems to be talking about.
After the most recent crypto bubble that burst around 2018, many people were skeptical about if cryptocurrency would make a real comeback. These doubts have proven to be unfounded, as today, everyone seems to be asking the same questions: what’s the deal with cryptocurrency, and more importantly, how do I get my hands on some?
But what exactly is cryptocurrency and what will it mean for the financial services industry in the long term? We’ll answer these questions and more as we cover the basics of cryptocurrency and what it means for credit unions.
What is Cryptocurrency?
The concept of cryptocurrency is relatively simple: it’s a decentralized, purely digital currency that can be used anywhere in the world, by anyone who has an internet connection and smartphone.
There are many types of cryptocurrencies that exist today (over 5,000 – and counting), with the most well-known being Bitcoin and Ethereum.
Cryptocurrencies use a distributed ledger system called blockchain to verify and keep records of the transactions made using a particular currency. Every cryptocurrency has its own unique blockchain that anyone can access using open-source software and a computer.
A key tenant of cryptocurrencies is that their blockchains are not owned by any single party. Everyone on the network owns a copy of every transaction that has ever occurred. This makes cryptocurrencies extremely secure as it is virtually impossible to forge or duplicate transactions: everything that happens on the blockchain is verified and provable by multiple participants.
How do Cryptocurrencies Gain and Retain their Value?
A cryptocurrency gets its value because coins are difficult to find. Much like gold, you have to “mine” cryptocurrencies using powerful computers (often called “rigs”) to solve complex math problems.
Cryptocurrencies gain and retain their value based on the economic principles of scarcity and supply and demand. For example, Bitcoin has scarcity because there are only ever going to be 21 million coins that can be found by solving these math problems, and currently there are only about three million Bitcoin left to be found.
With currencies like Bitcoin, this drives up value because the amount available is finite. The scarcity of a given cryptocurrency also adds an important layer of complexity that sets them apart from fiat currencies that are controlled by governments, banks and central authorities.
Some cryptocurrencies are guarded from the economic forces of inflation (depending on the coin) because there is a limited amount of them. You can’t print or produce more of a given cryptocurrency like you can with traditional money, which is part of the reason we are seeing huge surges in demand for currencies like Bitcoin (currently one Bitcoin is valued around $70,000 CAD).
And of course, it helps that people around the world are buying into the idea that cryptocurrencies are a valuable way for us to transact with one another. This is in part thanks to big market players like Tesla showing confidence in cryptocurrencies by announcing massive investments in currencies like Bitcoin, sending prices skyrocketing overnight.
The well-known cryptocurrency exchange, Coinbase, went public recently as well. With a market capitalization of $85.8 billion, various crypto prices went soaring along with Coinbase following the IPO, marking a huge milestone for the future of cryptocurrencies.
These developments show that slowly but surely, cryptocurrencies are gaining market acceptance as everyday consumers and investors explore the possibilities of digital currencies. Even the Big Five Canadian banks are coming around to the idea of how they can meet consumer demand to buy cryptocurrencies, and may even dabble in holding small amounts of cryptocurrencies to support the trading activity of their customers.
According to a recent article published by The Globe and Mail, the challenge for Canadian banks and credit unions who may want to invest in crypto themselves is that:
“ under International Financial Reporting Standards, cryptocurrency holdings are not considered cash, which makes them a risky asset. Banks must test intangible assets on their balance sheets at least annually to ensure their value is not being overstated, and the wild swings in bitcoin prices could result in write-offs and charges against earnings.”
Although cryptocurrencies have been around for over a decade, there is still a lot of maturing that needs to occur with currencies like Bitcoin and Ethereum to achieve a level of stability that will give financial institutions the confidence they need to fully buy-in to this new opportunity.
What does the Future Hold for Credit Unions and How can they Take Advantage of Blockchain Technology?
Although cryptocurrencies (and how to invest in them) are the main focus of many conversations right now, the future for banks and credit unions lies in the underlying technology of cryptocurrencies – blockchain.
This is where currencies like Ethereum become important, because unlike Bitcoin (which is purely a digital currency), Ethereum is a cryptocurrency (known as Ether), but it’s blockchain can also complete countless other types of tasks using smart contracts.
Smart contracts can be used to establish and execute the terms of agreement set by two or more parties. When one party fulfills their contractual obligation, this automatically triggers another action (or set of actions) outlined in the smart contract. The execution of these smart contracts is tied to the currency of the blockchain they are built on, so smart contracts executed on the Ethereum blockchain are completed using Ether to pay for and facilitate the completion of the contract.
Banks and credit unions are completely reliant on creating legal agreements with their customers and members to give them access to financial services, and smart contracts open a whole new world of possibilities and ways to deliver services that are faster, cheaper and more secure than traditional contracts.
In fact, there is a huge push in the financial services space to explore decentralized finance (or DeFi) opportunities. From simple loan financing applications to managing complex syndication loans, banks and credit unions are already exploring how they can leverage blockchain technologies to streamline the way they do business using blockchain-based systems like R3’s Corda platform.
What’s clear is that we’re only scratching the surface of cryptocurrencies and blockchain technology. We envision a future where eventually, banks and credit unions alike will be building crypto payment rails and widely accepting and participating in the cryptocurrency economy as consumer demand continues to rise.
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Celero is a leading provider of digital technology and integration solutions to credit unions and financial institutions across Canada. Clients trust Celero’s proven track record delivering innovative banking technologies, digital and payment solutions, cloud computing, outsourcing, IT and advisory services.
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