Digital Currency: Is it a Threat to Big Banks?

The world economy is dominated by a small number of major banks, almost all of which have been established for many years. For practically centuries, the global economy has gone through peaks and troughs. However, the underlying principle of finance has remained unchanged.

Traditional System

From the advent of paper money, as opposed to gold or coinage, the banking system, in general, has been able to leverage clients’ money to generate often obscene levels of profit. Banks have controlled the supply of money in the economy, decided where investment should flow, and have wielded exceptional influence levels over the populations they serve. Today, 90% of the money out there exists in the form of digital deposits, essentially created by banks as assets on their books when they have issued loans to clients. The ease at which banks can create this money is primarily controlled by central banks, which set interest rates in their respective countries. The higher the interest rates, the lower the demand for debt. In fact, as central banks are the ones who issue currency by printing money, one could say they control the flow of money in tandem with commercial banks.

Could the Advent of Cryptocurrency Finally Upset the Status Quo?

Especially in light of the global pandemic, many nations are moving towards becoming cashless societies. Electronic payments have overtaken cash as a means of providing funds for transactions, regardless of the amount of currency involved. In the short to medium term- this has increased the level of significance banks have, as, whereas previously we paid for small-ticket items with cash, now a bank is involved, whether it’s a card payment or made via a mobile payment system such as Apple Pay. However, longer-term, the establishment of these technologies could be leveraged to cut out the middle man, in this case, the bank, altogether.

Changes in the Way We Do Business

Traditionally, commercial banks were more than happy to issue loans to companies, as tangible assets underpinned these loans. Today, most modern companies have very few physical assets and instead hold valuable intellectual property rights. These companies now turn to equity investors for funding, cutting out the need for banks in the process. The role banks play in financing is diminishing over time.

Fintech

Innovative fintech companies, such as AliPay in China, allow users to circumvent banks with the advent of digital wallets – even letting users spend abroad without the need to convert funds as was done previously. These services are expanding to the point where users can borrow funds via the app. Central banks fear that this process could cut the cord between themselves and the wider economy, relieving them of their toolkit when it comes to monetary control.

Digital currency, through digital wallets, could potentially do everything that a regular bank does, in a democratized form, given that users would be in charge and could vote with their feet if they were unhappy with a service. In an attempt to regain their lost ground, some central banks are now creating their own digital currencies to rival the super apps.

Takeaway

Banks are recognizing that they are facing an existential threat from fintech and innovation more broadly. They are playing catch-up to add new services and applications, and some have branched out into whole new areas, such as food delivery and taxi services. It has yet to be seen whether crypto can prove the death knell of big banks, but the world has already witnessed the revolution that it has brought about. And this is just the start.