Why do banks see existential threat in cryptos? Let us study the reasons why this is so. But before we delve into the possible reasons why banks want to ban or regulate crypto, let us first consider the traditional role of banks.
Yes, yes, you say that In the USA Biden signed a law on regulating the sector, as did the European Parliament. In both cases these regulating laws do not regulate anything, and don`t let that fool you.
And so, let’s get started.
The role of banks in the economy
Before the advent of banks, people had to constantly keep precious metals with them. It was inconvenient to pay for goods and services, and people could lose their entire fortune as a result of a single theft or robbery.
However, with the invention of banks, people had a place where they could store their gold and receive paper banknotes in return. Paper currency was much easier to carry around and use for transactions. Despite the fact that the paper itself was worthless, the denominations represented the bank’s reserves. They carried value.
However, bankers soon realized that people rarely withdraw all their assets from the bank at once, so purchases lie idle. Bankers saw this as a huge opportunity, so they started charging interest for the issuance of currency, depending on the available assets. However, in the end greed took its toll, and banks began to give out more cash than the assets they had to secure them. This situation led to problems when the economic downturn caused a massive default of debtors on loans.
Therefore, bankers organized central banks to help out when their risky lending practices were disrupted due to the “black swan”, which nullified the ability of borrowers to repay their loans.
Small retail banks had to hold only a part of their deposit reserves, since everything was in large central banks. They could lend the rest to get more interest. Thus, the central bank has become an insurance policy.
Centralized systems like the central bank have their advantages and disadvantages. One of the positive aspects is that retail banks relying on a reliable currency issued by the central bank have universal value.
Supporters of central banks point to the old “bank runs” that caused convulsions in the US economy. Before the advent of the Federal Reserve System (FRS), municipal corporations could issue various currencies without having a good reason to evaluate them.
History of US Central Banks
Going back a few hundred years, the National Currency Act of 1863 and the National Bank Act of 1864 laid the foundation for a centralized Federal Reserve system that appeared in 1913. Along with it, there were promises to ensure the financial stability of the economy.
However, the Fed’s problem is that decision-making powers are concentrated in the hands of a few. This centralized distribution of power has brought us debilitating recessions and financial chaos.
For example, before the advent of the Fed, if a bank in Missouri issued a bunch of questionable loans and failed, local residents suffered. But the subsequent withdrawal from the bank and the financial disaster remained local.
When the Fed mismanages the money supply, the entire US suffers. In addition, since the US economy affects many other countries of the world, there is a ripple effect.
An example is the Great Depression. It was the most significant financial collapse in the history of the United States. The whole fiasco was the result of incorrect economic policy and incorrect decisions of the Fed reserve banks. In 2008, the Fed helped slow down the economy with low interest rates. As a result, a lot of moral risks arose when banks engaged in super-risky investments were rescued without any consequences.
Apologists of central banks argue that they are vital to keeping the economy afloat with stable prices and are the best institution to support the financial system during a crisis.
Critics of the system believe the opposite. They argue that institutional banks have damaged the economy and are responsible for debilitating recessions.
The role of central banks in the economy
Currently, the mandates of central banks vary from country to country. But their policies define the entire global financial system. In particular, in the US, they shape monetary policy and manipulate interest rates and the money supply. The Fed controls the level of employment and inflation. Similarly, the Bank of England manages the UK financial system.
They distribute money through a network of banks like spokes in a wheel. Therefore, if the country’s economy is in a sluggish state, the central bank can increase the amount of money in circulation to force people to spend again. When too much inflation starts in the economy, the bank can raise interest rates to cool the situation. Thus, their political mandates trickle through the system and are responsible for economic booms and recessions.
The modern financial system has turned into a complex infrastructure, which has further complicated the role of central banks in the economy.
As money becomes more digital, it circulates faster in the global economy. Thus, modern financial products and transactions are becoming more abstract and complex. An example of such complexity is the recent crash of 2008.
Various academics, journalists and financial analysts point to exotic derivatives trading as the culprit. Insolvent borrowers received their dubious loans repackaged into more sophisticated products that made them more attractive to potential investors.
Before the bubble burst, it was one ”big party” with profits. Citigroup CEO Chuck Prince put it this way about that period: “While the music is playing, you have to get up and dance. We’re still dancing.”
However, when the dancing ended, workers all over the world suffered. In general, this interconnected global economy has demonstrated that the wrong decisions of one central bank affect many nation-states. It took quite a bit of time for the Great Recession of 2008 in the United States to jump across continents and contribute to a global downturn in the markets.
The emergence of Bitcoin was a direct response to the 2008 crisis.
With the help of decentralized blockchain technology, the creator(s) of Bitcoin Satoshi Nakamoto hoped to eliminate the outdated central banking system, which has too much influence on the economic fate of entire states. Moreover, the limited supply of Bitcoins, amounting to only 21 million coins, means that developers will not be able to release even more Bitcoins when they need an incentive.
The reason why banks don’t like cryptocurrencies (or rather, the first cryptocurrency) is that Satoshi Nakamoto created the BTC as an alternative to the dominance of the central bank. It is a peer-to-peer version of digital cash, with which users can send payments directly to each other without going through financial institutions.
The shortage factor was purposeful. The 21 million limit prevents future central bankers from printing money out of thin air and flooding the economy with it. Nothing could be more controversial for their system.
A solution using Bitcoin
- Countering counterfeit currency
Bitcoin eliminates the problem of double spending because Bitcoin is cryptographically secure and unique. This means that it cannot be hacked or forged.
- Without trust
The BTC is decentralized, and transactions are approved by nodes scattered throughout the network, which takes power out of the control of a few.
There is no need for a centralized infrastructure with third-party intermediaries. Peer-to-peer transfers between two addresses occur on the Bitcoin blockchain without the help of bankers.
Therefore, the old chain of banks in a network with centralized management is no longer needed to distribute cryptocurrencies. Now it becomes clear to you why banks don’t like cryptocurrencies?
Some disadvantages of cryptocurrencies
Cryptocurrencies promise economic freedom, but there is one catch, or rather, several: since Bitcoin entered the market, consumers still do not use cryptocurrency as a means of exchange. Firstly, people expect their cryptocurrency to grow in value, so they want to keep it, and not spend it on everyday goods. In addition, volatile price fluctuations make it difficult to use cryptocurrencies in everyday transactions, even if they want to.
Bitcoin is the largest cryptocurrency by market volume, but most countries are still suspicious of it. India is working to ban cryptocurrencies, and China has banned Bitcoin in one form or another. Even the UK has recently banned bitcoin ATMs. Only El Salvador considers Bitcoin a legitimate currency. So it is still far from mass adoption as a means of exchange.
However, Bitcoin’s problems have not prevented central banks from copying some features for their digital currencies.
At first, the banking authorities tried to ban cryptocurrencies, but now they say, “If you can’t beat them, join them.” Imitation is the most sincere form of flattery, and banks are working to create their own central bank digital currencies (CBDC).
CBDCs are digital currencies of central banks that will be used in their economy, and banks in different countries are at different stages of their development. According to Coinmarketrate.com JPMorgan launched its digital currency in 2019, while other banks are still mulling over the idea. But banks will have to step up their game to prevent Ethereum DeFi platforms from overtaking them further. At the same time, more central banks are likely to introduce their CBDCs to try to compete.
After all, CBDC is a boon for central banks. They can use the best aspects of technology while eliminating decentralization and scarcity. More importantly, governments will salivate at the ability of the central bank to track every spending of its citizens.
Most people agree that in the future all assets will go digital, this is not news anymore. After bankers failed to stop cryptocurrencies with previous lobbying efforts, their latest strategy is to use what they like best in blockchain solutions to avoid extinction.
Their strategy consists of two directions: to experiment with digital currencies and at the same time lobby politicians to introduce regulations that prevent competition. After all, banks are nervous. A decentralized and private way that allows individuals to trade freely around the world without third-party intermediaries regulating and controlling them is contrary to the principles of banks.
They manage the modern global financial infrastructure, and most countries bow to their power in managing their economies. That’s why banks don’t like cryptocurrencies. They represent a terrible competition that can eliminate the suffocating control of banks over the financial system.