Institutional Adoption of Crypto: The ultimate problem

crypto adoption

A deep dive into cryptocurrency adoption on a global scale

“We believe that digital currencies have the potential to extend the value of digital payments to a greater number of people and places. As such, we want to help shape and support the role they play in the future of money,” said Visa in a statement last year.

This is a drastic shift in tone to the company’s previous stance on cryptocurrency. In 2018, Visa, MasterCard and Paypal cracked down on cryptocurrency transactions. This was a direct consequence of the bullish Bitcoin market of 2017.

Now all three companies are looking to expand their cryptocurrency program. Mastercard has signed a contract with the digital payment platform Wirex. This allows Wirex to issue payment cards on MasterCard’s network.

Similarly, in March 2021, Paypal has begun allowing its US-based customers to convert their cryptocurrency holdings to fiat currencies when making purchases using the platform. This allows users to make payments with their cryptocurrencies.

As the first half of 2021 comes to an end, cryptocurrencies have received tremendous publicity both good and bad. One prominent reason for this publicity is the investments made by legacy financial institutions in the crypto market. Traditional financial institutions like Goldman Sachs, JP Morgan, Morgan Stanley and Blackrocks have all set up bitcoin funds in the past couple of months. In December 2020, JP Morgan announced their blockchain-based application ‘Onyx.’ Recently Goldman Sachs has begun trading on the platform as well.

Reasons behind the adoption of cryptocurrency

One prominent reason why Institutions are adopting crypto is financial gain. For instance, the digital payments company Square has seen US$306 million in revenue through Bitcoin transactions on its cash app. The crypto market size in 2021 is US$1.6 billion and is expected to grow to US$2.2 billion by 2026. As the market continues to grow the investment possibilities in the sector become tough to ignore.

The introduction of Initial Coin Offerings (ICOs) has made it easier for institutions to invest in cryptocurrency. ICOs are done to raise funds to launch new coins. Investors can buy into an ICO to receive tokens which can be used to purchase a product or service of the company. ICOs can also represent stakeholding in a company or project.

The blockchain technology that facilitates cryptocurrencies can also be used to provide efficiency and transparency to banking operations. Blockchain is a digital ledger of transactions. Each block contains data about the transactions taking place within a given period of time. Blockchain serves as a way to solve the problem of processing costs. A traditional bank requires multiple agencies to work together to verify the applicant which can now be replaced with a smart contract on a digital ledger. A smart contract is automatically enforced once the terms and conditions under which it was signed have been met, reducing the time taken and the number of agencies involved. This can help banks cut out US$3 million to US$11 million in processing costs within the United States and the European Union.

Diversification of investment could be another possible reason behind the institutional investment in cryptocurrencies. The rise and fall of cryptocurrencies may not correlate with changes in the traditional stock market. Thus banks entering the crypto market while the trading structure is still in its infancy can reap benefits in the long run. Besides the investors, most companies innovating in the crypto sector are fairly young. These young companies would over time shape the way the sector looks in the future.

Challenges in adopting digital currencies

While using distributed ledger technologies like blockchain might provide transparency, it is not technically possible. Most digital ledgers cannot handle the volume of transactions a bank facilitates daily.

For effective functioning within the traditional banking system, it is critical that a digital ledger is interoperable. For a digital ledger to be functional for banks, it needs to be able to connect with the existing financial infrastructure as well as digital currencies.

The environmental implications of cryptocurrency are also a rising concern. Mining cryptocurrency requires a high processing speed. Cambridge researchers report that Bitoin mining consumes 121.36 terawatt-hours (TWh)of energy a year. This is more than the entire country of Argentina.

Thus there is a need for any new digital currencies created to be more energy efficient. A possible solution to this problem comes from Ripple, the real-time gross settlement system. Ripple is currently working on a private ledger for central banks. The ledger would be used to facilitate transactions of central bank issued cryptocurrencies. Ripple claims that this private ledger is 61,000 times more efficient than public blockchains.

The irony of institutional adoption

The central idea behind cryptocurrency is to provide a decentralized network in which peer-to-peer transactions can take place. Decentralization means that no central authority issues the cryptocurrency and has control over it.

Investments by financial institutions are thus ironic because they bring cryptocurrency under institutional control and in the process lead to a loss of crypto’s freedom from middle men. The decentralized system is trustless, no single party manages the overall system which ensures the users that their data is safe. Thus a system where cryptocurrency is longer decentralized, it loses all the features that make it attractive, such as seamless access to transaction data.

Today, banks and governments are working towards establishing their own digital currencies. This is a response to the reduction in the use of cash. Sweden for instance has worked with Accenture to create ‘e-krona.’

Cryptocurrencies offer faster transaction speed, low transaction costs and higher levels of security. Moreover, Decentralized financing (DeFi) platforms also facilitate ease of borrowing and repayment through cryptocurrencies. What remains to be seen then is what banks can bring to the table when competing against the pre-existing cryptocurrencies with their own renditions.

Image courtesy of Unsplash

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