Bitcoin and Banks (by )

The existing financial industry isn't exactly welcoming Bitcoin with open arms. Paypal regard bitcoin as a currency and their terms of service disallow currency purchases, while where I live in the UK, Bitcoin exchanges keep having their UK bank accounts closed (which is a problem, as wire transfer is generally the best way to get your pounds sterling into the Bitcoin exchange).

Clearly, there's a strong case for the current banking system to see Bitcoin as a competitor, but it's a bit more complex than it seems; Bitcoin only competes with part of the banking business.

Banks are complex beasts

Banks perform lots of functions, all piled together. One function is to look after your money for you; they give you some interest on it, and provide some security compared to burying it in the woods. They do this so that they have heaps of cash lying around to lend to people or otherwise invest, and make even more interest themselves.

This is a useful function in society - it provides a source of loans to help new businesses get started, and centralising the task of securely storing money brings economies of scale, compared to us all having to build our own bank vaults at home.

But another function of banks (with the help of companies like Visa and Mastercard), that has been built on top of the money-storing facility - is funds transfer. We can tell our bank to transfer some of our money to another bank account, rather than having to go and get cash out, hand it to somebody, and have them pay it into their bank. Or we can use our convenient plastic cards to request that this happen (but only to special merchant accounts, and the banks and payment processors take a cut on the way in exchange for all that convenience).

How Bitcoin competes

Bitcoin competes a bit with the storing-money function, because it makes it easier to securely store your own money; using strong crypto, paper wallets, and so on, you can keep your bitcoins safe. However, your own bitcoin wallet doesn't provide interest. The value of each bitcoin may rise, but the number of them in your wallet remains the same. A bank could provide a bitcoin deposit account, and give you interest (as well as the value of each bitcoin rising), and use the bitcoins to provide loans to people. There's still a business for banks there.

Bitcoin's transfer mechanism beats Visa, Mastercard, wire transfer, PayPal, and handing over cash in very many respects, but it still has its downsides; it takes about an hour to get six confirmations, the gold standard of transaction safety. That's not a problem for Internet mail-order businesses, but it's not really practical for buying your weekly supermarket shop. So there's still a future for card payments as a way to instantly zap some of your bitcoins over to a merchant; even if the card processor fees and risk of chargebacks is worse than the risk of fraud if you accept bitcoin transactions with six confirmations, cards are still convenient, which is very valuable for a large retail operation.

New opportunities for banks

So I think that banks are right to "fear" Bitcoin somewhat, as it will certainly cut into some profitable parts of their business.

But I think it's certainly wrong to assume that Bitcoin will somehow make the banking industry irrelevant.

Now, technology destroying a business model is hardly a new story, and we've seen the same dramas played out before as the long-standing incumbents struggle to fight the tides of change; the music industry is a particularly relevant case in point. And as usual, there are entirely new lines of business that the incumbents could expand into if they adopted the new technology and found ways to profit from it.

So, I've been thinking about roles banks could hold in a mainstream-Bitcoin future; deposit accounts and payment processing might be reduced, and loans and mortgages and insurance would still be going strong, but what about new businesses?

Enterprise-grade hardware wallets

One that particularly came to mind is that banks, who have good (if not always deserved) reputations for technical and organisational security measures regarding financial IT, could probably make a pretty penny selling and supporting high-end hardware wallets. I'm imagining nice rack-mount boxes with multiple network interfaces and tamper-proof storage modules inside; on one (public) network interface they work as a Bitcoin node in order to be able to process transactions, while the other interface(s) provide control over the wallet stored in the tamper-proof storage within. The device could provide fine-grained access control over the balance it stores, allowing different "accounts" to be provided with varying levels of budget, or approval required for outbound transactions, and the like. It could also support encrypted peering with other boxes, automatically mirroring the wallet state so it's safe in case of disaster, or providing encrypted copies of the wallet and configuration for storing offline somewhere. It could interface with cold storage wallets on removable media, possibly including split-key systems so that any two of the five "splits", stored on separate devices, can be used to access the funds. All sorts of advanced security facilities could be placed into such a device, while offering the convenience of full electronic control of an organisation's spending.

Although making such a device would largely be a matter of technical development, which anybody with the required computer security experience could do, banks would be uniquely placed to use their reputations to actually sell such devices into large businesses, and to back their security claims up with insurance products.

What else?

There's plenty of other services banks could provide in a Bitcoin world. Consumer-grade hardware wallets are one, and could be used to replace the card payment networks (which cost a lot to run). For a bank, that could be a way to eliminate Visa or Mastercard's fees from their operations; for Visa or Mastercard, it could be a way to slash their operating costs. Banks would be excellently placed to offer trusted escrow services for bitcoin transactions, and would be well equipped to run bitcoin exchanges.

So I'm sure that banks are currently hoping Bitcoin will collapse, or at least remain safely stuck in a niche; and trying to do all they can to prevent it from taking off. But they can't help but notice how poorly that kind of tactic has helped other industries threatened by technological change in the past, so I'd hope they're spending some time considering how they're going to fit into a Bitcoin world.

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