There’s a phrase that has become almost a cliché in the cryptocurrency world: “Bitcoin is bad, but blockchain is good.” The people pushing that sentiment? Banks. Financial services providers. Lenders. Because while Bitcoin is a clear and present threat to the established financial market, blockchain represents a remarkable opportunity.
While Bitcoin’s underlying code was intended to end the rule of traditional financial institutions, the big banks are now seeking to leverage blockchain technology to continue dominating the market.
However, if these financial incumbents decide that blockchain technology is the wrong approach, what would the future of banking look like? Could it result in the end of the modern banking era?
In this article, I’m going to explore a hypothetical situation concerning banks and their refusal to adopt blockchain technology. I’ll focus on the short-term ramifications, such as the bank’s operational costs, which lead to medium and long-term issues, like the loss of market share to other blockchain-based alternatives.
I’m also going to investigate the underlying reason why banks are so quick to hop on the blockchain wagon. Throughout history, banks have overcapitalized on a definite need. These profiteering institutions understand that if they are in trouble, the public will not come to their rescue, especially when it comes to retail and commercial banking, a sector that has always been a price first market.
“If you run a very large US bank, most probably you are afraid of blockchain and Bitcoin,” said Rainer Michael Preiss, executive director at Taurus Wealth Advisors. With blockchain technology crossing the chasm, banks are well aware that if they don’t adopt new technologies, they would quickly lose power in the global finance ecosystem.
Short Term: Expensive operational inefficiencies
While blockchain technology can solve many problems within the banking industry, there are many pressing, direct, and immediate issues with existing banking services. These problems range from complicated clearing and settlement processes, slow transfers (especially international transfers) and a lack of transparency in the whole system.
According to the Santander/Oliver Ayman report, the inefficiencies in the global collateral management market cost banks $4 billion annually: “Distributed ledger technology could reduce banks’ infrastructure costs attributable to cross-border payments, securities trading and regulatory compliance by between $15-20 billion per annum by 2022.”
Blockchain technology can reduce these inefficiencies by providing an alternative decentralized approach to organize and conduct payments, clear and settle transactions, and provide greater transparency. It would be incredibly naive of banks to pass on an excellent opportunity to reduce substantial operational costs. If banks don’t embrace blockchain in the short-term, they’d be spending a lot more on operational processes, a decision that will impact their customers in the medium to long run.
Mid-Term: Losing their competitive advantage
Big banks have a lot of control in the financial sector, especially with the lack of competition. The financial services market, particularly retail banking, is, however, a price-first market. Especially when it comes to creating a relationship, customers rarely have strong loyalty or attachment to a particular service or company. In this industry, the provider that offers the lowest fees while maintaining everyday convenience wins the customer.
Banks currently have high fees regarding transactions (especially international transactions) as well as many fees for their services. While it’s easy to criticise banks, these institutions are constantly under financial pressure from shareholders to maximize profit. Banks are also dependent on expensive infrastructures like commercial offices in the city, ATMs, high-security centralized servers, banking customer service branches, and the sheer number of employees required to support their services.
Unlike traditional banks, blockchain technology leverages the existing internet grid to provide the same, if not a better solution. Thus, the operational costs of blockchain-based fintech companies are already lower than traditional brick and mortar banks. If banks do not leverage blockchain technology, not only will their existing banking services fall behind, they will also incur significant costs as a result of their expensive overheads and lose competitive advantage in the market. Smaller nimble startups will recognize the opportunity and offer cheaper and more superior services.
Long-term: Losing market share to nimble startups
The banking industry has an extremely lucrative business model that is only possible with the lack of competitors and high barriers to entry. US commercial banks alone made $171 billion from the American public in 2016 by taking deposits from consumers and lending out ten times the value to others in the form of loans, profiting from the interest earned.
“The bank decides how much you earn on your money, and the big banks have collectively decided that rate is 0.1 percent,” said Beam, a high-interest FDIC-insured mobile bank. “Meanwhile, they raise loan interest rates long before they increase deposit interest, all the while funding year-end perks, bonuses, extravagant lobbies and their bottom line.”
Unfortunately, banks know that we need their services and continue to overcapitalize on our needs. Banks are slow to innovate compared to other industries because there is no significant threat or competition in the market. These financial institutions also run oligopolies in almost every country with many colluding with their direct competitors.
Therefore, if banks do not leverage blockchain technology and startups can offer superior services with lower fees, people will naturally opt for the startup instead. These blockchain-based startups will pass on their cost savings to their consumers and offer them the added benefits of blockchain technology like improved transparency, faster transaction times, and greater security. Since banking is a price first market, people would not be hesitant to try and switch over to other companies, especially if the decision appears like a no-brainer.
Example: A startup challenging the banking giants
A great example of a company looking to disrupt the entire banking business model is Lending Blocks, a blockchain-based startup which functions a bit like a bank. If consumers have tokens in their savings, they may loan it out to other people on the blockchain in exchange for interest.
Although the solution is only available for placing one token as security to borrow another, if the concept proves successful, there will be more options including a tokenized fiat currency. The blockchain lending system allows individuals to earn more interest based on market conditions, with the profiteering middleman replaced by a software platform.
Lending Blocks is just one example to show how aggressive small, nimble startups are despite competing against larger incumbents that are already pursuing blockchain technology. If banks weren’t proactive in implementing blockchain, it’d be relatively easy for these competitors to win over customers and disrupt the bank’s control in the financial ecosystem.
While it may be a significant leap for consumers to go from a trusted centralized institution to a decentralized peer to peer platform, if banks do not embrace blockchain technology, consumers will go to other competitors that offer better value, changing the power, control, and hierarchical structure of the modern banking system.
Banks are however well aware of the impact of blockchain technology. According to an Accenture report, nine out of 10 banking professionals mentioned that their company is currently exploring the use of blockchain technology. While I’ve investigated the short and long-term impacts of banks refusing blockchain, it’s a highly unlikely scenario, at least for developed nations.