How Cryptocurrencies are Reshaping Financial Systems
TL;DR
This is a 1600 word article looking at a summary of the impact of cryptocurrencies on existing financial systems. It considers specifically
What money is
What crypto currencies are
Financial inclusion and empowerment
Cross-border payments
Smart contacts and automations
Central Bank Digital Currencies
Regulatory challenges and adoption
Introduction
In the past decade, cryptocurrencies have emerged as a disruptive force, challenging traditional financial systems and redefining the concept of money. With the advent of Bitcoin in 2009 and blockchain technology, followed by a multitude of alternative cryptocurrencies, we are witnessing a paradigm shift in the way we perceive and transact with money. In this article, we will explore the transformative impact of cryptocurrencies on traditional financial systems and discuss the key factors driving their adoption and potential challenges they face. Let’s take a closer look.
A brief look at money
We all know what money is, don’t we? Well, what is this stuff that is so central to our human society today? Before the concept of money as we know it today, people used barter and exchanged goods directly. This might work between two people, but quickly gets cumbersome beyond that. Over time, other accepted forms of money were used, like shells, livestock, or grains.
The earliest recorded reference to coins as currency can be traced back to around 600 BCE, by the Lydians in present-day Turkey. Coins work, but in larger quantities quickly become heavy and cumbersome. One solution to this was paper money. The earliest recorded example of this was in China during the Tang Dynasty. It involved certificates representing the value stored in a warehouse. In time, this led to banknotes issued by trusted institutions.
Fiat (deriving from the Latin for "let it be done") currency was detached from the value of physical commodities. It gained prominence during the late 20th century. Governments declared fiat currency as legal tender, relying on trust and the stability of the issuing authority. Central banks were established to regulate the money supply, interest rates, and maintain stability in the financial system.
Modern money possesses several key characteristics:
It serves as a medium of exchange, enabling the trading of goods and services
It acts as a store of value, allowing individuals to save and accumulate wealth over time
It functions as a unit of account, or measure of value, providing a standardised measure for comparing the value of different goods and services in different places
One significant point here is around the term money vs currency. People typically think money and currency mean the same thing, and can be used interchangeably. They are not the same at all. We will pick this point up and explore it in more depth in future articles.
As we are talking about ‘terms’, there are a couple more that we will encounter later:
FinTech, or Financial Technology, is an area of business using new technologies like artificial intelligence, blockchain, cloud computing, and big data. These technologies enable FinTech firms to compete with traditional financial services in a way that was simply not possible before
DeFi, or decentralised finance, is a term for a range of financial products and services based on smart contracts on a blockchain that do not rely on intermediaries such as brokerages, exchanges, or banks
A brief look at cryptocurrencies
Cryptocurrency, or crypto for short, is a type of digital asset that uses encryption techniques to secure transactions and to control its environment. Unlike traditional currencies, which are backed by governments and regulated by financial institutions, cryptocurrencies operate independently of any central authority. This decentralised nature is one of the key features that sets cryptocurrencies apart and has led to their increasing popularity in recent years.
Another defining feature of cryptocurrencies is the use of blockchain technology. A blockchain is a decentralised, digital ledger that records transactions in a secure and transparent way. Each block in the chain contains a list of transactions, and once a block is added to the chain, it cannot be altered. This makes the blockchain an immutable record of all transactions that have taken place, providing a high degree of security and transparency.
Financial inclusion and empowerment
One of the most significant advantages of cryptocurrencies is their potential to promote financial inclusion and empower individuals who lack access to traditional banking services. The Worldbank reports that globally, 1.4 billion adults remain unbanked. These are the hardest to reach – and more commonly women, poorer, less educated, and living in rural areas. Cryptocurrencies enable anyone with an internet connection to store, send, and receive value without the need for a bank account. This has the potential to uplift these marginalised communities globally, providing them with greater financial control and opportunities.
Disrupting Cross-Border Payments
Traditional cross-border payments are plagued by inefficiencies, high fees, and long settlement times. Cryptocurrencies, on the other hand, offer fast, low-cost, and borderless transactions. By bypassing intermediaries, cryptocurrencies streamline the payment process, enabling individuals and businesses to transact seamlessly across borders.
To put this in some form of context, each year, over $20 trillion is moved across countries by large corporations, incurring $120 billion in transaction costs, according to a report by JP Morgan and Oliver Wyman. The cross-border payments segment of FinTech is significant, and when it can offer fees of 0.64% compared with standard fees of 3% - that will significantly impact the nature of the industry. [bcg-qed-global-fintech-report-2023]
Smart Contracts and automation
Cryptocurrencies, such as Ethereum, introduced the concept of smart contracts, which are self-executing agreements with predefined conditions written into code. Smart contracts automate processes, remove the need for intermediaries, and enable the development of decentralised applications (DApps) on blockchain platforms. These programmable contracts have the potential to revolutionise many industries, including finance, supply chain management, real estate and insurance. They can do this by, among other things, streamlining operations, reducing costs, and eliminating the potential for human error.
To put this in some form of context, Emergen Research put the value of the DApps market at $10.52 billion in 2019, and is expected to reach $368.25 billion by 2027. This is driven by features like fast transaction processing times, transparency, reliability, flexibility, scalability and security. As this technology matures and becomes more mainstream, its impact on how financial systems develop will be significant.
Central Bank Digital Currencies (CBDCs):
As cryptocurrencies gain traction, central banks around the world are exploring the development of their own digital currencies, known as central bank digital currencies (CBDCs). CBDCs aim to combine the benefits of cryptocurrencies, such as faster transactions and enhanced financial inclusion, with the stability and regulatory oversight of traditional fiat currencies. The implementation of CBDCs has the potential to bridge the gap between traditional finance and the crypto space. CBDCs have the potential to enhance financial inclusion, facilitate faster and cheaper cross-border transactions, and enable more efficient monetary policies.
CBDCs are a huge topic. Way beyond the scope of this article, but consider:
What will they mean for physical money, the coins and notes in our pockets?
What will they mean for privacy, surveillance and personal freedom?
What will they mean for how we relate to commercial banks?
What will they mean for monetary policy and financial stability?
What about adoption and public acceptance?
What about cybersecurity - how many reports of hacking have you heard of in the past year? And if the target of the attack becomes taking over the money system… how much nefarious resource will go into that?
What legal and regulatory frameworks will be required?
Will they happen, won’t they happen? Consider, as at October 2022, according to MacKinsey, roughly 90% of the world’s central banks are pursuing central bank digital currency (CBDC) projects. Some, including those in the United States and South Africa, are at the exploratory phase; others are development projects (the European Union) and pilots (China). In some locations, including Nigeria and the Bahamas, solutions are already operable, and central banks are looking to expand. Despite the high level of activity, most CBDC initiatives today remain in the nascent stages of market development and, in many cases, even technical design.
Regulatory challenges and adoption
As cryptocurrencies gain prominence, regulatory bodies are grappling with the need to establish frameworks that balance innovation, consumer protection, and financial stability. Issues such as money laundering, tax evasion, and market manipulation have prompted governments to develop regulations to address these concerns. Achieving widespread adoption of cryptocurrencies also requires addressing scalability, energy consumption, and user-friendly interfaces to enhance usability and accessibility.
While cryptocurrencies offer promising opportunities, they also face challenges that must be addressed for widespread adoption. Volatility, scalability, security, and regulatory concerns are among the key issues that need to be overcome.
Balancing innovation and consumer protection has become a key focus. Regulatory frameworks are being developed to address concerns related to anti-money laundering (AML), know-your-customer (KYC) requirements, tax compliance, and investor protection. As the regulatory landscape matures, widespread adoption of cryptocurrencies is likely to increase.
As an example, in May 2023, Reuters reported, “European Union states on Tuesday gave the final nod to the world's first comprehensive set of rules to regulate cryptoassets, piling pressure on countries such as Britain and the United States to play catch up... The rules are expected to be rolled out from 2024.”
In Conclusion
Cryptocurrencies are transforming financial systems by offering decentralised, secure, and transparent alternatives to traditional money. The future of money lies in the ability of cryptocurrencies to empower individuals, streamline processes, and foster financial inclusion on a global scale. While challenges and regulatory hurdles exist, the potential benefits of cryptocurrencies are reshaping the way we transact, invest, and interact with money, setting the stage for a new era in the evolution of financial systems.
{This is an article of around 1600 words, aimed at a reasonably technical audience in the crypto / finance / macroeconomic space. It is intended as an example of research and writing that I can offer. Forget the old warning, “There be dragons”. Here, the warning is, “There be rabbit holes”. Pretty much every topic and point in the article above could be taken into a much deeper dive. How technical do you want to get, and what audience are you aiming at? What voice do you want to express it in? What do you need the article to achieve? I can do that for you.}
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