Discuss the rewards and drawbacks of Bitcoin s existence for the banking industry The definition of money may be broad but the most widely accepted is that it functions as medium of exchange a unit of account and a store of value The history of money goes back about 11 000 years ago when cows was used as a medium of exchange to buy goods or services Later coins of gold and silver started being used as money but due to its difficult to carry governments started to print paper money that could be exchanged for specific amounts of gold with the central banks This system was called Gold Standard and lasted until September 19 1931 when Britain abandoned it Since then governments issue paper fiat currency and its value is not backed by any commodity instead they have value because governments declared it to be legal tender Now a new currency has been created which are online currencies based on cryptography and with no central authority to control it
This report aims to discuss the advantages and disadvantages of the cryptocurrencies for the banking industry by first introducing its background and how does it work then discussing possible threats for the banks such as becoming an alternative online payment option The report will also show that banks could benefit from Cryptocurrencies by spending less on compliance and finally Bitcoin will be analysed as a possible investment option Since Bitcoin is the most well known and used cryptocurrency this report will focus on the Bitcoin rather than referring to the broad market of cryptocurrencies Bitcoin is an online currency that has no central authority and it is not regulated its main objective was to create a peer to peer system where transactions do not need third parties to be settled Frisby 2014 explains that the bitcoin has no central authority to issue new coins and therefore this process is made by anyone who download the Bitcoin system and start creating new coins which is a process called mining However this is a costly process that requires huge investment in powerful computers that are capable to do this job All Bitcoin transactions are recorded in a blockchain where each party of the transaction provides a public key to be registered on the block and this key is not directly linked to the buyer seller behind the transaction and this is the reason why the anonymity is preserved The process of mining is simply users who run the bitcoin software and it maintains the block chain The user is adding and verifying the records of every recent transaction on the public ledger compiling it all into a block A block is just a file where the most recent transactions are recorded Due to the fact that Bitcoin provides direct transfer it has low transaction costs and therefore it is an alternative for online money transfer
The traditional system where online transactions need a financial institution to serve as third party to transfer the money could be under threat As of October 10 2017 the number of Bitcoin s daily transaction was 303 101 but a vast majority of this transactions are speculative and according to Fred Ersham co founder of Coinbase which is one of the leading providers of digital wallets some 80 of his client s transactions are estimated to be speculative Applying this estimate to the broader market around 60 000 are made with the objective of buying goods and services so the Bitcoin is far from being a strong competitor in the online transaction market Bitcoin provides a degree of anonymity and this fact has attracted several criminals to the online currency On one hand Bitcoin has made the life of criminals much easier but on the other hand and especially for the bank industry now money transactions related to crimes are being done through Bitcoin and therefore the risk of a bank being used a third party intermediating a criminal related transaction has decreased Thus the image risk for the bank might have decreased and if this relation holds in the long run the compliance costs within the bank industry should be smaller Finally Bitcoin might be useful within the baking industry to further diversify portfolios since it has nearly no correlation with other financial assets
According to the Modern Portfolio Theory in other to decrease the portfolios variance one needs to combine assets with lower correlations between them Therefore Bitcoin theoretically seems to be useful when it comes to portfolio diversification However if Bitcoin is analysed alone it is not a good investment option due to the fact that it presented a volatility as high as 142 in 2013 compared to 22 for gold and other currencies lying between 7 and 12 See chart bellow Moreover not only Bitcoin has no intrinsic value since it is not backed by any government and it cannot be exchanged for any commodity but also it has no consumer protection in the case of a market downturn Volatility of daily percentage change in U S Dollar prices To sum up this report has briefly presented how Bitcoin works as well as its features then it was argued that Bitcoin does not seems to impose a threat to banking industry as a possible competitor as a medium of exchange on the internet The report also showed a possible advantage of the Bitcoin for the banking industry because criminals are now using the cryptocurrency as an alternative way to the banks Finally it was shown that Bitcoin might to further diversify a portfolio but as an investment alone it does not seem a good option Cryptocurrencies are now a reality and as any other investment offers advantages and disadvantages and based on the evidences above mentioned it seems that cryptocurrencies have some rewards to offer to the bank industry but since it is a relatively new investment option extra care must be taken
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