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The cryptocurrency market saw three-fold growth in 2016, reaching an estimated $27bn by April 2017, according to a recent global study published by the University of Cambridge. But why have these digital currencies yet to reach the mainstream?
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The Global cryptocurrency benchmarking study says there are currently 2.9 million to 5.8 million cryptocurrency users globally. This may seem like a small user base to some, given the first digital currency, bitcoin, came about in 2009 and half of the world’s adult population has a bank account.
Bitcoin is by far the preferred cryptocurrency, says the report, accounting for around 72% of transactions, with a record $14bn market cap recorded in December 2016. Other players have also come about and are growing, such as Ether (which has a 16% market share), Dash (3%), Monero, Ripple and Litecoin, each with around 1% of the total.
“[Cryptocurrency] is a globalised as well as localised industry, with no frontiers in trading operations, but with geographically concentrated mining,” the study says.
“It’s an increasingly fluid industry, with lines between transactions and wallets increasingly blurred and a multitude of currencies, not just bitcoin, supported by a growing ecosystem.”
In addition to the best-known names, there are more than 500 cryptocurrencies currently in circulation, according to market data provider Coincap. However, these units are not backed by any country’s central bank or government.
While these numbers might seem impressive, the actual use of digital currencies remains limited and the use of digital ledger blockchain is still something that resides mainly in innovation labs, with little evidence of its application across financial institutions.
A niche pursuit
British digital money expert and director at consulting firm Hyperion, David Birch, states that cryptocurrencies such as bitcoin currently are – and will remain – a financial tool that caters for niche user categories.
“If it was true that bitcoin was a faster way of doing business, then banks would use it. They are not sentimental about money,” says Birch.
“Things such as bitcoin seem great for a teenage programmer or someone interested in technology and finance, but people don’t want control of their own money. They want it to be safe in a reputable financial institution, a regulated environment where there are fail-safe mechanisms in case things go wrong,” he adds.
While making the case for the banks, Birch argues that cryptocurrencies are mostly used for specific purposes such as evading capital controls and financial speculation, as well as unlawful activities such as drug purchasing and payment for cyber crime services.
“Suppose there is say, an islamic cryptocurrency, like an e-dinar that was also non-interest bearing and associated to gold reserves. People would probably use it because it reflects their own values rather than those of the financial industry,” says Birch.
Practical use of cryptocurrencies is also complicated by nature, says Rodrigo Garzi, CMO at bitcoin processing platfom Pagcoin.
According to Garzi, the currency was created out of a programming challenge so vast that it somewhat justifies the reason why people with more technical knowledge have been attracted to and became bitcoin’s early adopters.
Quite a few years have gone by since bitcoins became available for purchase, but the ins and outs of the digital currency are still hard to understand and explain – even though familiarity of the general public with the concepts has improved over recent years.
“The very fact that it is difficult for people to get access to bitcoin already restricts its use: it requires exchange registration, which takes a bit of time, for example. You need to have at least a little bit of financial knowledge to be able to handle the currency properly,” says Garzi.
The blockchain revolution
Even though most banks are investigating what they can do in terms of dedicated services or integration to cryptocurrencies including bitcoin, a view that echoes across the entire financial industry is that the digital money revolution will come from blockchain – rather than any current or future digital currency.
While digital currencies remain associated to people with specific social, investment, payment and speculative purposes and motivations, blockchain has the clear potential of becoming the bedrock of a vast array of new services and act as a tool for improvement or even replacement of current offerings.
Beyond the development of answers for financial services demands, blockchain can also speed up services across other businesses such as public notaries – which in many countries also bear the weight of bureaucracy and excessive regulations resulting in all-too-common slowness and cost – with centrally stored, openly available data that does not necessarily infringe people’s right to privacy.
“Blockchain developments are quite similar to the way in which the internet has evolved, since the web started out as an information exchange mechanism and later acted as a platform for other services, such as social networks and communication tools such as Skype,” says Garzi.
In financial services, the industry has realised that the blockchain revolution is already here and that it enables the creation of faster, cheaper financial services and real alternatives to outdated systems, such as money transfer network Swift.
Evidence of this is the R3 consortium, which comprises more than 70 institutions globally for the research and development of blockchain across the sector.
In terms of potential uses of blockchain, technology transfer company Crossword Cybersecurity recently conducted a research exercise with Warwick University specifically focusing on the “smart contract” aspect – that is, computer protocols that facilitate, verify, or enforce the negotiation or performance of a contract – of blockchain transactions.
The research found some interesting possibilities. Identified uses ranged from the idea of “drop in economies”, such as refugee camp-type scenarios with the ability to drop in a specific cryptocurrency that can only be spent on defined purposes, to negotiating and paying for microservices in an internet of things (IoT) environment to a wide range of mechanisms for securing and transferring ownership of digital assets.
It all looks promising, but work around blockchain is not entirely a bed of roses. There are several hurdles to adoption, which have been hampering the development of the technology in sector institutions.
The industry view
According to Guga Stocco, the head of innovation and strategy at Brazil-based Banco Original, work on blockchain as well as understanding from the global banking community on what it can offer has evolved significantly over the past two years.
“Banks started to understand that blockchain, as well as digital currencies, are very useful and bitcoin for example is not such a bad guy. But they also understand that there are better alternatives, such as creating a cryptocurrency and adding a smart contract functionality, so it becomes a much more powerful tool,” says Stocco.
Banco Original was launched in 2011 as a pure-play digital bank, but even for an institution that is ahead of the curve in comparison to traditional banking organisations, traditional concepts still apply when it comes to adoption of new technologies.
“All banks are conservative about emerging tech and blockchain is way too recent and not yet ready for massive adoption. We are getting there though – at Original, for example, we are developing lots of projects to take advantage of it in the near future,” Stocco adds.
“But every project like this needs to have a clear purpose. We can’t just launch our own currency for example and integrate it with bitcoin-based service. It would be a niche within a niche.”
Citing examples of initiatives that have been grabbing the bank’s attention as evidence of opportunities to be exploited in the cryptocurrency/blockchain space, Stocco mentions the advent of initial coin offerings (ICOs, or cryptocurrency crowd-sales) decentralised transaction network Ripple and bitcoin debit card Xapo. He adds that Original will soon join the party with some kind of disruptive service based on blockchain.
“We are watching this space closely and are close to launching a [blockchain-based] offering. But we have to go through a maturity cycle in terms of technology and market elements and strike a balance between the two,” says Stocco.
The executive argues that as well as customer-facing offerings, there is also the prospect that blockchain could be used to reduce the complexity and cost of core banking applications.
A global survey by Accenture and operations-benchmarking firm McLagan launched in July 2017 suggests that investment banks cut costs and deliver savings of more than 30% across the middle and back office with blockchain, an economy of $8bn to $12bn annually.
“Using blockchain in core banking could be beneficial as underlying systems are complicated and built on comprehensive legacy. Here, the issue with blockchain is not only that it is still a nascent technology, but the fact that data will be public,” says Stocco.
The road ahead
For Tom Ilube, former CIO at Egg – one of the world’s largest pure online banks – and currently CEO at Crossword Cybersecurity, timing is still the issue in terms of blockchain adoption in the global financial services industry.
According to Ilube, an established financial institution tends to be very cautious about the rate of adoption of new technology, and 10 years is not actually a long time in the scheme of things.
“I expect the challengers are more likely to adopt blockchain technology quicker. There are some technical challenges to be addressed, such as scalability and privacy, but various researchers are working on these,” he says.
“It’s best to think of blockchain as a specific manifestation of ‘consensus-based decision making’, so it may be that in certain applications the solution that emerges in practice might not be identical to the blockchain that we know and love today,” he adds.
Privacy is also a key challenge for a range of blockchain applications, part of the point being that blockchain transactions are not intrinsically private, says Ilube. This is another spanner in the works in terms of the time that it will take until institutions can fully “trust” the technology.
“Additional technical solutions need to be put in place to preserve privacy if it is important to the application. There is a lot of work to be done in this area,” he says.
According to Banco Original’s Stocco, 2016 has seen a plethora of tried and tested – and failed – experiments and new offerings by startups within the blockchain and cryptocurrency space, as well as many financial institutions dipping their toes in the water.
This year, says Stocco, will see errors being corrected and products and services becoming more adherent to market demands and realities.
“It won’t be until 2018 that players will start to deliver a more significant stream of relevant offerings, and we won’t see blockchain reaching the mainstream until 2020. But things are surely moving fast,” he says.