If you’re curious about cryptocurrency, you’re not alone. Cryptocurrency is making headlines around the globe, but what is cryptocurrency? And what do financial institutions and their customers need to know about this alternative form of payment?
To shed light on the topic, the National Bank of Middlebury, a $5 million-asset bank serving the needs of people in west central Vermont, invited a panel of cryptocurrency experts to discuss the topic and answer questions during a June 23 customer webinar. Panelists included Joe Casali from NEACH, Jim Cunha from the Boston Federal Reserve, and Ethan McLaughlin from the Vermont Department of Financial Regulation.
"Cryptocurrencies, think of Bitcoin, are private currencies that nobody backs,” explained Jim Cunha, Executive Vice President of Secure Payments and FinTech at the Federal Reserve Bank of Boston. "There's no government backing. It's really an asset that is traded electronically, usually on distributed ledger or blockchain."
To that point, panelists emphasized that cryptocurrencies are a highly volatile and speculative investment.
“Lots of cryptocurrencies are more like investing in risky assets than an actual digital currency," said Joe Casali, Executive Vice President, NEACH. “Think of buying a risky stock on credit. There could be the problem of stock volatility and a margin call.”
Casali considers himself a “student of cryptocurrencies,” ever learning, with the goal of exploring cryptocurrencies in the context of payments. It's possible cryptocurrencies might one day address existing challenges like the speed of payments and financial inclusion, but it is too soon to know how that might play out.
Until then, cryptocurrencies remain a speculative investment.
Although crypto caught the public's eye in 2018, the beginning of crypto is attributed to Satoshi Nakamoto (a pseudonym used by the creator(s) of the cryptocurrency Bitcoin), who published a white paper in 2008, initiating crypto’s rise in popularity, according to Investopedia.
“When Nakamoto created the bitcoin, it was for P2P transfers to bypass the banking and regulatory systems,” explained Casali. “The government is now looking at how to regulate this thing that was never built to be regulated.”
Cryptocurrencies are created with a specific purpose in mind, he said. “Suppose I want to create a video game, and the way I’m going to fund that video game is to create a coin,” said Casali. “Everyone is going to give me money, and in exchange, I am going to give them coins. I’m going to use the money to create the video game, making the people who gave me coins stockholders.”
Currently, there are somewhere around 18,000 different cryptocurrencies. But despite their growing popularity and claims to the contrary, cryptocurrencies are better thought of as digital assets than digital dollars.
And if you've done any research on cryptocurrencies, you're probably familiar with the term "blockchain." To level-set, blockchains, distributed databases, or ledgers play a critical role in cryptocurrencies by keeping track of the transactions.
“As a database, a blockchain stores information electronically in digital format,” according to Investopedia. “Blockchains are best known for their crucial role in cryptocurrency systems, such as Bitcoin, for maintaining a secure and decentralized record of transactions.” However, not all blockchain models are as secure as they would have you believe. Some blockchain models include code that fraudsters can exploit, warns Casali.
“When it comes to cryptocurrencies,” said Casali. "The one we’re (NEACH) really interested in is the Central Bank Digital Currency (CBDC), which, if developed, will be backed by the Federal Reserve.”
An Update from the Fed
According to the Fed, they've made no decisions on whether to pursue or implement a central bank digital currency or CBDC. They are simply exploring the potential benefits and risks of CBDCs from various angles, including through technological research and experimentation.
“Our focus is on whether and how a CBDC could improve on an already safe and efficient U.S. domestic payments system,” says the site. As part of the process, the Fed released a discussion paper, Money and Payments: The U.S. Dollar in the Age of Digital Transformation, that examines the pros and cons of a potential U.S. CBDC.
“It’s up to the Fed to understand what it would take to actually build a digital currency,” stated Cunha. “We're not necessarily going into production. We're trying to understand whether we could build a digital currency that would work at scale."
The Fed is currently partnering with the Massachusetts Institute of Technology (MIT), the premier institution in the world on digital currencies and CBDCs. According to Cunha, “What the Fed has done is built a prototype, rather than a complete system. It’s the ‘core engine’ of what you need to create, store, and move money between parties.”
In February, the Fed published a paper, Project Hamilton Phase 1: A High-Performance Payment Processing System Designed for Central Bank Digital Currencies, which details its results. “We did something the Fed has never done,” said Cunha. “We’re the first central bank in the world to create an open source code base for digital currencies.”
Phase two of the project will explore policy and privacy questions to determine the potential impact on initial benchmarks and potential trade-offs. The Fed is currently looking at different ways of thinking about privacy, including balancing privacy with Anti-Money Laundering (AML)/Combatting the Financing of Terrorism (CFT). The more private it is, the harder it is to catch the "bad guys." The Fed is exploring whether there's a way to maximize privacy while still responding to nefarious actors.
“We have no charge to go to production,” he said. “But if we go to production, we’re years away from being there, so we want to be ready. Basically, Project Hamilton is studying to see what’s possible.”
In the meantime, financial institutions should remain informed about the various forms of cryptocurrency. Doing so will enable them to knowledgeably discuss the topic with their customers and members and answer any questions that might arise.
To that end, Ethan McLaughlin, a Vermont Department of Financial Regulation lawyer, rounded out the panel, encouraging people to remain informed about cryptocurrencies and avoid scams.
"First, we want to emphasize that cryptocurrencies are highly speculative, a risky investment," he said. "Profits and losses are impossible to predict, and values are highly volatile. As a result, they're unsuitable for most investors, savings, and retirement goals." He added, "No investor should speculate in cryptocurrency with money they cannot afford to lose."
Although some large institutions are involved in cryptocurrencies, and many have profited from cryptocurrencies, investors should not interpret that as an indicator of safety and soundness, says McLaughlin. This sphere has rampant non-compliance with state and federal laws and regulations.
McLaughlin went on to describe some of the unique risks associated with cryptocurrencies. Typically, you store cryptocurrency in an online digital wallet, your phone, or an external hard drive. Because the government does not insure digital wallets like a bank account, it may be impossible to recover your funds if you lose your password or your wallet is stolen or compromised. And when you pay with or send cryptocurrency, the transaction is generally irreversible. There are very few protections if something goes wrong.
The Future of Crypto
Because the crypto market is so volatile, it is difficult to predict what its future could look like. For example, if the Fed moves forward and develops a CBDC, will crypto die a slow death?
“I think they would coexist,” said Cunha. "I think there could be some competition, but I don't see one negating the other. One is for speculation, and the other is generally for large-dollar movement."
“If you’re having a hard time getting it [cryptocurrency], you’re in good company,” Cunha added. “These cryptocurrencies change every day.”
To listen to the webinar in its entirety, visit the National Bank of Middlebury website.
AUTHOR: Joe Casali, AAP, NCP
Executive Vice President
As the EVP of Payments Innovation for NEACH, Joe focuses on exploring innovative solutions and technologies that will help position members for success, both now and in the future. Connect with Joe to read more of his blogs, articles, and posts.