Understanding digital assets and blockchain will provide credit unions with valuable tools to expand financial services to their communities.
Describing 2020 as “weird” is like saying the distance to the moon is “far.” It does not do it justice. A weird headline that was an attention-grabber in 2020 was the astronomical rise of bitcoin and the overall cryptocurrency market. Bitcoin started 2020 at ~$7,400 and had a market capitalization of ~$134 billion and ended 2020 with a price of ~$29,000 and a market cap of ~$550B. During that time, the overall cryptocurrency market grew from $200 billion to $750 billion. This type of growth conjures up images of the dot-com bubble for many. Furthermore, for Bitcoin, boom and bust cycles are not new. There were “crazy” bull runs in 2017 and 2013, only for the price to come crashing back down.
However, there is something different about this cycle. Corporations, institutional investors and Wall Street firms started adopting or telegraphing plans to get involved in the cryptocurrency market. Even regulatory agencies like the Office of the Comptroller of Currency provided blessings for financial institutions to engage in the growing crypto market. With all this hubbub and a $1.5 trillion market cap, crypto is still confusing to the masses and traditional financial institutions. To understand the potential crypto offers to your financial institution, it is imperative to grasp the basics.
What Is a Cryptocurrency?
To start, what exactly is a cryptocurrency? In simple terms, a cryptocurrency is a digital or virtual currency that is secured by cryptography, which makes it nearly impossible to counterfeit or double-spend. Most cryptocurrencies are decentralized networks that run on blockchain technology. Blockchain technology is the system of record or ledger for cryptocurrencies and uses a network of disparate computers to keep track of information or transactions.
So how does Bitcoin fit into this? Bitcoin was created in 2009 and was the first digital currency to use cryptography and blockchain technology, thus becoming the first cryptocurrency. The creation of Bitcoin, and more specifically blockchain technology, has ushered in innovation across industries not seen since the creation of the internet. This innovation has even caught the eye of many central banks across the globe.
Central Bank Digital Currencies
Currently, central banks around the world are experimenting with digital currencies known as Central Bank Digital Currency. Unlike Bitcoin and other cryptocurrencies, CBDCs would be centralized and operated by a country’s central bank, similar to the physical cash central banks issue to allow for everyday transactions. Therefore, a CBDC would act as a digital version of a country’s fiat currency.
Currently, China is at the forefront of developing its own digital currency, which is driving other countries to enter this arena in a timelier fashion. This has left countries grappling with how to implement the technology in a safe and functional way and stay ahead of foreign competition. The U.S. Federal Reserve has announced plans to release a working paper this summer on CBDCs and how the Fed may look to incorporate a digital dollar.
Engaging With Cryptocurrencies
While the Fed sorts out how to utilize and implement digital dollars, regulatory bodies have been updating guidance for financial institutions on engaging with cryptocurrencies. In July 2020, OCC provided guidance allowing banks to custody crypto assets. Furthermore, in January 2021, the agency provided guidance that allows banks to use a form of cryptocurrency known as stablecoins, which attempt to offer price stability and are backed by an asset, to conduct payment activities and other bank-permissible functions. So far, no such guidance has been given by the National Credit Union Administration toward cryptocurrencies.
With credit unions having a rich history of leading technological innovation, it seems inevitable that NCUA’s guidance will follow the OCC’s. The allure of blockchain technology is vast for financial institutions, ranging from quicker settlement times, reducing counterparty risk, increased transparency, and the list goes on. Central banks and regulators understand the genie is out of the bottle and digital currencies like Bitcoin are here to stay. Spending time understanding digital assets and blockchain technology will provide credit unions with valuable tools to expand financial services to their communities.
D. James (Jim) Lutter is chief funding/trading officer at PMA Financial Network and PMA Securities where he oversees PMA Funding, a service of both companies that provides over 1,000 financial institutions with a broad array of cost effective funding alternatives. Lutter is a registered representative with PMA Securities and investment advisor representative with PMA Asset Management. He has the following FINRA licenses with PMA Securities, LLC: Series 7, 24, 50, 53, 63, 65 and 99.
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