Bank of America, JPMorgan Call Cryptocurrencies a Threat

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Bank of America, JPMorgan Call Cryptocurrencies a Threat

Bank of America Corp. (BAC) mentioned cryptocurrency among the risk factors that might damage the bank’s competitiveness and diminish revenues and earnings in its annual 10-K filing with the Securities and Exchange Commission (SEC), which was posted on Feb. 22. JPMorgan Chase & Co. (JPM), whose CEO, Jamie Dimon, has previously termed bitcoin a “fraud,” issued a similar warning on Feb. 27.

The notion that bitcoin and other cryptocurrencies pose a threat to established financial institutions dates back to Satoshi Nakamoto’s whitepaper, which begins, “A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.” However, the notion that this danger was genuine, much alone impending or existential, was long relegated to enthusiast forums, devoted subreddits, and particular Twitter corners.

To be sure, Bank of America’s short references of cryptocurrencies as risk factors – first identified by the Financial Times – are not cause for alarm. The bank outlines three potential threats posed by cryptocurrency. The first two imply a dismissal of the new assets. “Emerging technology, such as cryptocurrency,” the statement states, “may hinder our capacity to follow the transfer of funds,” making it more difficult for Bank of America to comply with know-your-customer and anti-money-laundering requirements.

“Furthermore,” the bank continues, “customers may choose to do business with other market players who operate in or provide goods in areas we consider speculative or dangerous, such as cryptocurrency.”

The final danger issue, however, is unrelated to the legal complexities of cryptocurrencies or the proneness of flighty clients to bubbles. It stems from bitcoin’s ability to avoid intermediaries:

“Additionally, the competitive landscape may be impacted by the growth of non-depository institutions that offer products that were traditionally banking products as well as new innovative products. This can reduce our net interest margin and revenues from our fee-based products and services. In addition, the widespread adoption of new technologies, including internet services, cryptocurrencies and payment systems, could require substantial expenditures to modify or adapt our existing products and services as we grow and develop our internet banking and mobile banking channel strategies in addition to remote connectivity solutions.”

If that disclosure is a little wordy, JPMorgan’s is straight to the point, virtually mirroring Nakamoto’s language:

“both financial institutions and their non-banking competitors face the risk that payment processing and other services could be disrupted by technologies, such as cryptocurrencies, that require no intermediation. New technologies have required and could require JPMorgan Chase to spend more to modify or adapt its products to attract and retain clients and customers or to match products and services offered by its competitors, including technology companies.”

A Real Threat?

While decentralized financial networks may jeopardize banks’ long-term sustainability, bitcoin and its colleagues offer no immediate danger.

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Bitcoin, in particular, has numerous well recognized weaknesses that its opponents see as debilitating. It can only process a few transactions per second, as opposed to the tens of thousands that big credit card networks can handle. As highlighted by Bank of America, its pseudo-anonymity makes its usage risky, if not unlawful, for some applications, notably by tightly regulated organizations. Accepting a salary or taking out a mortgage in bitcoin is particularly dangerous since its price in currency terms is so erratic. Finally, its erratic and oftentimes exorbitant costs render it almost useless for modest transactions. Other cryptocurrencies have attempted, with little success, to tackle one or more of these issues.

At the same time, bitcoin and its peers offer something never previously imaginable in human history: remote transactions without relying on a middleman. The business models of banks are based on their function as trusted nodes in a centralized financial system. Replacing them with a decentralized network is still purely theoretical. However, as Bank of America and JPMorgan seem to recognize, it is potentially feasible. (See also, Blockchain Could Make You the Owner of Your Data, Not Equifax.)

Blockchain Not Bitcoin

While this is the first time that large banks’ 10-Ks have alluded to the fundamental danger presented by peer-to-peer money, the industry has been in a multi-year debate with cryptocurrency supporters. It has mostly been contentious.

Earlier this month, Charlie Munger, vice-chairman of Berkshire Hathaway Inc. (BRK-A, BRK-B), termed bitcoin “noxious poison.” Wells Fargo & Co. (WFC) is Berkshire’s largest stock investment, having established over 3.5 million bogus accounts in clients’ names without their consent from 2009 to 2016. Following the crisis, Munger said that authorities should “ease up” on the lender, which bitcoin supporters may say demonstrates the “inherent vulnerability of the trust-based paradigm” – Nakamoto’s words. (See also: John Stumpf, CEO of Wells Fargo, Will Retire Immediately.)

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JPMorgan CEO Jamie Dimon has labeled bitcoin a scam while praising the underlying blockchain technology. This blockchain-not-bitcoin stance has been repeated by a number of other financial institutions, and it’s hinted at in JPMorgan’s 10-K statement that it may need to “alter or adapt its offerings.” The bank is already developing a blockchain platform known as Quorum.

Almost every major lender has joined one or more blockchain consortiums, and central bankers, most notably the Bank of England’s Mark Carney, have shown excitement for blockchain that does not extend to bitcoin.

When Is a BlockchainNot a Blockchain?

Some critics regard this blockchain-not-bitcoin stance as a ploy to divert attention away from bitcoin’s main breakthrough. Bitcoin and other blockchain-based assets provide distributed networks for transferring value without relying on a single entity, such as a bank. This argument holds that banks cannot innovate their way out of difficulties by constructing their own decentralized networks: banks must be absent from any such network.

Another criticism is that blockchain technology is inefficient, at least in its most reliable version, known as proof of work (and carries potentially severe environmental consequences).Banks, for example, have few clear reasons to use blockchains, which provide no benefit over standard databases unless the aim is decentralization and promise to require much more power in order to process transactions at slower rates. Banks have responded by claiming that blockchain technology may reduce settlement times, especially for complex derivatives contracts. (For more information, see How Does Bitcoin Mining Work?)

Many suggested commercial blockchains, on the other hand, employ alternate consensus methods that are more akin to proof of stake than proof of work. These models may be more energy efficient, but detractors say that they lack the same security as proof of work.

It may make sense for huge bank consortia to use blockchains since they might enable all parties to transact without trusting one other. The problem is that a blockchain-based network must be at least 50% honest in order to be trustless. A so-called 51% assault may occur if even the smallest majority of banks collude. Previous manipulation of currency and precious metals rates and markets by consortia of financial entities suggests that this is not an unjustified fear.

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In any event, banks are not required to expressly coordinate to hack a network. Blockchains are designed to facilitate trade across networks of nodes that do not know or trust one another. Even if a majority of members had a shared interest, which is doubtful in a group of a several dozen financial incumbents, the network is unsafe enough. That is, the additional inefficiencies introduced by blockchain technology may offset the advantages of decentralization.

“Some of these platforms are “created to be kind of replicas of the old system,” MIT assistant professor of technological innovation, entrepreneurship, and strategic management Christian Catalini told Investopedia in September, “where the trusted intermediary has nearly the same control, or exactly the same control, it would have had in the old system.” Then you wonder why we’re migrating to a less efficient IT infrastructure. Because it’s fashionable?”

That, or to mitigate a growing threat.

Investing in cryptocurrencies and Initial Coin Offerings (“ICOs”) is very dangerous and speculative, and neither Investopedia nor the author suggest that you do so. Because every person’s circumstance is different, a knowledgeable specialist should always be contacted before making any financial choices. Investopedia makes no guarantees or warranties about the accuracy or timeliness of the information provided on this site. The author has no cryptocurrency positions as of the day this post was published.

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