Introduction

Post 2008 global financial crisis, reputation of financial institutions including banks was tarnished leading to declining trust in conventional banking systems. Banks worldwide subsequently reported significant liquidity shortage (Milne, 2018)as, in the US, crisis hit big financial powerhouses like JPMorgan Chase, Morgan Stanley; Finland reported considerable decline in private investments (Söderlund & Kestilä-Kekkonen, 2014); Chinese banks halted hiring (Marquez-Velazquez, 2010). This distrust put a major setback on the banking industry and paved way for new technology in financial market. Pseudonymous person/persons named ‘Satoshi Nakamoto’ introduced peer-to-peer online transfer of electronic cash without the involvement of financial intermediary institutions called Bitcoin (Nakamoto, 2008). 

Today we have several such cryptocurrencies based on the blockchain model, attracting generous attention from financial institutions and governments. Therefore this paper discusses emerging cryptocurrency and the impact of said currency on governments and banks, alongside explaining the base technology and money model underlaying its existence. Sudden growth of cryptocurrency has impacted the financial markets worldwide thus this paper comments on the conceptual and ethical feasibility of incorporation of crypto in financial institutions. 

There prevails lack of a cumulative approach of both underlaying technology and money model of economics, ergo this paper finds a midway via slightly compromising the concept of crypto to incorporate it in banking, if desired. This paper also strives to critique the bill proposed in Indian Parliament while exploring the wide range of extreme stands already picked by several nations like the US, Japan, Germany and China. 

Methodology and Literature- Overview

This research paper thus discusses the effect of recent technological advancements on the functioning and regulation of modern financial systems via conducting narrative literature review from available academic databases and publicly published papers. This paper uses Google Scholar, ResearchGate, Springer Link, Google books and Scopus to serve as secondary sources. The research area is not well developed and have multiple biased approaches, cumulation of which aided the paper to reach its conclusion. This paper also then implement the reading of multiple jurisdictional approach of Japan, US like accepting countries and China like restrictive approach to discuss India’s standing in the subject matter while critiquing the recent bill passed on cryptocurrency. 

I have narrowed down two approaches of existing research, technological approach and economic approach. These two approaches lead to partial analysis of the use of cryptocurrency in current financial institutions. My paper collaborates both approaches and provide the most workable solution for successful implementation of the upcoming financial instrument. The result of this qualitative research differed entirely for my initial hypothesis where I was of the opinion that cryptocurrency should be incorporated as it is and have negligible shortcomings. Concerning the stand point of different nations, similar two approaches are analysed; restrictive approach and accepting approach to locate India’s stand.

The paper begins with (Carvalho et al., 2021) which provides for detailed tech behind the functioning of e-currencies. This paper is written by economic professors and research analysts thus provides for a simplified understanding of underlaying DLT technology. It is then followed by (Nakamoto, 2008) where cryptocurrency can find its roots. While introducing crypto in the paper, it is measured in the DLT technique tools as well as money model as simplified in (Hun Oh & Nguyen, 2018). The newer technology of XRP Ripples compared with the pre-existing Bitcoin technology is explored in (Jani, 2018) to find which suits the financial institutions best. The theories of artificial intelligence in the financial institutions (Choi & Huang, 2021) and tools such as smart contracts (Vigliotti & Jones, 2020) are picked form books available to find ways to incorporate crypto in banks. Further implementing the understanding of the subject and following the trends of new regulations being made in several countries is analysed to criticise the new bill cryptocurrency under discussion in Indian parliament. 

Subsequently, news articles, open-access pdfs with keywords “cryptocurrency”, “financial institutions” and “banks” were searched to strengthen the conclusions and deductions. The sources were searched in accordance with the highest focus ratio of the content on cryptocurrency in financial institutions and the latest search results from past two-three years. 

I found with my research that though existing model of cryptocurrency is financially benefitting to individuals howbeit it has several ethical limitations that prevent fair use and promote security threats and can contribute to several illegal activities such as terrorism. However, crypto can be incorporated albeit compromising certain principles and motives for emergence of said currency. This result lead me to conclude that maintaining the current state of cryptocurrency, it can be incorporated in the current financial institutions with suggested changes, which depends on the developers and the incorporators to negotiate over, exactly the current torment of Indian government. 

Distributed ledger technology

DLT is a “technological infrastructure which provides for a simultaneous access, validation and record updating, in an immutable manner, spread across a network spread over multiple entities/locations” (Frankenfiel et al., 2021). This technology is known as blockchain, introduced to the world via Bitcoin. Frankenfiel notes the difference from the conventional methods as it has decentralised digital database which stores data using cryptography and is governed by the rules of the network, only accessible via ‘keys’ or cryptographic signatures. He also clarifies that where in conventional distributed ledgers are connected to a central system and is individually updated periodically which makes it prone to cyber attacks and also slows down the process, decentralised ledgers are better as all copies need to be attacked together for a successful attack. Moreover the peer-to-peer transfer makes it faster. 

(Carvalho et al., 2021) simplifies the DLT technology as mapped below. DLT can be divided in three parts which are interlinked while functioning. Layers are then further segregated into three parts; protocol, network and data. The authors define protocol layer as essentially governing the system via defining, updating and managing the set of rules; Network layer as ensuring consensus throughout the system via binding the system with the set of rules and necessary steps required; and data layer as setting the meaning and nature of data upon which consensus was agreed upon. 

The clear understanding of this technology leads to the conclusion that it is not as vague and as secretive as presumed. It is decentralised however has a maintained public ledger where transaction are recorded. The decentralised operation protects it from general cyber attacks and though are not governed by states and subject to manipulation by rising/falling governances, it is governed by protocols which are mathematical and cannot be manipulated. The most effective role of DLT that the model of cryptocurrency is based on is the absence of role of intermediary hence reducing transaction cost and time to negligible.

Basics of cryptocurrency- technology and money market model

The emergence of this currency was due to lack of trust post global economic. By understanding of DLT above, it is clear that that trust is gained via no intermediary and public-key cryptographic mechanism which secures money transactions (Korpela et al., 2017; Rowan et al., 2017; Uddin et al., 2019). To be clear, crypto is not blockchain rather it uses the blockchain model to function. Crypto, especially Bitcoin can be gained in two processes; mining and transactions. The mining process is a way of earning the currency as a reward of solving puzzles. Miner are basically computers called nodes (for current purposes) which generate hash of first block after solving the puzzle, which adds block in to blockchain, which also has a limit (Carvalho et al., 2021). This process bypasses all other additional costs of intermediary commission, settlement procedures, entering or uploading contract etc, mitigating the cost of trust (Berg et al., 2019). 

The identity of crypto holder is a random alphabetical sequence which can only be decoded by the owner. Therefore every time a transaction request is made, the user would be required to provide a private key to make it successful. In case of Bitcoin, link timestamping system is used by Nakamoto, which basically enlists all records to form a block, which when linked to others forms a blockchain. This timestamping forms a timeline which ensures are transactions are recorded (Nakamoto, 2008). The nodes would not accept the block if all previous transactions are not valid and as there is no third party involvement in the public ledger, like in the case of digicash therefore, the ‘giant ledger’ is an open public database. 

(Hun Oh & Nguyen, 2018) noted that cryptocurrency has greatly effected the digital world in this fourth industrial revolution. Though it claims to be a currency however (Hun Oh & Nguyen, 2018) used the standard function of money defined by European Central Bank (2009) to prove that cryptocurrency is a currency in actual terms. There are three functions of money;

1. Medium of exchange- used to avoid inconvenience of barter system which requires the want of both parties to be involved in the transaction. In case of cryptocurrency, it is more like a private club, therefore those who own crypto (like the membership card) can deal in crypto, therefore fulfilling the criteria of medium of exchange. 
2. Unit of account- the currency act as a standard to measure the value of goods and services. As crypto is relatively new and many countries are not comfortable with this idea, as it threatens their profits from financial institutions and authority over financial markets, therefore it is yet not that big to be a unit of account, however it has promising future. 
3. Store of value- the value can be saved and retrieved in future. The current price volatility does not allow to meet this criterion. The institution though relies upon the increasing distrust over the government. (Hun Oh & Nguyen, 2018) is of the view that if given the choice between investing in a governmental regime with questionable regime or with blockchain technology security, most people would choose the latter and that would establish the legitimacy of crypto. 

The authors also substantiated the money demand of cryptocurrency using Friedman’s demand for traditional money model;

 Md = 𝑓(𝑌𝑝,𝑇𝐶𝑚,𝑇𝐶𝐶𝐶,𝑟𝑚,𝑟𝑐𝑐,𝑟𝑏,𝑟𝑒,𝜋𝑒,…) 𝑃  

 CCd =𝑓(𝑌𝑝,𝑇𝐶𝑚,𝑇𝐶𝐶𝐶,𝑟𝑚,𝑟𝑐𝑐,𝑟𝑏,𝑟𝑒,𝜋𝑒,…) 𝑃  

𝑀′𝑑 = 𝑀𝑑 + 𝐶𝐶𝑑

Here, real income has positive relation with both demand of real money and crypto; traditional cost has positive relationship with crypto however.a negative one with traditional money; the real demand of traditional money holds positive relationship with real money and similar is the case of crypto, however rb and re hold negative relationship therefore higher the demand for traditional money/crypto, higher the expected return; lastly inflation has negative relationship with both crypto and traditional money as when rates increases purchasing power of any currency decreases. It can be concluded that only benefit different from traditional money in today’s market is that of transactional costs. This model thus provides for two options, either government and banks can have their own cryptocurrency or let the non-governmental organisations rule that market. The deductions in (Hun Oh & Nguyen, 2018) have agreeably concluded that government and banks have a greater incentive to issue their own crypto so as to control the state’s overall monetary policy.  

XRP Ripples- is new better?

Payment network or protocol made by Arthur Britto, David Schwartz, & Ryan Fugger released in 2012 to enable “secure, instant and nearly free global financial transactions”, on similar principles that of Bitcoin with slight variations (Jani, 2018). It can be said that ripple is more like online bank with XRP as its own cryptocurrency as it allows to make loans and open credit lines amidst the existing peers on the network. Today it serves as counter party to large firms and financial businesses, as a network for transfer of money whilst serving as an intermediary amidst currency exchanges.

Bitcoin technology is rather quite different from that of Ripple. To begin with Bitcoin’s motive was to provide open access to all however Ripple gets more technical and focuses on asset transfer solutions. Ripple however is faster than Bitcoin with a huge difference of 4 transactions/second and 70 minutes for latter. Even the transaction fee for Ripple is as minimal as a fraction of a cent, whilst Bitcoin’s rose to $27. Though the token value of Bitcoin is as high as $16,426 per token as compared to $3.12 per token for Ripple. However, Ripple is relatively new as it entered the market in 2012 whereas Bitcoin has been there since 2009. Another drawback with Ripple is that the XRP currency is privately regulated by Ripple Labs whereas Bitcoin uses Proof of Work. That proof of work, also called mining, though is harmful for the environment as it consumes electricity equivalent to that of small nations, whereas Ripple is eco friendly as it does not involve mining process, and is mere transaction based. The transactions are more transparent in Ripple than bitcoin and as are leaked in public issue. Ripple functions on consensus ledgers but is privately owned whereas Bitcoin is owned by a community.

Smart Contracts

Smart contracts are not new technology however just not noticed by us. When we pay online via cards or other apps to shop or book tickets are all smart contracts we engage in on regular basis. While concerning blockchain, it is merely a code. (Vigliotti & Jones, 2020) describes these contracts as “code located on the blockchain that is recorded on ledger” where all participants have a copy of the code which is auditable and is open to interaction to provide input. However once the contract is registered on blockchain, it cannot be modified. Nonetheless smart contracts are time efficient, cost efficient and readily available anywhere required. It is claimed that Nick Szabo, a computer scientist coined the term in an article in 1996. As per his modified definition, these contracts are simply “a set of promises simplified in digital form which includes protocols for performance”. In general understanding a contract should be enforceable, verifiable, observable and should be available to the interested parties only. 

This idea of smart contracts binds the parties also by the legal frameworks which would most probably be the basic principles of host party’s national legal framework. Though the legality that strikes as an issue in this case is of traceability. Unless the concerned parties have an identifiable address, how can legal proceedings commence. Other than this shortcoming it has several pros such as cost reduction, speed operation, human error reduction, real-time data updates and disintermediation (Vigliotti & Jones, 2020). 

Where Banks can fit in

In this rapid digitalisation, Fintech has become must. Fintech is “interaction between information and communication technologies and the established business of financial industry” (Choi & Huang, 2021). Banks though have already started getting technologically active by using apps such as WeChat and Alipay however the incorporation of DLT techniques, some pointers from Ripple to regulate crypto is released, alongside smart contracts in blockchain to prevent fraud and any other criminal activity. 

In the money model, we discussed the effects of crypto on total money and the only contribution of crypto over traditional money was transaction cost which is somewhat caused by banks as intermediaries. However, if the central banks decide to launch their own cryptocurrency, it would turn economically and functionally beneficial for them. Via detailed calculations by (Hun Oh & Nguyen, 2018) it can be concluded that introduction of cryptocurrency would not reduce or increase total money inflow however would give complete control of monetary policy in hands of the governing bodies. 

Nonetheless if they decide to add crypto, they needn’t go through the Bitcoin technology, Ripples provide for a public ledger with disclosed public ledger and is also environmental friendly with fast transactional speed. The legality can be handled with smart contracts, which wouldn’t be an issue as the addresses are now made traceable. As the Ripple technology requires to reach consensus, there would not be undue duress or power autonomy. Moreover private banks can gain as Ripple allows for loans and credits as well. 

Jurisdictional Approach- India’s Case 

Several countries have enacted upon the issue of upcoming cryptocurrency. US’s Chicago Mercantile Exchange group announced to launch Bitcoin Futures contract with tightened monetary policy (Hun Oh & Nguyen, 2018). The authors further noted that Japan gave endorsement to 11 cryptocurrencies and have also seeking to launch J-coin as its own personal cryptocurrency with exchange rate of one-to-one in yen. Similarly Sweden is also planning to launch its own crypto e-Krona with continued control of central bank on the e-currency as well. Venezuela on top of all have announced to launch its own cryptocurrency backed by oil, gas, god reserves. Whereas Germany and China are moving against this addition in economy. China has ruled dealing in crypto illegal and hence banned it in the country. Similarly German central bank has warned its citizens to deal in crypto. 

Indian central bank, RBI in 2018 issued a circular restricting all financial institutions and all banks to deal with cryptocurrency against which SC ruled that it goes against the principle of fairness and equality of opportunity and lifted the blanket ban in 2020. The cryptocurrency and regulation of Official Digital Currency Bill is yet to be introduced and discussed over in the parliament to create framework for creation of official digital currency to be issued by the RBI alongside prohibiting the other private cryptocurrencies. Though India is inclining towards digitalisation acceptance, however, restricting other private cryptos, going against the principle of fair trade and thus have inclined towards restrictive approach in this area.

Conclusion –

Cryptocurrency is at a nascent stage and therefore it can’t be defined under money however the idea proposed of parallel digital economy in the world of technological advancements, got us nothing to lose. If it can be incorporated with less trouble it should be. Currently it serves more as an asset than currency as it is used similar to stocks to earn profits with rising value. However, if not incorporated it definitely will serve as a threat to banks indeed. Tough the idea behind crypto was to omit centralisation and governmental control, however the centre can either ban the currency and yet the transactions happen like other banned websites used with VPNs or can profit from it. Regarding the safety concern, as aforementioned, it is not easily hackable and if slightest possibility is considered then bank accounts are hacked too. It can also help reduce corruption as digitisation of the entire country becomes must henceforth. Those who can jump along rising tides can only survive. 

References

1. Carvalho, C. E., Pires, D. A., Artioli, M., & Oliveira, G. C. D. (2021). Cryptocurrencies: technology, initiatives of banks and central banks, and regulatory challenges. Economia e Sociedade, 30(2), 467–496. https://doi.org/10.1590/1982-3533.2021v30n2art08
2. Choi, P. M. S., & Huang, S. H. (2021). Fintech with Artificial Intelligence, Big Data, and Blockchain (Blockchain Technologies) (1st ed. 2021 ed.). Springer.
3. Frankenfiel, J., Rasure, E., & Reeves, M. (2021, August 27). Distributed Ledger Technology. Investopedia. Retrieved November 22, 2021, from https://www.investopedia.com/terms/d/distributed-ledger-technology-dlt.asp
4. Godart-van Der, A., & Vonlanthen, K. P. (2018). Banking and Monetary Policy from the Perspective of Austrian Economics (1st ed. 2018 ed.). Springer.
5. Hun Oh, J., & Nguyen, K. (2018). The Growing Role of Cryptocurrency: What Does It Mean for Central Banks and Governments? International Telecommunications Policy Review, 25(1), 33–55. https://www.researchgate.net/publication/329023530_The_Growing_Role_of_Cryptocurrency_What_Does_It_Mean_for_Central_Banks_and_Governments
6. Jani, S. (2018, January 12). An Overview of Ripple Technology & its Comparison with Bitcoin Technology. ResearchGate. Retrieved November 22, 2021, from https://www.researchgate.net/publication/322436263_An_Overview_of_Ripple_Technology_its_Comparison_with_Bitcoin_Technology
7. Nakamoto, S. (2008, October 31). Bitcoin: A Peer-to-Peer Electronic Cash System | Satoshi Nakamoto Institute. Satoshi Nakamoto Institute. Retrieved November 22, 2021, from https://nakamotoinstitute.org/bitcoin/
8. The Report of the Stiglitz Commission: A Summary and Comment (SSRN Scholarly Paper ID 2196125). (2010, December). Alejandro Márquez. https://www.researchgate.net/publication/256043858_The_Report_of_the_Stiglitz_Commission_A_Summary_and_Comment
9. Söderlund, P., & Kestilä-Kekkonen, E. (2014). Economic voting in Finland before and after an economic crisis. Acta Politica, 49(4), 395–412. https://doi.org/10.1057/ap.2014.11
10. Vigliotti, M. G., & Jones, H. (2020). The Executive Guide to Blockchain. Springer Publishing. https://doi.org/10.1007/978-3-030-21107-3

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