In its annual 10-K filing with the Securities and Exchange Commission (SEC), released Feb. 22, Bank of America Corp. (BAC) listed cryptocurrencies among the risk factors that could impact the bank's competitiveness and reduce its revenues and profits. The disclosure was followed on Feb. 27 by a similar message from JPMorgan Chase & Co. (JPM), whose CEO, Jamie Dimon, has previously called bitcoin a "fraud."
The idea that bitcoin and other cryptocurrencies pose a threat to incumbent financial institutions is as old as Satoshi Nakamoto's whitepaper, the abstract of 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." But the idea that this threat was real – much less imminent or existential – was long limited to enthusiasts' forums, dedicated subreddits and certain corners of Twitter.
To be sure, Bank of America's brief mentions of cryptocurrencies as risk factors – first spotted by the Financial Times – hardly signal panic. The bank describes three ways in which cryptocurrencies could pose a threat. The first two implicitly denigrate the new assets. "Emerging technologies, such as cryptocurrencies, could limit our ability to track the movement of funds," the filing says, making it harder for Bank of America to comply with know-your-customer and anti-money-laundering regulations.
"Further," the bank writes, "clients may choose to conduct business with other market participants who engage in business or offer products in areas we deem speculative or risky, such as cryptocurrencies."
The third risk factor, however, does not derive from cryptocurrencies' legal complications or flighty customers' susceptibility to bubbles. It derives from bitcoin's ability to bypass 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 bit mealy-mouthed, JPMorgan's is to-the-point, almost echoing 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 could threaten banks' long-term viability, the immediate threat posed by bitcoin and its peers is negligible.
Bitcoin in particular has several widely acknowledged flaws, which its detractors see as crippling. It can process only a handful of transactions per second, compared to the tens of thousands major credit card networks can handle. As Bank of America mentioned, its quasi-anonymity makes its use dicey if not illegal for certain applications, particularly by heavily regulated institutions. Its price in fiat terms is so volatile that accepting a salary or taking out a mortgage in bitcoin would be extremely risky. Finally, its occasionally high and generally unpredictable fees make it all but worthless for small transactions. Other cryptocurrencies have made attempts to solve one or more of these problems, with limited success.
At the same time, bitcoin and its peers enable something that has never before been possible in human history: transacting at a distance without placing trust in an intermediary. Banks' business models depend on their role as trusted nodes in a centralized financial system. Replacing them with a decentralized network remains firmly in the realm of theory. But it is, as Bank of America and JPMorgan appear to acknowledge, theoretically possible. (See also, Blockchain Could Make You—Not Equifax—the Owner of Your Data.)
Blockchain Not Bitcoin
While this is the first time big banks' 10-Ks have hinted at the fundamental threat posed by peer-to-peer money, the sector has engaged in a multi-year dialogue with proponents of cryptocurrencies. Mostly it has been acrimonious.
Charlie Munger, vice-chair of Berkshire Hathaway Inc. (BRK-A, BRK-B) called bitcoin "noxious poison" earlier in February. Berkshire's biggest stock holding is Wells Fargo & Co. (WFC), which opened perhaps 3.5 million fake accounts in customers' names without their permission from 2009 to 2016. Munger said regulators should "let up" on the lender following this scandal, which bitcoin's proponents might argue illustrates the "inherent weakness of the trust based model" – Nakamoto's words. (See also, Wells Fargo CEO John Stumpf to Retire Immediately.)
Dimon, JPMorgan's CEO, has called bitcoin a fraud, but has expressed enthusiasm for the underlying blockchain technology. This blockchain-not-bitcoin line has been echoed by a number of other financial incumbents, and it's hinted at in the 10-K's suggestion that JPMorgan could have to "modify or adapt its products." The bank is already building a blockchain platform called Quorum.
In fact almost every major lender has joined one blockchain consortium or another, and central bankers – most recently the Bank of England's Mark Carney – have expressed enthusiasm for blockchain that does not extend to bitcoin.
When Is a Blockchain Not a Blockchain?
Critics of this blockchain-not-bitcoin posture see it as a way of deflecting attention from bitcoin's core innovation. Bitcoin and other blockchain-based assets offer distributed networks in which value can be transferred without trusting any single party, such as a bank. According to this logic, banks cannot innovate their way out of trouble by building their own decentralized networks: banks are necessarily absent from any such network.
Another critique is that blockchain technology – at least the most reliably secure form, known as proof of work – is highly inefficient (and carries potentially severe environmental consequences). Centralized parties such as banks have little obvious reason to employ blockchains, which offer no advantage over traditional databases – unless the goal is decentralization – and promise to consume vastly more electricity in order to process transactions at slower speeds. Banks have countered that blockchain technology can speed up settlement times, particularly for complicated derivatives trades. (See also, How Does Bitcoin Mining Work?)
On the other hand, many proposed enterprise blockchains use alternative consensus models, which are more similar to proof of stake than proof of work. These models are potentially more energy efficient but, critics argue, have not demonstrated the same security as proof of work.
It may make some sense for large consortia of banks to employ blockchains, since they could allow all parties to transact among themselves without trusting each other. The issue is that, in order to be trustless, a blockchain-based network must be at least half honest. If even the slimmest majority of banks collude, the network can suffer a so-called 51% attack. Past manipulation of rates and markets for currencies and precious metals by groups of financial institutions indicate that is not an unreasonable concern.
In any case, though, it is not necessary for banks to explicitly conspire to compromise a network. Blockchains are intended to enable commerce among networks of nodes who do not know or trust each other at all. Even if a majority of participants shares an interest in common – which is not unlikely in a group of a couple dozen financial incumbents – the network is insecure enough. That is, the added inefficiencies of using blockchain technology may outweigh the benefits of decentralization.
"Some of these platforms are developed 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 almost the same control, or exactly the same control, it would have had in the old system. And then you're wondering, why are we switching to a less efficient IT infrastructure? Because it's trendy?"
That, or to mitigate a growing threat.
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