Will cryptocurrency replace banks?

The interest in cryptocurrency in the last few years has led many to suggest that banks will become redundant, now that cryptocurrency is an effective way to pay for things.

In fact, the whole idea of Bitcoin (the original cryptocurrency that started the whole movement), is to be fully decentralised, and therefore works to make banks no longer needed.

But could cryptocurrency ever actually replace a bank and the currency of a nation? Crypto evangelists will claim that it’s the solution to all financial inequality in the world, but sceptics make the claim that cryptocurrency is worthless and nothing more than a fad. Most notably, Warren Buffett referred to Bitcoin as a ‘gambling token’ that has no intrinsic value.

Currency vs cryptocurrency

As we explained in our currency vs money article, currency is simply a form of money, and what constitutes a currency’s use is simply the belief that it has value. Since the separation of the US dollar from the gold standard, following many currencies to follow suit and become fiat currencies, almost all major currencies have been free-floating, meaning they are maintained completely by the trust in the currency.

Theoretically, cryptocurrency could do the same. If cryptocurrency was implemented by everyone at once, it could act as a replacement for fiat currency, and after that, the banking system entirely. The unbreakable, ledger-like system of cryptocurrency could see fraud almost diminish, and economic equality flourish. However, there are a few issues that stand in the way of this wide adoption.

Problems with cryptocurrency

Despite all the predictions about cryptocurrency being the future, there are some major issues that could prevent it from replacing currency and banks:

Accessibility

Cryptocurrency is still not accepted by most establishments, and even companies that once offered products and services in cryptocurrency have since retracted this, such as Tesla in March 2021, but cancelling it by May of the same year. Merchants have limited acceptance, there is a lot of instability in exchange rates, and for most people, cryptocurrency offers more problems than solutions.

Volatility

Cryptocurrencies are notorious for their wild volatility, which means that they cannot be a secure store of value, as someone’s life savings could be halved without any indicators. It is also not an effective medium of currency exchange, as the volatility makes it incredibly hard to use for business transactions. If you are a business owner, this would be a difficult thing to tackle.

Trust and security

Cryptocurrencies circulate in a new and fairly unregulated environment, which creates a lot of uncertainty for investors and users. There have also been some high-profile cases of cryptocurrencies and cryptocurrency exchanges being fraudulent, such as the ongoing case with FTX’s founder Sam Bankman-Fried, which harms the trust in crypto immensely.

Energy consumption

Cryptocurrency mining for coins that require Proof of Work (PoW) to validate transactions has pushed miners to use significant amounts of energy, which against the looming reality of climate change is not a very desirable quality. Cryptocurrencies such as Ethereum have adopted a Proof of Stake (PoS) system, which allows much less energy consumption.

El Salvador and Bitcoin

As an example of where cryptocurrency was used as legal tender in an attempt to replace banks and currency, El Salvador introduced the Chivo Wallet in September of 2021, as well as a rollout that Bitcoin would become legal tender in the country. This was not only a move to boost the country’s prestige, but also escape the dominance of the US, as since 2001, El Salvador has been circulating the US dollar – some say part of the USA’s dominance in fixed exchange rates.

The Chivo Wallet included $30 worth of free Bitcoin with each download, as well as a discount on gasoline paid for using Bitcoin. Only a phone was needed to do this, which roughly two-thirds of citizens have.

However, despite the good intentions and the incentivisation, the results were lukewarm, and most of the population has returned to the dollar. According to the National Bureau of Economic Research (NBER): “among early downloaders, more than 60% have not made a transaction after spending the free Bitcoin that came with the account, and 20% have yet to spend the bonus”. This suggests that the interest can be cultivated, but is hard to maintain.

There is also the difficulty in changing systems that already work with cash: “Although the law requires all firms to accept Bitcoin, in reality only 20% do so. Roughly 5% of all sales have been paid in Bitcoin through Chivo Wallet, and just as most households using Chivo prefer to keep their money in cash rather than in Bitcoin, 88% of firms convert their Bitcoin into dollars.”

Any kind of advance in technology always seems like a perfect replacement, but the reality of that replacement is a lot easier said than done, and can even bring up new problems.

Currencies are also tied to a nation and its identity, but cryptocurrency is not. This might seem like a good thing, but it means that a government won’t be able to regulate or control the currency in their own country, which could upset the world economy. Radical economic change provides a good solution to economic dominance over an economy, but it doesn’t necessarily provide a solution for economic stability.

Benefit of banks

Against these issues of cryptocurrency, there also exists the importance of banks in an economy. A bank’s purpose goes beyond just storing and distributing money, as they are able to provide products and services such as:

• Loans
• Investments
• Insurance
• Probate
• Financial advice

An economy is far more complex than simply making payments to one another.

Banks also help people manage their money, and provide certain protections, such as the FSCS protecting up to £85,000 in the event of the bank’s failure, whereas cryptocurrency wallets provide no such protection.

While the trust in banks has been severely damaged after the Great Recession, their role in the economy is still incredibly important, and banks provide many services that cryptocurrency couldn’t replace.

So in conclusion, it is very unlikely that cryptocurrency will replace banks in the near future. Banks may replace certain currencies with cryptocurrencies in the future, for example, the proposed idea of ‘Britcoin’, but the value of banks is still too great for them to be made completely redundant.