To most people, the concept of digital currencies is synonymous with the name Bitcoin. However, hundreds of digital currencies exist. In fact, WorldCoinIndex.com tracks 445 currencies, and CoinMarketCap.com tracks 732. Bitcoin is by far the largest, with a market capitalization of almost $10 billion (at the time of this article).
 
A Peer-to-Peer Exchange of Value in an Electronic Currency
 
In their book, Blockchain Revolution, authors Don Tapscott and Alex Tapscott explain the origins of digital currency and the underlying technological platform of the blockchain or distributed ledger. Most people’s first experience with these currencies occurred when they heard of the somewhat recent failure and bankruptcy of the Mt. Gox exchange or the arrest of Ross William Ulbricht, the founder of the Silk Road underground internet market.
 
However, digital currencies can trace their birth back to 1993, when a mathematician named David Chaum created eCash, a digital payment system that allowed for anonymous payment for goods over the internet. It was, in a sense, a forerunner of today’s digital currencies. However, while Chaum appears to have guessed correctly where online transactions were going, he guessed too early. Chaum’s eCash never gained traction with consumers, and like many first movers into any industry, it didn’t survive. By 1998, Chaum’s company DigiCash went bankrupt, and eCash ended.
 
On November 1, 2008, a person or persons using the pseudonym Satoshi Nakamoto published a paper online proposing what the paper called a peer-to-peer electronic currency. The paper discussed the rise in commerce over the internet and the fact that this commerce almost always relies on trust being placed in a third party, usually a financial institution. He argued that such an arrangement has an inherent weakness. A financial institution usually seeks to maintain goodwill with customers and has obligations to take action on disputes between the parties to a transaction. The unavoidability of disputes means that trust is the lynchpin of the entire network, and the possibility of disputes in some transactions increases the costs of all transactions. While these problems can be avoided in face-to-face transactions involving currency, these problems cannot be avoided in electronic commerce.
 
In response, the paper suggested the creation of an electronic payment system based not on trust in a third-party institution, but rather on electronic proof between the parties to the transaction. He proposed the use of a blockchain.
 
Broadly speaking, an electronic coin that represents value, for example Bitcoin, is created with a unique alphanumeric sequence. When a coin is transferred between parties, each party has a unique alphanumeric sequence that identifies the transferor and transferee, and those are attached to the coin. The alphanumeric sequence that signifies the transfer of a coin is batched with those of other coins.
 
Volunteers around the world use computers to locate, or “mine,” transactions. Every few minutes, those miners upload a block of verified transactions to the Bitcoin network. If the new block is valid, it is added to the existing blocks to form another link. The series of blocks is what is referred to as the blockchain. Miners are rewarded for the efforts by being awarded a quantity of Bitcoins for each successful block.
 
Thus, a coin’s entire history of transfers is publicly available on the blockchain, which the Consumer Finanical Protection Bureau (“CFPB”) explained as a massive public spreadsheet run by “vast networks of unidentified, private computers around the world.” Instead of the transfer of currency being maintained on a financial institution’s proprietary system, those transfers are publicly available at any time to everyone who has an internet connection.
 
This publicly available blockchain, Nakamoto argued, guards against an owner double-spending a coin. It also guards against theft as a thief would need to rewrite the coin’s entire history on the blockchain.
 
The Impact on Banks
           
What does all of this mean for banks? For the past few years, digital currencies have caused a nightmare for regulators both in the United States and abroad. Regulators, in particular the CFPB, worry that their decentralized nature (being maintained on anonymous computers around the world) means that their security is not really known. They also worry about consumers losing their coins through security breaches and theft, like the recent hack of the exchange Bitfinex and theft of more than $72 million of Bitcoin, especially since transactions for the most part are irreversible. Further, even aside from actual transactions, regulators worry that virtual currencies inherently involve more risk because of the lack of any required disclosures and because of the possibility for volatility in their prices.
 
The use of digital currencies represents a compliance risk for banks that deal with the users of these currencies. Because they are anonymous, digital currencies may make it harder for banks to understand the activities of their customers and whether those activities are legal, which in turn may make it more difficult to comply with Bank Secrecy and Anti-Money Laundering obligations.
 
The blockchain technology that accompanies digital currencies threatens to impact traditional banking as well. It likely will lead to an increase in the speed of all transactions. This is most readily seen in investment trading. Currently, after a trade is executed, the transaction involving that trade still needs to be settled behind the scenes. This process usually takes days to complete. Using blockchain technology could reduce this time to minutes.

One of the biggest potential changes to traditional banking may come in the storing and lending of money. For decades, banks have enjoyed the position of being the repositories for consumers wishing to store money or the lender for those seeking to borrow money. Opening a first savings or checking account and taking out a first loan have become rites of passage for many consumers. Blockchain technology would allow consumers to store money by instantaneously purchasing digital currency with little to no transaction costs and without leaving their homes. Then, the consumers can just as easily liquidate that currency when they need dollars again.
 
Likewise, blockchain technology opens a new world for anyone to securely lend money in peer-to-peer fashion to anyone else around the world. This concept is especially attractive to those in countries where access to traditional banking services is limited. Entrepreneurs also may take advantage of digital currencies and blockchain technology to raise money without going through traditional funding options and without all of the traditional costs.
 
The bottom line is that the momentum of blockchain technology is continuing to gain speed. What was once the backbone of digital currencies threatens to move into the traditional banking arena. Banks and other institutions are taking notice. In part two of this article, which will be published in the next issue of West Virginia Banker magazine, we will discuss how the financial industry has reacted to this new technology and how governments, both here and abroad, are climbing onto the bandwagon.