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July 18, 2019

Cryptocurrencies and What They Mean for Banking

Technology has added efficiency and modern conveniences to your customers’ daily lives. Among these conveniences, computer experts have managed to apply digital traits to new, online currencies that are commonly called cryptocurrencies.

Cryptocurrencies are digital currencies that use encryption techniques to regulate the generation of units of currency and verify the transfer of funds. This digital money operates separately from a bank and can be used similar to cash around the world. The digital nature of these currencies provides some benefits that appeal to consumers thus increasing their popularity.

Bitcoin, the most popular cryptocurrency, was declared legal tender in Japan in 2017. Online businesses like Microsoft, Overstock and PayPal also accept the currency. Libra, one of the newest digital currencies and infrastructures, addresses two major criticisms of cryptocurrencies in two ways: (1) it will be backed by a reserve of assets and (2) founding members include large payment companies, technology firms, marketplaces and recognizable global brands (eBay, Uber, Vodafone), likely ensuring a wider acceptance as a payment instrument than other cryptocurrencies. Overlaid with Facebook's broad reach (about 2.4 billion users), Libra should benefit from a wider audience and could eventually disrupt corporate payments.

After being trapped in a bitter bear market throughout 2018, bitcoin seems to be back, and with the introduction of Libra to the Facebook audience it seems likely that some of your customers will be caught up in the excitement and potentially lucrative nature of cryptocurrencies. What better time for a refresher on how they work, as well as their positives, negatives and risks? 

How Do Cryptocurrencies Work?

While it may seem confusing on the surface the way cryptocurrencies function is actually quite simple. Like most currencies used around the world, cryptocurrencies store value, have specific exchange rates and are limited in supply. However, most are decentralized and work without administrators; instead they rely on encryption technology and verification to make transfers. This means there is no central authority that manages the creation and use of cryptocurrency.

In place of a central authority, most cryptocurrencies implement a network that allows users to make transactions directly between each other. These networks use a shared system of private keys and public ledgers to authenticate new transactions and create an encrypted log of past transactions. Bitcoin, the first cryptocurrency to implement this form of authentication, encourages users to participate in the system by rewarding them with additional bitcoins. In fact, this is the only way that new bitcoins circulate.

To use cryptocurrencies, consumers and businesses must first acquire a cryptocurrency wallet account. These accounts work like a bank but are designed specifically for individuals who want to purchase or accept cryptocurrency. Most cryptocurrency coins have an official wallet or recommended third-party wallets. It’s important to conduct thorough research before choosing a service.

After you have acquired a wallet, you can purchase cryptocurrencies on open exchanges and use them for a variety of transactions. They can be converted to cash at a later date. 

Before businesses adopt cryptocurrencies, they should consider the benefits and drawbacks and how they may impact operations.

Benefits of Cryptocurrencies

  • Little or no processing fees — Unlike credit cards and other traditional forms of payment, cryptocurrencies often have no processing fees. This is because transactions are facilitated through the cryptocurrency’s public network on what is known as a blockchain. Transactions are recorded on the blockchain chronologically, and users can create, verify and enforce transactions without an intermediary or central authority.
  • High transaction speed — Credit and debit card payments often take two to three days to process and clear. With cryptocurrencies, transactions happen in real time and take about 10 minutes or less. As an added bonus, cryptocurrency transactions are final, which means consumers can’t dispute a charge and negate a sale.
  • Increased payment options — The more payment options you can provide as a business, the better. As such, cryptocurrency has the potential to attract a wider customer base.

Drawbacks of Cryptocurrencies

  • Price volatility — The value of bitcoins and other cryptocurrencies can change drastically over a small period of time. Bitcoin reached a value of $17,000 in January 2018 before falling to $7,000 less than a month later.
  • Anonymity — While the details of cryptocurrency users and transactions are often held in a public ledger, names and locations are encrypted. This can be an issue when complying with regulations on customer identification or fraud protection.
  • Cybersecurity — Cryptocurrencies exist digitally, and the proof of ownership is often limited to the private keys used to authenticate transactions. This makes cryptocurrencies a prime target for hackers, especially because many businesses aren’t aware of how to protect this new form of currency. (Ironically, cyber criminals make their ransomware demands in Bitcoins.)
  • Intrinsic value – Historically, money must be both a medium of exchange and a reasonably store of value. Although a seemingly terrific medium of exchange, it has been unclear why cryptocurrencies would be considered a reasonable store of value. They are neither backed by a tangible (gold) object or by the full faith and credit of a government. (The new entry, Libra, is backed by a reserve of assets designed to give it intrinsic value.)

One of the key questions worldwide regarding financial transactions accomplished in cryptocurrencies is the issue of taxation. Governments will undoubtedly seek to play a larger role in the cryptocurrency scheme of things, particularly with respect to security and tax compliance. Coming guidance from the IRS will address longstanding questions about the tax treatment and, just recently, President Trump weighed in as “not a fan” with his July 11 tweet. More on this topic to come.

Should Banks Be Concerned about Customers Accepting Cryptocurrencies?

While global companies like Amazon and Microsoft accept cryptocurrency that does not necessarily mean it is right at this time for many small businesses. Before using cryptocurrency, your bank’s business customers should conduct adequate research to understand how it may impact the company. As a financial advisor, bankers should have an understanding of cryptocurrency and be prepared to have thoughtful conversations with their customers. In addition, a qualified insurance broker should be consulted to determine how using cryptocurrency may open the business up to new risks. We will address the risk perspective more directly in a future article.

Your Team – We Are Your Risk Management Experts 

Managing risk is a key factor in meeting compliance requirements, as well as safeguarding you and your customers’ assets. CBIZ risk consultants in our banking and financial services group have the knowledge and experience to provide comprehensive insurance and risk solutions designed to safeguard your institution. Don’t hesitate to reach out to Kris St. Martin, Director of CBIZ Financial Institution Services, at 763.549.2267 or kstmartin@cbiz.com for more information. We encourage you to check out our latest blog post on the Top Cyber Threats for 2019 or register for our upcoming webinar: Ensuring Your Business Is Prepared for the Next Disaster.

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