TL;DR
- A centralized financial system, like banks, has shortcomings that cryptocurrencies can resolve.
- From the inclusion of the unbanked to a single point of failure and time required for transactions, cryptocurrencies can address some of these challenges.
- Central Banks of each country have the responsibility of managing the country’s finance, and currency strength both at home and abroad, by controlling the circulation of money.
- Central Bank Digital Currency (CBDC) is the digital equivalent of fiat currency, but they are issued by the central banks of a country.
- There’s no perfect financial system but Crypto and CBDCs working together can help provide more financial services to the masses
Can Cryptocurrency Replace Banks?
Before the introduction of cryptocurrencies, traditional banks facilitated all financial transactions from authentication, identification, evaluation, and regulation through clearing, settling, and recordkeeping. Banks ensure that transactions run smoothly and that everything is recorded and accounted for.
But all this changed when Bitcoin (BTC) was introduced in October 2009.
Innovative Features of Cryptocurrencies
Cryptocurrencies and blockchain technology have created a decentralized financial system, which solves the inadequacies of centralized financial systems:
- Centralized systems are exposed to a single point of failure. For example, a hacking incident will instantly paralyze the entire financial operation.
- The unbanked and under-banked lack access to financial services due to a lack of funds, identification, or residential address, limiting them from engaging in local and overseas digital transactions.
- It can take days or weeks for money to move through the SWIFT system (The Society for Worldwide Interbank Financial Telecommunication).
During the 2008 financial crisis and numerous other fraud occurrences involving financial institutions, surfaced the issues of a centralized financial system, were subsequently addressed by the development of blockchain technology.
Satoshi Nakamoto created leveraged the technology that enables the use of Bitcoin, a digital asset that solves the double-spending problem. Bitcoin established a "trustless" network through its blockchain, which serves as a digital ledger that records every transaction cryptographically. Through crypto, financial transactions can be done peer-to-peer without the need for intermediaries such as banks, enterprises, or the government.
The greatest benefit of blockchain technology is transparency. Virtually anyone who has access to the internet can own cryptocurrencies, transact cryptocurrencies, and view transactions that are happening in real-time. The blockchain network makes it possible for a digital wallet like Coins.ph to transact with other digital wallets.
No single point of failure
Blockchain technology runs through multiple computers located around the world, verifying and recording transactions. Because multiple computers are involved, this reduces the chances of a single point of failure because a transaction has to be agreed upon by multiple computers before it’s put onto the blockchain, making them immutable.
In addition, all types of assets, including money, music, art, and commodities, can be stored, transferred, transacted, and maintained within the network, allowing users to verify their ownership in the form of an NFT.
Cryptocurrencies also allow faster international transactions. For example, TRX (TRON) has zero transaction fees and conducts approximately 2,000 transactions per second, whereas XRP can process 1,500 transactions per second.
The Crucial Role of Central Banks to the Economy
The foundation of a financial system is the central banks. Every nation bestows different functions on its central bank.
For example, the Federal Reserve in the U.S is in charge of monitoring financial systems and images at home and abroad to help ensure that the system supports a healthy economy for U.S households, communities, and businesses.
In the United Kingdom, the financial system's stability and solvency are guaranteed by the Bank of England.
For the Banko Sentral ng Pilipinas, its mandate is to maintain price stability conducive to the balanced and sustainable growth of the economy and employment.
To fulfill their missions, central banks employ a range of monetary policies. However, the central bank's primary role is to control interest rates and the supply of fiat currency.
For instance, a central bank can adjust the volume of money in circulation in a country by “printing” money to increase circulation or issuing bonds to reduce circulation. When consumer spending increases this leads to more economic growth, which means more circulation of money. In contrast, having less money in circulation means people are less likely to spend, which leads to a recession.
Imports, exports, and foreign investment are all impacted by the decisions made by a central bank, like introducing high-interest rates, this prevents foreign investors from making investments or putting up businesses. Low-interest rates, on the other hand, can attract foreign investment because the cost of borrowing is much lesser.
Central banks use a network of banks to spread money around an economic system. They however serve as the central point for the banking and financial systems of an economy, and their policies have an impact on the economy.
One of the benefits of entrusting the economy to a central authority is the ability to establish trust in the system. The currency issued by a central bank is backed by a reliable institution and has a specified exchange rate which gives people the trust that US$1 will always be worth US$1.
Therefore, each country has a currency with a certain value, making local and international transactions possible. The government created a standard national banknote that can be used as a form of payment for goods and services. Additionally, the establishment of national reserves brought economic and financial stability.
What are CBDCs?
CBDC or Central Bank Digital Currency is the digital equivalent of government-backed fiat currency. They are issued by a national central bank and pegged to the currency of a specific country.
You can think of CBDCs like stablecoins, which are cryptocurrencies that seek to keep the same value by being linked to fiat currency, but the primary difference here is that CBDCs are issued by governments of that particular country.
As a form of digital currency, CBDCs can be used as a means of payment for services and goods. Compared to having multiple banks and financial institutions, CBDCs expedite transactions in a single business day rather than requiring numerous institutions to coordinate and fulfill transactions.
All transactions would be recorded in real-time on a centrally controlled digital ledger. In addition, CBDC holders wouldn't require a bank account to make purchases. Therefore, CBDCs would allow the unbanked to send and receive electronic payments.
The Future of Financial Systems
In the current economic system, the central bank serves as the undisputed leader of the world's monetary system. Central banks are used by the majority of countries to govern their economies and there are benefits to a centralized system, but it also has some issues.
Cryptocurrencies like Bitcoin are built on a decentralized network that relies on algorithmic trust to function as a viable alternative to the established financial system. However, cryptocurrency has low widespread adoption, and its legitimacy in the law remains unclear.
Central banks may soon introduce their own version of digital currency and there are already a number of countries that are actively exploring CBDCs, developing pilot programs, and even preparing to launch their official digital currency.
At the end of the day, there is no best financial system, but through collaboration, we can build a financial system that is inclusive and fair for everyone.
Disclaimer: The information and publications in this article are not intended to be and do not constitute financial advice, investment advice, trading advice, or any other advice or recommendation offered or endorsed by Coins.
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