Banking with digital currency - A futuristic application

July 01, 2015, Carlos Pelaez, Director of Business Development

Digital Currency is a thing?
$3 Billion dollars (USD) of money is out there in a digital format, not printed or managed by a government. It has many different product names and each one operates separately. One example of a digital currency is Bitcoin. It is only one of the many digital currencies that are being mined and traded today. The impact that digital currency will have in the world of banking and how we operate with money will be undeniably significant.
 
You may be wondering if there is gold or silver that backs digital currency and what exactly digital currency is, so I’ll provide a quick rundown before I jump into the futuristic prediction of where digital currency can be applied.
 
This post is certainly speculative, but it also draws down on my experience in banking, information technology, software development, entrepreneurship, and most recently cyber security.
 
Mining for Digital Money
The United States Dollar (USD) currency used to be valued by the amount of gold in the reserve vaults that backed the dollar. However, in 1971 the US went off this Gold Standard, which meant that the government would not give you gold for your dollar bills. Digital currency picked up at this same trend. There is no gold behind the digital currency. Its value is similar to the US Dollar -- the value of the currency is built by those that transact in it and the users of the currency give it value because they make purchases with it.
 
In order to mine a digital currency like Bitcoin, you essentially need to have your computer solve a mathematical problem. The problem takes days upon days to solve, and each time someone solves one problem and produces another Bitcoin, the next one is incrementally harder to solve before you can obtain a new Bitcoin. The computer power required to produce the currency means that it takes an investment of some sort and because the problems are mathematical, they have been provided a finite amount of Bitcoins available to be mined, and just like gold, it too is finite because there is only so much of it on the planet.
 
The digital currencies can be owned and traded without the need of a bank. Because the currency is digital, it can cross countries without taking an exchange hit, or being supervised by a government regulator. There are websites online that take it as payment, and you can even go to an ATM and withdraw money after you have converted it to US Dollars. As far as owners of digital currency are concerned, it’s the same money that paper currencies provide, except in digital format.
 
Moving Money within a Corporation
Large corporations have multiple bank accounts. Each business unit can have its own account number, and on a nightly basis, money gets moved around into something called a “sweep” account. These accounts basically tally up all the dollars and cents collected, and the system will then project expenses for the next day. If there is a surplus, it gets invested, and if there is a shortage, a short-term loan can be made on the overdraft account using a lender. These things happen in such short periods that the return is usually a fraction of a percentage, but over time, the return can be quite healthy—for example, this could earn you the equivalent of a 30% interest rate over the course of 12 months, which means that instead of getting 1-2% from your savings account, you get 30% from investing the money that would otherwise be sitting idle. The challenge of using multiple banks and multiple bank accounts means that a computer has to move money around. It’s not a big deal, but it takes some planning and timing.
 
Using digital currency in the future could enable companies to program the money. Yes, you read that right. Digital currency could be money that is “smart” and knows where to go to get the right outcome and time it on its own. For example, if the balance it resides in tells it that they have a surplus, it can move itself into a high yield vehicle for X days—with X being the number of days that it knows it can be gone. Another example would be if someone orders something online. Their bank deducts the payment, but it takes it a few days (or hours in really rare occasions) to move from one place to the other. If the bank had digital currency programmed to automatically route itself to a Treasury Bill during the 24 hour purchase time and then move itself to the payee’s bank account to complete the transaction, it could earn interest on its own.
 
Programming and money can be combined to enhance digital currency, and that means that the management of cash flow for corporations, individuals, payments, and all other vehicles out there can be coded to become efficient on its own.
 
Risks
Digital currency provides many risks to the existing banking industry and the risk of cyber-attack this could bring about theft to organizations unprepared with dealing with digital currency. A recent hack left one company missing the equivalent of $1.75 million USD in Bitcoin currency. As the currency gains in popularity and value, the risk grows with it because it will go up in value. Because there are no regulators and no compliance requirements, the users presumably hope that the system is trustworthy enough that it their currency is safe from theft, or devaluation. In the US, we have the FDIC that ensures deposits up to $250,000 USD. This kind of insurance for digital currency is not available because the digital currencies are not backed by governments.
 
In addition to the risk of theft, there is the risk that a virus or error in the algorithm built around “smart” money that employs more sophisticated cash flow manipulation can be breached. This could significantly cripple the cash flow and operations of businesses. For example, coding investment banking to react to the news or external sources can go awry when the news is falsified and the pre-programmed selling of stock is triggered. Recently, this happened after the Associated Press’ Twitter account was hacked and false news was tweeted about an attack on the White House. Automated investments triggered a selling algorithm that made the stock mark take a fall.
 
Conclusion
As we move towards a world where our cell phones can process payments, our watches know our buying habits, and we rarely have to step foot in a bank, the future of currency is also at risk from digital currencies. Yes, we will still need to use some form of payment and carry cash on us, but unless we return to the days of bartering for goods and services, a currency provides this common ground and it may very well be a digital currency that works with traditional currencies. Outside of replacing government issued currencies, digital currency is still relatively new, so it is in the development phase of creating the product and adding users to the system.
 
In the future, the digital currencies will be able to morph into useful forms of cash flow management and possibly play the role banks do today. As digital currency technology moves at a faster pace than traditional currencies, especially without government and regulatory standards to reel it in, this could create a new market and a new risk. However, its application (when safely implemented and vetted) could lead to new surges in how we view and interact with “money” that puts the value we get from banking under a new light.
 
Sources:
The Value of Cash: http://bit.ly/1u1SlkQ
10 Things you should know about Bitcoin and digital currencies http://tek.io/1gl9ykv
Wikipedia: Bitcoin https://en.wikipedia.org/wiki/Bitcoin
$1.75 Million in Bitcoin Stolen in Cold Wallet Hack: http://bit.ly/1CAgoHz
AP Twitter hack causes panic on Wall Street & sends Dow plunging: http://bit.ly/1KWBF45 
One example of a digital currency is Bitcoin. It is only one of the many digital currencies that are being mined and traded today. The impact that digital currency will have in the world of banking and how we operate with money will be undeniably significant.

Carlos Pelaez

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Carlos Pelaez — Director of Business Development

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