Bitcoin Opportunities for Banks
How banks can benefit from Bitcoin technology
While many bankers still continue to ignore the benefits of Bitcoin as well as the challenges it poses to traditional banking services, the potential of Bitcoin technology continues to raise the eyebrows of visionary bankers. In this article, we will shed light on how fast, secure, and low-cost cryptographic payments can be leveraged in the next generation of banking services.
Latest movement in the B2B market
Although Bitcoin’s adoption in the Business-to-Business (B2B) market has been slow to date, a wave of Bitcoin acceptance looms large on the horizon. Noticeable examples of B2B adoption of Bitcoin include eZanga.com, which has partnered with Coinbase to start accepting Bitcoin payments, and Johnson, Morgan & White, a US corporate debt-recovery agency which recently announced it has also begun accepting Bitcoins as a form of payment. The number of businesses accepting digital cash has risen sharply in the past year and is expected to reach one hundred thousand companies across the globe within the next few months [1].
Transfers are faster and more economical with Bitcoin
Receiving payments is a central function of any company. Despite enormous technical progress in recent years, many companies still wait for as long as five days to receive payments by wire transfer. To address this issue, Bitcoin offers a modern, real-time payment system for B2B financial transactions on a global scale. Think of it as PayPal for businesses. It allows for fast and secure payments around the clock, which avoids expensive bank fees. It also facilitates collaboration between buyers and sellers through direct communication and the exchange of payment data that contains additional, rich information. Bitcoin technology allows companies to plan both liquidity and cash flow more accurately for further cost reductions.
More than speculative purposes
International money transfer transactions are both time-consuming and expensive. Fortunately, cryptographic coins such as Bitcoin have clearly demonstrated their ability to transfer large amounts of money across borders safely. Although the volatility seen in Bitcoin prices can be problematic, the underlying technology can still be utilized to provide the basis for faster transfers that are settled throughout the day at a lower cost. This makes digital cash a viable option to alter existing payment systems and currencies.
Bitcoin technology and supply chain finance
While supply chain finance (SCF) has been available for years in various forms, only recently has it shown substantial global growth. The rising popularity of SCF is largely driven by the increasing globalization and complexity of the supply chain, especially in areas such as the automotive, manufacturing, and retail industries. However, this landscape is quickly changing to include nearly all forms of industry. As the pace of business continues to accelerate on a global basis—and because there are many new trading partners to manage—it’s easy to see how SCF in combination with Bitcoin technology can make transactions faster, safer, and smarter for both buyers and suppliers. There are a variety of SCF transactions, including the extension of the buyer’s accounts payable terms, inventory finance, and payables discounting. These SCF solutions differ from traditional supply chain programs such as factoring and payment discounts in the following two ways: firstly, they connect financial transactions to value as it moves through the supply chain; and secondly, they encourages collaboration between buyers and sellers rather than competition that pits buyers against sellers and vice versa.
Banks can white label the Payment21® gateway for processing Bitcoin payments
The Bitcoin processing gateway of Payment21® uses a SCF-technology platform to automate transactions, track both invoice approval and the settlement process from initiation to completion. It adds real-time payment capability, and helps to make the process clear for buyers and sellers in the supply chain. This is where the value propositions of proprietary gateways such as Payment21® play a key role. By enabling structured (e.g., invoices and purchase orders) and unstructured data (e.g., photos, pdfs, etc.) to flow between buyers and sellers to make and reconcile payments in a dynamic fashion, the Payment21® custom-made solution for Bitcoin processing provides the technology platform necessary to enable SCF. Financial institutions and payment service providers can benefit from Payment21® by white-labeling the gateway.
The current needs of global businesses
As of this writing, the Federal Reserve is in its fifth triennial study to evaluate current payment trends against the new requirements of businesses and consumers. The purpose of the study is to recognize and drive improvements in strategically important end-to-end transaction processing demands. In 2014, payment speed, security, and efficiency rose to the top as the most critical payment attributes for both buyers and suppliers. Players in the supply chain are looking to their financial institutions and payment service providers for higher levels of transparency in their transactions, faster payments, and the ability to mask their sensitive financial data to protect against fraud. The Federal Reserve’s study highlights the following:
- 75% of all business payees want real-time or one-hour payment speeds.
- 75% of all business payees expressed willingness to pay a fee for payments that have faster availability.
- 67% of all buyers will use a new payment method if it is accepted by most of the supply chain.
- 81% of all businesses indicated that they would rather share an email address or a phone number to make or receive payments.
- 82% of businesses stated that it is important to receive timely notification that a payment has been upon the payee’s receipt of the payment.
Traditional providers have all come up short in these areas, and businesses are looking for alternative providers to meet their needs. Payment21®’s gateway offers a solution. By facilitating faster, smarter, and more secure commercial transactions, the Bitcoin technology provided by Payment21® is able to meet the needs of every member of the supply chain, making it an attractive alternative to traditional currencies and payment methods.
Union Bank of Switzerland (UBS) acknowledges Bitcoin as a feasible payment technology
According to a recently released report from UBS, Bitcoin technology offers innovative new features for adoption by the financial services industry. As Bitcoin has already demonstrated, a distributed “block chain” offers a robust and secure way of storing funds. In addition, transactions completed by verification through a consensus system and cryptographic public/private key offer a fast, inexpensive, and safe way of transferring funds nearly anywhere in the world. These new features help banks optimize their payment systems and provide faster, more secure services to their customers at lower costs while also improving services to corporations, such as settlement for trade finance.
Banks are well positioned to implement Bitcoin-like technology
In spite of their tarnished creditability from the recent global economic crisis, financial institutions remain the most reliable entities for consumers engaging in money-related transactions. The inclusion of Know Your Customer (KYC) safeguards adds even more credibility to cryptographic payments. Rather than dealing with completely new financial service companies in the Bitcoin sector, banks are the logical choice to absorb the benefits of this technological innovation and introduce faster transactions to their customers within a context of established trust. However, given that most banks will likely be reluctant to cannibalize their existing fee income, Bitcoin technology is likely to remain the domain of third parties [2].
Banking your own coin
Because Bitcoin is still a new concept that is both volatile and associated with strong speculative purposes on the market as well as money-laundering issues, banks are not likely to adopt Bitcoins in the near future. However, they will likely start utilizing the Bitcoin protocol. Any financial institution heavily involved in global trade finance where foreign currency hedging plays an important role ought to start thinking about banking their native crypto coin. Utilizing the Bitcoin protocol to issue proprietary crypto coins pegged to currency baskets compounded of fiat money represents one of the hottest trends in cross-border payments today. Doing so can significantly reduce volatility and is actually not a new concept.
Bankable opportunities for crypto coins pegged to fiat money
Created in 1969 to supplement a shortfall of preferred foreign exchange reserves, Special Drawing Rights (SDRs, ISO 4217 currency code XDR) are defined by a weighted currency basket of four major currencies: the USD, the Euro, the GBP and JYP. The International Monetary Fund (IMF) allocates XDR to member states [3]. Pegging XDR to a cryptographic payment system is a bankable opportunity currently examined by leading currency experts. By the same token, the WOCU® (World Currency Unit) was created as a global composite of currencies from the world’s top 20 economies, which represent the vast majority of global production. WOCU® is weighted based on IMF figures and offers market professionals and individuals alike powerful currency stabilization, hedging against exchange rate volatility and individual currency purchasing power [4].
How banks benefit from “Colored Coins”
Surprisingly, most financial institutions have yet to discover the tremendous opportunities offered by so-called Colored Coins. This is a protocol that operates on top of the Bitcoin protocol. It allows “coloring” of the coins so that people can hold various assets like USD, Euro, Gold and different securities on the same decentralized, secured cloud platform. This new innovation has emerged as a viable solution for people to freely make transactions with various financial instruments [5]. Such a system also drastically reduces duplication in the legacy transaction infrastructure, where each bank has to run its own proprietary system for managing funds and transactions.
Bitcoin technology benefits in the direct online banking environment
Ripple Labs, a Bitcoin-like decentralized payment network provider based in San Francisco, recently announced that the German Internet-direct bank Fidor is now using the Ripple protocol as part of its transaction infrastructure [6]. “Ripple enables us to securely and instantly send money anywhere in the world at no additional cost and through the same customer-facing products and relationships we offer today,” said Matthias Kröner, CEO of Fidor Bank. The bank will offer the new services not only to its retail clients, but also to business clients as Fidor plans to utilize Ripple’s protocol for intra-bank payments between its German banks and international partners as well as to lower settlement costs and foreign exchange risk. Banks like Fidor, with their sites squarely set on e-commerce and the mobile Internet, are the likeliest candidates to introduce their own digital cash or establish further partnerships with existing crypto-coin protocols.
The block chain ledger as a superior alternative to the SWIFT network
The Society for Worldwide Interbank Financial Telecommunication (SWIFT) provides a network that enables financial institutions worldwide to send and receive information about financial transactions in a secure, standardized, and reliable environment [7]. Similarly the block chain of Bitcoin works as a public ledger in which payment transfers are stored. One of the message types supported by the SWIFT network is MT103. The MT103 message enables one bank to instruct another bank to credit the account of one of their customers, debiting the account held by the sending institution with the receiving bank to balance everything out. With the Bitcoin network, a similar process is completed through a network of “miners” using their computing power to verify a transaction’s validity. Upon verification, the entire process is complete. By guaranteeing security and reliability through a decentralized verification system, Bitcoin is a viable alternative to SWIFT.
The Bitcoin protocol transfers digital assets enabling clearing and settlements in one go
In fact, Bitcoin is likely the more efficient of the two. While SWIFT performs financial messaging, it does not move funds. Bitcoin-protocol, on the other hand, allows for the exchange of digital assets. Today, banks move funds through counter-entries on the balances they hold on each other’s bank accounts. Bitcoin’s unique innovation is the capability to store and transfer value without requiring the parties to physically ship funds or maintain bilateral accounts for reconciliation. Additionally, in contrast to SWIFT, no central party is needed for the block chain to function. Bitcoin’s block chain works without any corresponding banking relationships. With no maintenance of counterbalances or lengthy clearing and settlement mechanisms, more control and freedom is put in the hands of banks and users. This represents yet another Bitcoin advantage over the traditional SWIFT network.
Implementing Bitcoin innovation
It is important to consider what financial institutions would have to do to implement the various Bitcoin innovations described above. Essentially, banks across the globe would have to come together to create and maintain the back end in the form of a distributed block chain-like, consensus-building system in order to keep track of public addresses, balances, and other relevant information to send and receive payments with an acceptable level of privacy. On the front end, customers could keep their private keys or authorize their banks to handle their private keys for them. Banks can also choose to keep the customer front-end of their web portals more or less the same. In principle, there is still a minimum confirmation time required when carrying out a transaction, but banks could provide payment guarantees to overcome that issue. Moreover, they could keep track of which customers are associated with which public addresses for tax and money-laundering prevention purposes, among others.
Letter of Credit versus Coin of Credit
The advantages of Bitcoin technology are not limited to individual customers. The Bitcoin protocol can also bring changes to a bank’s corporate services, such as replacing the traditional Letter of Credit (L/C) with a Bitcoin-based digital version.
For any company entering into international trade today, L/Cs play a vital role in eliminating certain risks. A Letter of Credit, simply defined, is a written instrument issued by a bank at the request of its customer, the importer (buyer), whereby the bank promises to pay the exporter (beneficiary) for goods or services, provided that the exporter presents all documents exactly as stipulated in the L/C, and meets all the other terms and conditions it sets out.
One of the key principles underlying the L/C is that banks only deal in documents and not in goods. The decision to pay under the L/C entirely depends on whether the documents presented to the bank appear on their face to be in accordance with the terms and conditions of the L/C. Accordingly, the integrity of both the exporter and the importer are very important in the L/C transaction. Appropriate due diligence is expected to be exercised by both the buying and selling parties, but not necessarily by the banks involved, which puts most of the risk on their corporate customers.
Understanding the Letter of Credit
To understand how an L/C system works, consider a Swiss-based importer planning to purchase wine from an exporter based in Argentina. The exporter will send a pro-forma invoice to the importer who will request an L/C from his bank. The advising bank will issue the payment document according to the importer’s credit line with the bank. When the wine is loaded onto the ship, the seller or an inspection company will issue a delivery notice stating the Incoterms (pre-defined commercial terms widely used in international commercial transactions or procurement processes) [8]. Upon approval of the importer the advising bank will then release the funds to the beneficiaries’ bank via telegraphic transfer (T/T) in accordance with the delivery and payment terms, verifying that both parties agreed on using FOB (Free on Board) as part of the Incoterms. Cost and risk are divided when the goods are actually on board of the vessel. In this type of process there are usually several other banks involved in the transaction, which increases the fees. For example, exporters normally require the L/C issued by the importer’s bank to be guaranteed by a third party, and the third party will charge a fee to one side or both sides to provide the guarantee. The payment transaction from the importer’s bank may go through several other intermediary banks in order to arrive to the exporter’s bank account. The transfer time of the funds can vary from two days to two weeks.
Securing transactions through multiple signature functionality
Protecting clients in a transaction is an important task for both Letter of Credit and the envisioned Coin of Credit concept. A Coin of Credit, utilizing Bitcoin technology in combination with the so-called Multisig-functionality, ensures delivery and payment as much as the traditional L/C. To resolve and prevent one party from failing to deliver on the agreed transaction after the Coin of Credit has been funded by the bank through the importer’s credit line, Multisig-functionality is utilized. It requires consent from the seller, buyer and banks involved, acting as an escrow service in this context. Electronic signatures from either party and from the banks facilitating theCoin of Credit are required to release the funds in either direction. This requirement ensures that both the buying and selling parties are able to quickly release the money if an agreement is reached, and that the unbiased escrow service decides where the money goes in the case of a dispute. These features are highly attractive options that Bitcoin technology offers to the modern financial services industry. Furthermore, because Coin of Credit is able to accelerate the transfer time, the foreign exchange risk associated with trade is significantly reduced. This is vitally important when doing business in countries with high inflation rates.
A new concept: Proof of Existence
Apart from performing time consuming and costly due diligence on the trade partners when dealing with a traditional L/C or other legacy trade finance tool, a Coin of Credit operating via a block chain ledger offers Proof of Existence, an effective way to prevent dishonesty among the parties involved. Besides transferring payments,Proof of Existence can also be used to demonstrate document ownership and provide proof that a document was authored at a particular time. A Proof of Existenceauthenticates legal documents and other critical international trade files including the invoice, packing list, bill of lading, airway bill, insurance certificate, origin certificate, and inspection certificate. Online authentication of such documents significantly speeds up the supply chain because hard copies of the documents do not have to be sent back and forth by expensive courier services. According to BTProof.com, “Trusted time-stamping allows you to prove you held a document, some information or a file at some specific point in time, in a way that can’t be forged” [9]. While the prospect of the block chain providing key evidence in legal disputes may seem far-fetched today, it will soon become a reality [10].
Bitcoin technology for contracts international trade
International trade transactions often use a Non-Disclosure Agreement (NDA) and a Letter of Intent (LOI) to initiate a deal. The NDA, also known as a confidentiality agreement, is a legal contract that outlines confidential information that the parties wish to share with one another for certain purposes, but wish to restrict access to it by third parties. A Letter of Intent is able to protect against misconception and the consequences of a deal collapsing. This is done by thoroughly outlining the details of the transaction to both parties prior to establishing the final agreement. Unfortunately, producing such documents can be a time consuming process. Even after a Letter of Intent is in place, one must often issue an MT799 through the SWIFT network to prove that the funds to pay for the order do indeed exist. After this is verified, an MT103 will need to be issued by the buyer’s bank to the supplier to show that the credit transfer has taken place. As time consuming and costly as all of this is, things get much more complicated if there is a dispute. Traditional procedures make international trade transactions lengthy for both businesses and banks. With Bitcoin technology, banks and their clients are able to more quickly and efficiently submit required documents in a secure, cryptographic file that protects them from being altered.
Bitcoin technology to protect against copyright infringement
It is vitally important to recognize that Bitcoin is much more than a digital version of the ancient Bill of Exchange, having many more purposes than just transferring funds across long distances. For example, Bitcoin’s technology could revolutionize Intellectual Property (IP) rights by helping to protect against copyright infringement. Digital property can sometimes be considered intellectual property, and block chain technologies can essentially prove ownership of such digital property. One such service that is already using Bitcoin technology to prevent copyright infringement regarding artwork is Monegram.com, a website that notes, “Monegraph is built around block chains, the same technology that enables a reliable public ledger for transactions in Bitcoin. Instead of being used to verify a currency, Monegraph is designed to help people verify that a digital image is subject to a claim of ownership” [11].
Benefits for banks and their corporate account holders
If Bitcoin-like technology is adopted by banks, fund transfers will undoubtedly become much faster, safer, and more economical. Digital cash such as Bitcoin has already demonstrated its potential as a safe and faster way to transfer money internationally. Compared with the current process, the new process significantly reduces the amount of exporters’ accounts receivables and increases total turnover, which ultimately helps exporters improve their accounts and cash flow management efficiencies.
Additionally, if banks create a proprietary crypto coin denominated in a unit of account that is pegged to a basket of major fiat currencies like XDR or WOCU®, then the volatility associated with Bitcoin transactions will be greatly reduced. Improved stability of the prospective crypto coin results in reducing both importer and exporter expenses in hedging currency risks, which in turn increases their net profit margins. Moreover, as already mentioned, if a bank can provide proof of existencetechnologies, the time and monetary resources spent on due diligence can also be vastly reduced. Finally, another lucrative feature for both importers and exporters are the lower fees associated with the transfer of funds.
Bitcoin technology is a viable business opportunity for banks
Bitcoin’s inroad into the B2B market is imminent. For most corporations, it is another type of payment mechanism that provides fast, secure, and low-cost services compared to wire transfers.
However, banks lack the incentives to absorb Bitcoin technology because fewer fees could reduce the bank’s profit margin, unless the banks obtain a large enough increase in the overall volume of transactions to compensate for any reductions [12].
The main income opportunity for banks is not in providing payment services to corporations or consumers. Putting investment banking aside, the cash cow in commercial banks is from making loans to clients. This basic business model remains intact even with the envisioned Coin of Credit or other applications based on Bitcoin technology. Utilizing crypto coins enables financial institutions to offer a brand new range of digital products and banking services. Digitizing trade finance for B2B markets, for instance, offers various value propositions to financial institutions and corporations. It puts banks solidly in the driver’s seat of the Bitcoin ecosystem and allows international trade to become more economical and less risky. For this reason, it is very likely that the implications of Bitcoin technology are much more valuable than the per-bitcoin price that preoccupies so many players in the investment world today.
Now is the right time for banks to seize the opportunity to adopt Bitcoin as an effective alternative payment technology. In addition, there is a corresponding opportunity to adopt Bitcoin technology for corporate services. In trade finance, adopting innovative features will create the following benefits: Lower cost associated with settlement and fund transfers, speedier transactions and thereby reduced foreign exchange risks, reduced or eliminated courier costs and time for document delivery, increased transaction integrity with proof of existence technology, and finally, improved seller account and cash flow management efficiencies via shortened settlement processes.
About the author
Bernhard Kaufmann is the managing director of a Swiss-based payments technology company. He has contributed to the transatlantic crypto industry through his many years of expertise in ecommerce, payments processing, cross-border banking, regulatory compliance, copyright law, tri-medial publishing, and by developing pioneering use cases for financial service companies based on Bitcoin technology. Bernhard’s primary objective is empowering people by forging digital connections across developed and emerging markets. In the early days of the Internet, he was recognized as one of the first investors to take an active role in cross-media communication and multimedia production. Bernhard is an analytical and creative thinker with an influential voice in the community by hosting some of the most innovative business engineers and web architects at his company’s regular research boot camps in Switzerland. The firm is a financial service and software company powering state of the art platforms such as Payment21® and Benscha™ that connect users globally and provide alternative payment methods to consumers, businesses and financial institutions.
Links and sources:
[1] http://www.cmswire.com/cms/customer-experience/digital-marketer-ezanga-p...
[2] https://neo.ubs.com/#article/research/uea58805
[3] http://en.wikipedia.org/wiki/Special_drawing_rights
[6] http://www.coindesk.com/fidor-becomes-first-bank-to-use-ripple-payment-p...
[7] http://en.wikipedia.org/wiki/Society_for_Worldwide_Interbank_Financial_T...
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