Since the Bitcoin whitepaper was released in 2008, blockchain technology has disrupted the financial industry in unexpected ways. Near the end of 2020, cryptocurrencies and NFTs soared. Interestingly, NFTs opened new doors and opportunities in the world of digital art.
Cryptocurrency, blockchain, and NFTs are buzzing terms that many of us have heard in recent years. But how are these concepts related, and what is their impact on finance?
Read on to find out.
What is NFT?
NFT stands for non-fungible token. “Non-fungible” means that you cannot replace it with something else. In essence, it’s a unique trading card. NFT is built on blockchain technology, most often Ethereum’s blockchain. According to Alpha Sense, “They represent a new form of ownership for anything that can live in the digital world, and there has been a lot of chatter.”
NFTs are often used for digital artwork. The NFT tokens verify the authenticity of the artwork, which prevents replicas. One key example was the collage of images by Beeple, which sold for $69.3 million in March 2021. This was one of many instances that demonstrated the power and profitability of NFT sales.
How does blockchain relate to NFT?
A blockchain is a “cryptographic database maintained by a network of computers, each of which stores a copy of the most up-to-date version.” NFTs are part of a blockchain, most commonly Ethereum’s blockchain. However, other blockchains can (and have) implement their own NFTs. Blockchain technology verifies the authenticity of the one-of-a-kind token.
Nasdaq explains how NFTs are created via token standards. Developers create unique lines of code that represent the assets. Right now, token standards Ethereum ERC-721 and ERC-1155 are the most common token standards.
How do banks interact with cryptocurrency now?
Right now, financial institutions are cautious of cryptocurrencies. A study by the Association of Certified Anti-Money Laundering Specialists found that 63% of bank industry employees view cryptocurrency as a risk instead of an opportunity. The top reasons why banks perceive cryptocurrency as a risk are:
- Decentralized status. The cryptocurrency was designed as an alternative to the traditional financial institution infrastructure. Crypto assets do not depend on the centralized bank or government. Instead, they rely on blockchain technology. Part of the appeal of crypto is its decentralization, which is seen as undermining the power of central banks.
- Anti-Money Laundering. Since cryptocurrencies facilitate peer-to-peer transactions without transaction fees, financial institutions worry about the lack of anti-money laundering protocol. Many banks are concerned about how to track AML and “know your customer” with cryptocurrency.
- Volatility. Cryptocurrencies have already demonstrated immense volatility. Banks view this immense volatility as a concern and a risk. Many are unsure if cryptocurrencies can be a stable investment in the long run.
The Future of Financial Institutions and Cryptocurrency
While financial institutions are currently hesitant to engage in the cryptocurrency industry, they must find ways to enter the space. The future of innovation in commercial banking includes crypto. Furthermore, cryptocurrency and the adoption of blockchain technology offer many valuable opportunities for banks, like the ability to upgrade and streamline financial services.
Some key trends that suggest cryptocurrency will be necessary for the future of banks are:
- Fidelity Digital Assets creates their crypto fund.
- PayPal now allows cryptocurrency transactions.
- JP Morgan acquired two cryptocurrency exchange customers, Coinbase and Gemini.
- Signature Bank leveraged blockchain technology to create a real-time payment system. Its Signet digital payment system expands Signature’s ecosystem and has already helped bring in $10 B in deposits.
- Silvergate Capital is well known for its Silvergate Exchange Network. SEN is a digital payment network that can clear U.S. transactions 24/7, making it ideal for crypto traders.
Recommendations for Financial Institutions
Banks will need to adopt cryptocurrency technology in a safe, trustworthy manner. Here are some of the top recommendations for financial institutions from Wolf & Company, P.C.
- Offer Custody Services. Banks can offer crypto custody services, like holding the unique cryptographic keys for private wallets. The OCC trusts that banks can effectively hold the crypto assets or the key for the crypto digital wallet for customers.
- Crypto Investing Tools. Another critical way banks can enter the space is by providing tools for less experienced crypto investors. Banks can help investors protect their assets by holding them via interest-bearing crypto accounts. From there, the customers can invest in crypto through other financial tools. This process would alleviate some stress and confusion from less experienced crypto investors.
- Apply AML and KYC Regulations. According to the Financial Crimes Enforcement Network, cryptocurrency transactions must still abide by the AML and KYC regulations. This helps reduce some of the concerns for financial institutions. Additionally, blockchain technology may be able to automate these important verifications.
- Address Safety Concerns. Banks have the power to mitigate the security risks of cryptocurrency holders. By offering secure digital currencies, they can supervise cryptocurrency and give their customers peace of mind.
- Faster Payments. Financial institutions can also use cryptocurrency to speed up payment processing. Blockchain technology is quicker and less expensive for payment processing than clearinghouses. Banks that leverage blockchain technology can speed up clearing and settlements significantly.
- Smart Contracts. Smart contracts offer greater security and trust because the transaction is facilitated by computer code. By using smart contracts for commercial loans, mortgages, lines of credit, and other transactions, banks can increase their trust as a reliable third party.
Cryptocurrency, including NFTs, are relatively new. Understandably, this raises regulation and security concerns for financial institutions. However, the key is for banks to look for ways to mitigate risk while taking advantage of the incredible opportunities the crypto industry offers. Rather than viewing crypto as a competitor and a threat, they should embrace it as a valuable partner.