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Current Affairs

Crypto banking

Date: 07 September 2021 Tags: miscellaneous

Issue

The definition of money has changed over time after the development of Bitcoin and thousands of other cryptocurrencies.

 

Background

 Crypto businesses are trying hard to venture into traditional banking sector including financial services.

 

Details

  • In recent times the biggest concerns expressed by experts is regarding borrowing and lending services.

  • Many individuals are investing their money in digital currencies so that they get better returns in comparison to banking deposits.

  • Crypto currencies also have a feature to be used as collateral when an individual buys loans. They also do not need credit checks.

 

Difference in comparison to banking sector

  • Superficially both crypto and traditional banking look similar. Depositing cash or crypto currency will yield monthly interest for customers.

  • The difference however is the rate. Depositors can earn a yield more than 100 times higher on digital account than on average bank accounts.

  • The biggest threat will be non-guaranteed accounts.  Extreme market conditions or cyber-attacks will make the accounts non-operational.

  • Users will be barred from withdrawing or transferring their deposits temporarily or permanently in such cases.

 

Reasons for high yields

  • Traditional banks lend the deposits of customers in form of loans and give a part of earning as interest. Crypto banks offer a similar strategy.

  • They pool the deposits of their users and give them as loans. In traditional banking there will be some reserves kept to ensure that customers will have money to withdraw in case loans go bad.

  • In crypto banks, there are no such provisions of reserve requirements. In search of higher yields they take high risks.

  • Some firms lend to hedge funds and other institutional investors who make fast money without buying risky assets. They generate high returns when successful. 

 

 Stablecoin

  • They are crypto coins that are based on stable assets such as US Dollars. They ensure that crypto coins become less volatile and have more practical use.

  • Popular stablecoins are Tether and USD Coin. They provide the steady value of government-issued money in digital form.

  • Stablecoins issuers must hold and monitor reserves. They work similar to the central bank of a country that stabilizes currency value.

 

Central bank digital currency

  • These are crypto currency that is reliable as a source of money due to control exercised by central bank.

  • It will remove relevance of stable coins as supply, value and demand will be controlled by an official government-backed entity.