Despite the current turmoil within the Bitcoin industry regarding forks and protocol changes, banks are starting to wake up to the fact that bitcoin poses a real threat to their business. But what, specifically, is this threat? The answer can be found in one of the most important metrics of banking clout: Assets Under Management (AUM).
Athletes measure themselves in scoring points and beating times, governments tout their GDP, and although banks report hundreds of metrics to shareholders, the most important is the amount of capital that they control on behalf of their clients, their AUM. Capital is the lifeblood of both retail and investment banking, and without it there is no profit, performance, or bonuses.
In a world where money lives as either physical cash or as a deposit, most people choose to keep the majority of their funds in a bank. They do this for three reasons. First, money in the bank is more secure than cash. Second, using a bank to send and receive payments is (typically) more convenient than using cash. And third, although less in recent years than before, banks reward depositors with interest payments, creating an incentive over keeping cash under the mattress where it does not grow.
In this world, there aren’t many alternatives. Gold, which used to be widely regarded as money, is risky to store, cumbersome to carry, and isn’t really accepted anymore by individuals or businesses. If you want to play in the sandbox, you need to use dollars, euros, yen, or whatever local fiat currency your country supplies.
Although there are three reasons to keep your money in a bank, there remains one important reason to avoid it, and that is the dreaded “bank run,” accompanied by its cousin “capital controls.” If you think that bank runs are a relic of the past, before we had mature central banking and deposit insurance, you should be reminded of what happened recently in Cyprus in 2013 and then Greece in 2015 and then India in 2016, when restrictions were placed on certain bank notes.
The reality is that even if more developed countries may be the last to catch a monetary cold, that they are by no means immune to the disease. When people want physical cash, banks quickly find themselves in deep water.
So what does this have to do with bitcoin?
Unlike gold, bitcoin is easy to store, effortless to carry, and becoming widely accepted by its growing user base. In addition, it has chipped away at the three pillars of deposit incentives: Holding bitcoin can be done securely, sending and receiving bitcoin is as easy as using email, and in an environment of low or even negative interest rates, combined with its propensity to rise in value over time, bitcoin sports a value profile that is much more attractive than receiving interest payments that do not even exceed the rate of inflation.
So why should banks be worried?
Bitcoin is a bearer instrument, meaning that there are no liabilities or debts associated with it. If you hold it, it’s yours. And as such, there can be no run on a “bitcoin bank.” This makes holding bitcoin superior in many ways to holding fiat currency in a deposit account. It has all the benefits without the risk of capital controls. Because of this, the growth of bitcoin is sucking value out of national currencies.
There is now more than $60B worth of bitcoin sitting in bitcoin wallets, such as the one that breadwallet provides. If it isn’t Assets Under Management, then let’s call it Assets Under Protection (AUP). And here is where the risk to traditional banking resides. What does a world look like when a simple bitcoin wallet is indirectly protecting as much money as the likes of JP Morgan, Bank of America, or Wells Fargo?
At that point, and probably quite a bit before, that wallet becomes a bank. Not an old bank like legacy institutions, but a new bank, a decentralized bank, with different ethics, operations, and monetization streams—but a bank all the same, as measured by the most important bellwether of financial health: Assets Under Protection.
The real reason that banks should worry about bitcoin is that it threatens the bedrock of their business model, which is to use capital to pursue loans and investments. Less capital means less opportunity, and less opportunity means they will need to eventually adapt to the new and bright future that bitcoin brings.
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