Cryptocurrencies have been around for over a decade, but there are hardly any regulations supporting their use. Although various enterprises have also incorporated blockchains into their systems, their legality is still unclear. The lack of proper rules has always hindered the true potential of cryptocurrencies and blockchain. In May 2020, Brian Brooks was designated as the Acting Comptroller of the Currency for the Office of the Comptroller of the Currency or OCC in the US. Many in the industry knew that Brooks would focus on fintech and blockchain technology. As expected, the OCC provided much guidance and many interpretive letters for banks to custody cryptocurrency and stablecoins.
The OCC also launched a Special Purpose Payments Charter for FinTech companies. The Chief Economist of the OCC, Charles Calomiris, published a paper in December 2020, titled “Chartering the FinTech Future,” which pointed out the benefits of the OCC providing bank charters to stablecoin providers.
2021 Interpretive Letter and How it Affects Banking
The OCC released an interpretive letter recently on January 4th. The letter’s contents explain that banks in the US can use new technologies such as Independent Node Verification Networks (INVN) and stablecoins for bank-permissible functions like payment activities. This means that a bank can use stablecoins (cryptocurrencies with minimal price volatility) to facilitate transactions for its customers.
An INVN consists of a shared electronic database where multiple copies of the same information exist on different computers. A well-known form of INVN is a distributed ledger, and cryptocurrencies are recorded on these ledgers used in blockchain technology. What this means is that in the near future, banks can issue and exchange stablecoins for fiat currency as well as validate, store, and record payments serving as a node on a blockchain.
This letter enables banks and other industry participants to combine digital currencies’ efficiency and speed with the stability of existing currencies such as stablecoins.
Stablecoins Will Be The Future
Based on this letter, it is true to say banks are evolving with changing economic and customer needs. They are adopting new technologies to carry out various bank-permissible activities. The changing financial needs call for more innovative and faster payment methods through decentralised technologies such as INVNs.
The demand for such coins is rising already; billions of dollars worth of stablecoin are traded globally. In such cases, one stablecoin can be exchanged for one unit of the underlying fiat currency. This provides a mechanism to store, transfer, transmit, and exchange fiat currency, all of which facilitate payments.
The OCC has explicitly permitted US banks to adopt new and innovative technologies for their payment-related activities. Now, these banks can have their own ledger and transfer money from one account to the same or different ledger. With banks as INVNs, a new means of payment and validating transactions arises.
Banks must consult with OCC supervisors as required, before engaging in payment activities. The OCC will review these activities as part of the ordinary supervisory processes.
Benefits and Risks of INVNs and Stablecoins
The OCC recognises various benefits and risks of INVNs and stablecoins, and hence it neither encourages nor discourages banks from adopting these technologies. Banks must evaluate the appropriateness of these technologies before integrating them into their systems.
The major benefits of INVNs and stablecoins include improved efficiency, effectiveness, and stability of the provision of payments. Instead of a single node verifying transactions, INVNs use multiple nodes for verification in a trusted manner. These networks are also more resilient due to their distributed nature, which means they have no single point of failure.
In INVNs, no one can tamper or add inaccurate data to the database. Any information on the node is verified after a consensus is reached among the confirming nodes.
The use of stablecoins can help banks facilitate INVNs and also contribute to the stability of fiat currencies. Stablecoins can serve as a means of representing fiat currencies on the INVN, which helps fiat currencies access the payment facility of an INVN.
Although INVNs and stablecoins come with various benefits, there are many risks involved, too. The banks need to recognise these risks and the risk associated with the underlying activity. Also, implementing these new technologies requires sufficient technology experts in the field of cryptography.
Depending on the services offered, proper risk management practices should be in place. Payments involving digital currencies may increase operational and fraud risks. Based on the payment activities, stablecoins can also entail significant liquidity risks for banks.
Due to the decentralised nature of digital currencies and increased user privacy, they can be a front for major illicit activities. Hence, the banks must also guard against potential money laundering activities and terrorist financing. They must expand the cryptocurrency services to comply with reporting and recordkeeping requirements of the Bank Secrecy Act.
What This Means For Banks In The Future
Decentralised, open-source financial systems are becoming the foundations for the US economy and the global economy. With major economic activity shifting to blockchain and stable coins, other financial authorities may follow. Beyond payments and settlements, it also allows the invention of new modes of financial and commercial apps and dapps.
With the recent OCC interpretive letter, 2021 may be the year that cryptocurrencies and stablecoins go mass market. More regulated financial institutions will be part of INVNs or blockchains nodes and become validators. It also allows stablecoins such as USDT to become a mainstream payment medium.
Our traditional financial systems are slow, expensive, subject to holidays, banking hours, and are highly central in their governance. But with OCC’s guidance, the banks can operate on blockchains that allow transferring funds between financial entities faster. These services can be available 24/7, without the need for an intermediary. It also shows how the government is open to adopting the next-generation of financial systems.
With the adoption of such technologies, banks can enable cross-border transactions without any additional implications. However, stablecoins won’t replace the traditional financial systems, but it will normalise public blockchains and digital currencies – which is good for everyone involved.
As the US OCC shows interest in these new technologies, other countries will follow, and before you know it, the entire global economy will run on blockchain.