The era of Blockchain: Impacts of digital currencies on the financial systems

“Bitcoin: A Peer-to-Peer Electronic Cash System” argues that Internet-based commerce is at a disadvantaged due to reliance on trust model where parties back on a financial institution to serve as trusted third parties to process payments.  In trust-based model, it is not possible to have non-reversible transactions as financial institutions are eager to avoid disputes. This increases transaction costs and makes transaction in small amounts uneconomical.

However, if the payment system was based on cryptographic proof, instead of trust, such predicaments would not occur. Two willing parties would transact directly through a peer-to-peer version of electronic cash allowing online payments, as if they were doing it in person, without the need for a trusted third party. Nakamoto’s concept heralded a new era of digital currencies, with his Bitcoin rising to a market leader and trend setter.

Transactions in digital currencies transactions are facilitated by Blockchain, the underlying technology. Blockchain is a distributed ledger which details payment history of digital currencies in circulation and replaces a trusted third party. Blockchain enables parties to securely send, receive, and record value or information through a peer-to-peer network of computers, and only records a transaction after confirming its validity.

Regulation

Bitcoins and other virtual currencies have presented regulatory nightmares upon central bankers and other financial markets referees. The regulators have grappled to come up with an appropriate definition of virtual currencies. The European Central Bank in a report, “Virtual Currency Schemes – a further analysis” defines a virtual currency as “a type of unregulated, digital money, which is issued and usually controlled by its developers, and used and accepted among the members of a specific virtual community”.

Virtual currencies are certainly a disruptive technology in the financial sector. The distributed ledger has created considerable challenge for the enforcement mostly due to the degree of anonymity, ability to make payments across borders without going through intermediaries, and the fact that there are no third party authorities with the ability to freeze or reverse digital currency payments.

Regulatory reactions have been mixed. China treats Bitcoins as a special virtual commodity, not a currency, prohibiting banks from dealing in them. United Kingdom treats Bitcoin payments like ordinary payments for tax purposes. France and Germany have declared Bitcoin not a currency but an alternative means of payment. Russian denounced Bitcoins exchange as a “dubious activity” associated with money laundering and terrorism financing. Kenyan Central Bank declared virtual currencies as “unregulated” and warned the public against using them.

Nevertheless, usage of virtue currencies has continued to boom with more people warming up to them and in the process, revolutionizing international payments.  So popular has been the Bitcoins for instance, that there were fears the system would be unable to sustain transactions due to their rapid increase. Bitcoin has become like the official currency in the dark nets.

Effects to the legal sector

One of the areas blockchain will have revolutionary impact is to the legal sector. It will introduce trust-less transactions which will lead to the emergence of smart contracts, these being computer protocols facilitating, verifying, or enforcing the negotiation or performance of a contract, making several contractual clauses unnecessary, and in the process, changing the process of negotiating deals and depths of corporate transactions.

Visibly, virtue currencies are a world changing technologies with potential of expanding international commerce, supporting financial inclusion, and transforming modes of doing business. They present a faster and cheaper mode of bank transfers which are currently slow and archaic due to the need of going through country-specific clearing houses at both ends. With digital currencies, bank transfers would be instant, cheap and safe, going a long way in boosting global remittances as private users send money directly to their families.

Digital currencies would act as international currencies. The current currency system stifles international trade due to dominance of currencies of leading world economies. This has made leading currencies to be not only a medium of exchange, but commodities of trade. Digital currencies will kill this currency serfdom emerging economies have been placed in and consequently enhance their financial markets. It would offer a way to the un-banked population to save and protect themselves against inflation, cushioning their wealth from the devaluation of their national currencies.  On the flip-side, capital controls would become harder to enforce and criminal gangs and cartels would be hard to contain.

Conclusion

Regulators, financial institutions and businesses need to understand potential impact of virtual currencies. Instead of fighting and curtailing them, they should be busy in search for ways to bring regulatory certainties. This would be done by constant reform in the financial markets framework to have laws keeping up with the digital evolution and technological wizadry. Bitcoins and digital currencies is the idea which has come, stopping it is mission impossible.

*The Author is an Advocate of the High Court of Kenya Contacts [email protected]