Cutting through concepts: virtual currencies get real

Cutting through concepts: virtual currencies get real

Virtual currencies present both a threat and an opportunity to financial institutions. Regardless of your position on this new market development, you would be well advised to watch this space closely.

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Cutting through concepts

Virtual currencies such as Bitcoin are growing rapidly, with over eight million accounts anticipated by the end of 2014. Transactions are peer-to-peer, fast and low-cost, bypassing traditional payment systems.

These currencies and associated technologies are also impacting the investment banking sector. Seventy or so exchange forums worldwide allow the transfer of fiat currencies into virtual money or vice versa. Hedge funds and other capital markets players are considering holding such currencies, which, compared to stocks or bonds, are highly volatile.

In September 2014, TeraExchange announced the first regulated Bitcoin swap trading exchange and price index. This forum is based around Bitcoin derivatives, with traders buying and selling long and short against anticipated bitcoin future prices.

Ripple is less a currency than an exchange medium. Its ‘virtual trading floor’ enables investment banks to swap commodities, and also utilize the technology to optimize internal payments operations and offer clients enhanced payments services. 

The dark side of virtual currencies

The anonymity of the medium has brought perhaps its biggest challenge, in the form of money laundering and exchange of illegal goods by organized gangs, as well as terrorist financing and nation state espionage.

Following the 2014 collapse of Bitcoin exchange, Mt. Gox – where bitcoins worth over US$470 million were lost or stolen by hackers – the financial and brokerage community is scrutinizing exchanges for security, reliability and the ability to identify and authenticate customers.

Beat them or join them?

Virtual currencies and other new payment systems including PayPal, Dwolla and Google, could exclude banks, dramatically reducing transaction processing fees. The October 2014 launch of Apple Pay may provide a lifeline, as it is linked to credit/debit cards, with banks paying Apple a proportion of their margins. Retail and investment banks are still pondering whether to integrate with Bitcoin or Ripple, or even to start their own virtual currencies to attract a younger generation. By developing its own network, an investment bank can bypass traditional trading channels and cut costs. Virtual currency infrastructures such as Ripple could potentially decentralize clearing and settlements between investment banks, speeding up transactions and reducing costs. Victory in the battle for the digital wallet may not necessarily go the swiftest, but an over-cautious approach could leave banks trailing in the dust of early adopters.  

What is your bank’s role in the virtual currency revolution?

  • Does your bank trade on virtual currency exchanges?
  • If so, have you carried out full due diligence on the exchange?
  • Have you considered starting your own virtual currency?
  • Are you leveraging virtual currency infrastructures to decentralize clearing and settlements? 

To discuss these questions further, please contact the authors:

Ronald Plesco

Principal, Forensic Services

KPMG in the US

+1 717 260 4602

 

David Montes

Managing Director, Banking & Capital Markets

KPMG in the US

+1 40 4 979 2115

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