This document discusses Bitcoin and its potential impact on banking and financial services. It begins by explaining what Bitcoin is - a digital currency and payment system based on blockchain technology. It then discusses why Bitcoin is interesting as it allows for decentralized transfer of value globally at low cost. The key actors in the Bitcoin system are miners, merchants, consumers and businesses. The document closes by discussing the regulatory landscape around Bitcoin and arguing that its underlying technology could provide efficiencies for financial services, while also noting risks around illicit use and consumer protection.

1. BITCOIN AND BANKING
Digital currencies’ risks and benefits for financial services
Seth Hoskins*
Los Angeles West Meeting, May 30, 2014.
*Views are my own, and are not endorsed by the FDIC.

2. WHAT IS BITCOIN?
 Bitcoin is an internet protocol, like the Simple Mail
Transfer Protocol (SMTP)
 Open source
 Easily replicated: …
 Transfer of value instead of information
 “Internet of money”
 Video – Bitcoin, as explained by The Guardian

3.  Bitcoin has three main ingredients:
 Bitcoin protocol: a peer-to-peer network
 Bitcoins (BTC): units/pieces within the protocol
 Blockchain: a public record of bitcoins transacted and
history of ownership
Courtesy, bitcoins.com
WHAT IS BITCOIN?

4.  New technology; difficult to describe in traditional
terms
 IRS says commodity
 FinCEN says currency
 “A stroke of genius—a monetary system governed
by a computer algorithm.”
–David Andolfatto, St. Louis Fed VP
 Decentralized asset ledger; firstly as a payment
network
 Programmable money; store of value; commodity;
“digital gold”
WHAT IS BITCOIN?

6. WHY IS THIS INTERESTING?
 Decentralized transfer of ownership
 no PayPal, Visa, Bank needed
 Push vs pull
 Solved the double spend problem
 Secured by cryptography
 Balances cryptographic encryption
with public transaction history –
results in pseudonymous actors
 Global, fast, low cost
 Traditional payments can be expensive
and take days

7. WHO ARE THE ACTORS?
 “Miners”
 Servers that receive and broadcast transactions
 Check for “honest” transactions (double spending)
 Package transactions into blocks, forming blockchain
 Solve puzzle for BTC reward
 Consensus
Weaknesses
 ASIC mining; centralization
 51% attack
 Blockchain fork

8.  Merchants
 Accept bitcoin for product or service
 Usually avoid FX risk via payment processor
 Bitpay reportedly processing $1M payments per day
 Merchants see initial customer response, then volume
drop-off
WHO ARE THE ACTORS?

9.  Consumers
 Digital wallet
 Cloud wallet; trust 3rd party
 Coinbase – 1M+ wallets
 Circle – New
 Mt. Gox – Failed
 Local wallet
 Blockchain.info – 1M+ wallets
Consumer Protection
 Trusting 3rd party with value
 Insurance? Circle has it.
 Local wallets require adept consumers
WHO ARE THE ACTORS?
Courtesy, bitcoins.com

11. WHO ARE THE ACTORS?
 Businesses: exchanges, “banks,” money transmitters,
payment processors, vaults, more

12. IMPACT ON BANKING, FINANCIAL SERVICES
 Bitcoin’s inherent technology could enable low cost
financial services on a global scale
 Use cases: payments, remittances, escrow,
micropayments, smart property, assurance contracts,
 Digital money only requires an internet connection
 Estimated 5.9B smartphone users within 5 years
Source: Ericksson

13. “For financial services, an industry predicated on trust
in third parties, the long-term implications of Bitcoin's
underlying decentralized technology are staggering.”
-Marc Hochstein, Executive Editor for American Banker
 Disintermediation via the blockchain
 Minimizes trust needed, creating efficiencies through
automation
 Example: Distributed contract with smart property
 Car loan, with collateral controlled via the blockchain
IMPACT ON BANKING, FINANCIAL SERVICES

14.  Risks:
 Money laundering
 Purchase/sale of illicit goods
 Fraud
THE REGULATORY LANDSCAPE

15.  FinCEN guidance – released March 2013
 Clarified MSBs and money transmission in the space
 KYC and AML generally required—“four pillars”
 Subsequent ruling continue to clarify definitions
 Banks are dubious
 May not understand the technology
 Unsure of extent of responsibility
 Some are banking Bitcoin businesses,
none are utilizing the technology
THE REGULATORY LANDSCAPE

16. “Bitcoin does not present a threat to economic activity by
disrupting traditional channels of commerce; rather, it could
serve as a boon.” … “Illicit applications are rampant but not
endemic to Bitcoin; sovereign-issued currencies and other
precious goods are similarly used.”
-Federal Advisory Council to the Federal Reserve
May 2014 meeting minutes
 Criticism should pass “fiat currency test”
 Money laundering
 Illicit goods
“The estimated amount of money laundered globally in one year
is 2 - 5% of global GDP, or $800 billion - $2 trillion in current US
dollars.”
-United Nations Office of Drugs and Crime (UNODC)
THE REGULATORY LANDSCAPE

17. CLOSING THOUGHTS
 Bitcoin technology is an innovation that presents
valuable efficiencies to financial services
 Frictionless, low cost, global, fast, decentralized
 Cannot be un-invented
 The BSA is pre-internet regulation
 New regulation may need to be formed
 Regulation should innovate around this technology
 Ensure consumer protection
 Foster innovation
 National/global cooperation and consistency

18. QUESTIONS, DISCUSSION