Furthermore, additional confusion was caused by cryptocurrency bans and tightened regulations all around the world. But everything is not so devastating like many individuals can think, and it may sound surprising that the current legal framework and some financial institutions already allow conducting financial operations via cryptocurrencies. So, what’s the missing puzzle, and why things get traction so slow?
Tight Bonds — Banks, Regulators, Payment Systems
In order to grasp the whole picture, we have to understand how entities starting from regulators and banks, ending with merchants, interact in a financial environment between each other. Working for a several years as an Advisor to the Chairman of the Board both for Alliance Bank and SmartBank, I discovered that there are well-established old financial relationships between all market participants that practically don’t allow disrupting technologies to take place.
There’s an unshakable hierarchy of entities that interact with each other, and banks do not hold the supremacy here. Basically, who really sets all rules for banks are Regulators that have different names in many jurisdictions, and various payment systems such as Visa, MasterCard and others. These entities impose strict regulations on banks and if they find out that a particular bank doesn’t comply with those rules, then it gets significantly penalized. That’s why banks have to manage risks.
Regulator imposes strict rules and issues a banking license that allows banks to run financial operations. What’s really important to know is the price of this license, which often exceeds tens of millions of dollars depending on the jurisdiction, taking an enormous amount of time for the bank to get it. Let’s suppose a bank wasn’t compliant with some Regulator’s rules, and the license was taken away. That means a bank won’t be able to conduct any financial operations for a long time, plus it has to cover huge penalties imposed by Visa/MasterCard. On top of that, it has to pay for the license again and in some circumstances additional penalties. That’s why banks are so careful in choosing business partners.
Payment Service Providers and Merchants
Those business partners are very different, but in the context of this material we’ll be speaking about Payment Service Providers (PSPs) that play a role of the financial goalkeepers both for online and offline businesses, or simply Merchants. Basically, PSPs are intermediaries that provide a payment gateway for businesses, so that they can operate. In simple words, Merchants that run an online business turn to PSPs to have access to a payment gateway that allows them processing credit cards and accepting such payment methods as PayPal and others.
Payment Service Providers care about their reputation in the eyes of a bank because if a bank spots illegal activity, it will immediately shut down all gateways between itself and PSPs. That’s why payment providers are so watchful when they provide financial services to Merchants. Basically, PSPs are responsible for checking Merchants whether or not they comply with their strict rules, and they run checks very often. In the end, if a Merchant does get caught, then access to payment gateway cuts off, and business can’t operate. Moreover, almost all companies have a 1% chargeback redline and 10% holdback amount out of the total business volume.
Furthermore, both PSPs and Merchants don’t get penalized that much, being less responsible in comparison to banks. So, in this scenario, all parties are interested in controlling very strictly each other in all possible ways. Moreover, there are high-risk industries that banks don’t want to serve because very often they present unethical or shady types of activities, that’s no one wants to get involved there because corresponding risks are much higher than actual profits.
High Risk Industries and the Current Situation
At the moment, banks don’t want to deal with such high risk industries as: Gambling, Adult, Cryptocurrencies, Dating, Pharmacy, Gaming and others. In the end, the bank has to fill reports about its activities and source of funds. These industries literally present critical risks for a bank to lose its costly license.
In this case, Merchants simply don’t care, and they hate banks because they don’t allow them to conduct business. But if for a classic business everything is so complex, then it’s even harder for cryptocurrencies. Mainly, this problem had appeared on the rise of cryptocurrencies, when they were used primary by criminals to launder money and conduct unethical activities. On top of that, the volatile nature of cryptocurrencies caused people to lose money and its form of a new monetary instrument made a countless number of debates on a legal level. The whole industry was marked as high-risk because it has so many pitfalls. So now you may ask, where’s the room for cryptocurrencies?
Everything Is Set Up. But There’s No Initiative
The only thing that stops PSPs to process payments related to cryptocurrencies is the lack of knowledge about the source of funds and who owns particular digital money. The answer to this problem is plain simple — Banks and PSPs have to develop and implement a set of very effective KYC/AML procedures for cryptocurrencies financial operations, that will significantly mitigate all associated risks. When Merchants turn to PSPs for cryptocurrency gateway provision, there won’t be any room left for illegal or suspicious transactions. Once such verification procedures are developed, then banks will bear no risks or insignificant portion of them, which can be compared to dealing with a traditional business.
One can definitely say that it’s not possible to realize such innovations from a legal perspective, but considering the existing legal framework, it already suits the needs to conduct such activities in many countries. What’s really important to say, is that currently many PSPs can already start developing such KYC/AML procedures and cooperate with interested banks, taking a dominant position on the market. Needless to say, there are not many of them at the moment, but even existing traditional financial system wasn’t built overnight, and it took years to adopt such considerably simple things for our time as credit cards and other things.
At the moment, Merchants can conduct business accepting cryptocurrencies as a form of payment, and such companies as CoinPayments or BitGo allow that to happen. The widespread adoption that we are talking about will be triggered once a critical mass of Merchants will demand gateways that support both cryptocurrencies and fiat. But for most of the Merchants and even customers, cryptocurrencies are just a buzzword and not a monetary instrument for their daily activities.
Summarizing everything we do have all we need to conduct business via cryptocurrencies, and in the next years, more PSPs and Banks should become tolerant to the new asset class. We’ll slowly make a transition into the new digital market.