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The Pros and Cons of Digital Currencies

As recent media and government attention has stoked the debate surrounding the use of digital currencies in business, it has become evident that there are still many unanswered questions and discussions to be had around the risks and opportunities of digital currencies. First and foremost, it is important to understand that digital currencies, or cryptocurrencies, are currencies used as a means of exchange without the backing of a third party, such as digital currency on a gaming site. This distinction is critical when making parallels to the conventional banking system. While the benefits of using digital currencies, namely lower transaction costs and the ability to make payments at any time, may be appealing, the risks around security, payment beneficiary identification and currency volatility (e.g., Bitcoins) have raised concerns in the marketplace among consumers and businesses. Despite the significant unknowns surrounding digital currencies, some large corporates are beginning to open the doors for acceptance. The recent steps taken by large and prominent corporates in key sectors, including online retailing and food and beverage, demonstrate an appetite to continue expanding the use of digital currencies. Depending on the outcome of these early steps, digital currencies may emerge as a legitimate part of the mainstream payments landscape or recede into the background as novelty. Despite the allure of lower transaction costs, corporates should carefully navigate and understand the risks associated with these alternative payment methods. First, corporates should understand that there is currently a limited user base and the regulatory framework and tax treatments of digital currencies are still being determined. Additionally, much of the infrastructure required to support the broader use of digital currencies is, likewise, still being developed. For instance, digital currencies are not accepted by banks and thus companies cannot earn interest on digital currency balances. Also, the value of digital currencies relative to major fiat currencies can be highly volatile and there are few alternatives (i.e., derivatives) available to hedge this risk. Along with others, these areas of uncertainty and risk will limit the acceptance of digital currencies into the payments mainstream. Beyond these well-known barriers to wider adoption of digital currencies as a payments mechanism, a number of other considerations with respect to cash and exposure management require evaluation. These include critical concerns such as security of information, compliance with anti-money laundering regulations and customer identification.

Areas of promise

Despite all of these concerns, utilisation of digital currencies by corporates may hold great promise in several key areas. As it relates to currency exposure management, when corporates conduct business in foreign countries, transactions arise in foreign currencies creating economic and financial statement risk. Corporates must analyse these exposures and determine action steps to manage accordingly. Digital currencies may help companies to reduce and/or eliminate exposure risks by using them as a transport currency (e.g., to settle intercompany transactions), a concept that has yet to be fully tested in practice. Additionally, within the realm of cash management, conventional payments flow through banks who communicate on behalf of payors and payees. Funds flow through clearing systems from one bank to the other and the clearing house acts as a ledger where transactions are stored. The entire end-to-end process provides a level of assurance to the parties involved as to the security of their funds. In comparison, digital currencies bypass both banks and clearing houses as payments are made directly between payors and payees, thus eliminating intermediaries, process steps and infrastructure costs. Nominal transaction processing fees may be incurred; however the net fees are significantly less than the conventional method. Although this change in process may reduce fees and simplify the funds flow, it may come at the cost of increased settlement risk by operating outside of a well-understood, carefully regulated and tested interbank payments system.

Infrastructure required

In addition to potentially greater operational risk, widespread utilisation of digital currencies may also require companies to develop and maintain parallel processes and infrastructure environments to collect, concentrate and disburse funds. For example, cash positions are currently set through various data reporting mechanisms such as bank statement BAI/MT files flowing through a treasury management system. By contrast, standards around information reporting and integrated reporting tools have yet to be developed. From a broader cash management perspective, the challenges of digital currencies are heightened as today, fiat currencies rely on the robust transaction processing infrastructure of large global and regional banks. The management of digital currency ‘cash’ will also add a new layer of currently undefined stakeholders.

Putting pressure on banks

Alternatively, the emergence of digital currencies may have a positive effect on legacy banking infrastructure, products and services as large transaction processing banks may be forced to innovate in the face of the emerging competitive threat to their established infrastructure. Corporates have struggled for many years with bank connectivity challenges and the introduction of new bank communication standards. Digital currencies may help to raise awareness and increase pressure on banks and regulators in order to streamline connectivity. In response to this emerging threat from a disruptive new technology, banks may respond by accelerating the current trend toward increased connectivity in existing payment systems. For instance, initiatives like electronic bank account management (eBAM), which has experienced both advances and set-backs in recent years, may be influenced to further propel change by the introduction of digital currencies. As noted above, while there is much work to be done to build the infrastructure necessary to bring digital currencies into the mainstream landscape, as more interested parties have begun to utilise digital currencies, there has been an increase in the number of service providers and products that cater to digital currencies. With the continuing evolution of the market, corporates should carefully consider the potential of digital currencies and conduct proper due diligence of any proposed solutions to ensure all business requirements are being met and that potential risks are properly identified and managed. Although digital currencies may still be a new concept for many corporates, given the increasing consumer interest in recent years, the progressive infrastructure development and the adoption by certain companies, corporate treasurers should continue to monitor the evolution process and consider both the opportunities and the risks that digital currencies may present for their company’s payment landscape. While significant changes to existing processes and infrastructure may be required in the short-term, if implemented properly, digital currencies may represent the potential for significant gains in the long term.