Bitcoin promised to increase trust and security in financial transactions by introducing the concept of ‘blockchain’ for payments. While other blockchain systems have emerged since Bitcoin’s introduction, many consider Bitcoin to be the most developed and trustworthy system, as proven by the fact that the infrastructure built around Bitcoin continues to outperform that of its competitors.
Bitcoin now processes a large number of transactions with a high dollar value, attracting the attention of the rest of the world to its payment system potential. But how does it stack up against more established payment methods? Is it more effective than the previous method? This article will examine fundamental distinctions between Bitcoin and traditional banking methods. We will also discuss the shortcomings of each of them.
What is Bitcoin?
Bitcoin, which was created as a payment system, allows for the transfer of value in the same manner as bank transfers or credit card payments do. However, the name ‘Bitcoin’ can be perplexing at times, as it does not always appear to mean the same thing. The phrase naturally describes money, a protocol, and a network, among other things.
These subcomponents are similar to those found in typical electronic payment systems at a high level, although the two systems work in quite different ways. Let’s take a closer look at Bitcoin’s subcomponents before comparing them to existing payment systems.
Characteristics of Money
Money has taken numerous shapes throughout human history. Barter, tangible commodities such as rocks or shells, precious metals, banknotes, paper bills, digital money, and, lastly, decentralized digital currencies such as Bitcoin were all used.
People gradually become aware of the most desired characteristics that money should possess. To be practical and convenient, the currency should be:
- Divisible — can be broken down into smaller bits for specific purposes such as paying a set amount or making micro-payments
- Non-consumable – it is impossible to use for anything other than a value exchange
- Transportable — can be transported around easily
- Long-lasting — does not deteriorate or wear away over time or under particular conditions
- It’s safe – traders cannot copy it
- It’s simple to move
- Scarce — It is impossible to duplicate it indefinitely
- Fungible – each piece is worth the same as its counterpart
- Recognizable — as a means of transaction, it is acknowledged and accepted
A currency is a form of money widely acknowledged and utilized as a unit of account, a means of trade, or a store of value. Traditional fiat currencies, such as the country’s accepted currencies, including the US dollar, euro, and British pound, are government-backed and draw their value from that endorsement. Currency is no longer backed directly by gold or any other commodity or asset.
Bitcoin is utilized as a trade, a store of value, and a unit of account, just like its traditional equivalents. Cryptocurrencies, like fiat currencies, are not backed by any commodity or other asset. However, while fiat currencies are legal tender backed by a government and regulated by a central bank, Bitcoin is a ‘decentralized global currency that is not controlled by any centralized organization and whose quantity grows at a pre-determined rate.
A protocol is a network of rules that governs behavior or communication under certain circumstances. Bitcoin also refers to the transaction protocol or the collection of laws and processes that allow the system to function securely dispersed rather than centralized. Specific procedures have to be followed to verify and record crypto transactions. The Bitcoin protocol employs Distributed Ledger Technology (DLT)––a consensual, distributed database––and cryptography (which protects information) ––while also addressing the ‘double spending’ problem––the risk of digital money being copied and spent multiple times. The Bitcoin protocol is the first to address this problem without relying on a central authority.
The traditional banking system also relies on communication standards and various rules and mechanisms to authorize, clear, and settle transfers. Once again, the critical distinction is that the existing system relies on centralized counterparties, whereas the Bitcoin protocol eliminates the necessity for these intermediaries.
Transactions in the traditional payment system are processed through the banking network. Banks all over the world are connected, either directly or indirectly. When a payment is commenced from a payer’s bank, it passes through a series of checks via a network of intermediaries.
On the other hand, the Bitcoin network is a peer-to-peer network or ecosystem of networked computers that verify and authorize transactions while preserving a blockchain ledger of all previous transactions. This ledger is available to the public, and anybody may download Bitcoin software and view the complete history of all Bitcoin transactions. These machines are referred to as ‘nodes.’
Cryptocurrency is sophisticated digital money obtained through cryptography; many digital currencies are decentralized organizations based on blockchain technology, an appropriated record authorized by a separate organization of computers. And a slew of modern technologies is having a transformational impact on the global financial system, with cryptocurrencies taking the top spot on the list.
Cryptocurrency has many potential advantages, including increased speed and efficiency in processing payments and transfers, particularly across borders, and increased financial inclusion. This piece intends to highlight the differences between the traditional banking system and the Bitcoin transaction mechanism.
Also, why are people becoming more interested in Bitcoin methods these days, and what differences do they see when choosing a Bitcoin method over a standard or traditional cash technique? And how Cryptocurrency attracts the world’s attention and why so many people are interested in following the crypto trend.
Cryptocurrency Risks: What You Need to Know
Bitcoin was created on the premise of removing the need for third-party payment systems, banks, and brokerage firms to be trusted. The need for a direct connection between the two parties has emerged due to Bitcoin’s underlying technology, and financial intermediaries’ function is now to offer trust.
Crypto trading platforms are one of the simplest ways to get Bitcoins. Almost every platform now follows KYC (Know Your Customer) and AML (Anti-Money Laundering) guidelines. Users must declare they identify information when enrolling for crypto trading platforms per these standards. Some sites allow users to make Bitcoin transactions as long as they do not go over a particular amount of money and divulge their personal information to other users.
Since the inception of cryptocurrencies, one of the most questioned and debated topics has been the security of Bitcoin when used with blockchain technology. Bitcoin got a lot of criticism for financing illegal needs, money laundering, and criminal payments due to its semi-anonymity in its early existence. It constantly made news with hacking events fear at the time. Today, however, we can say that it appeals to a broad audience and can be used as an investment instrument.
The security of the Bitcoin network is very high. Due to its distributed and cryptography infrastructure, blockchain technology allows transactions to be carried out in a highly secure environment. There has never been a direct hack or theft on the Bitcoin network. Ponzi Schema refers to infrastructure issues with low-security platforms and traps; security flaws established by humans or intermediaries through fishing and other tactics can result in such incidents.
Bitcoin is favored for cybercrime rather than money laundering, according to the UK Treasury. According to the United Kingdom’s monetary policies report, Statements about cryptocurrencies, particularly Bitcoin, were made under the Treasury Secretariat. Bitcoin utilization in the criminal world was investigated using a quote from a National Crime Agency report. Bitcoin does not provide a swift process for money laundering, according to the analysis.
Understanding the Risks of Regulated banking system
Official FinCen papers revealed that five big banks were laundering money: Deutsche Bank, JP Morgan, Bank of New York Mellon, HSBC, and Standard Chartered Bank. The official Financial Crimes Enforcement Network (FinCEN) papers were leaked, revealing that the banks had laundered more than two trillion dollars. Financial institutions are wary about enforcing anti-money laundering legislation. Dirty money, on the other hand, continues to flow freely in well-known international banks.
Financial institutions should handle transactional risk in real-time without compromising the user experience or transaction process to protect their clients. A combination of broad insights and particular approaches is needed, including machine learning, artificial intelligence, real-time transactional data analysis, and more collaboration across the industry to discover suspected illegal conduct.
Financial crimes and other unlawful actions with which it is frequently related, such as human trafficking and terrorist financing, can be prevented by investing in technology and following the proper processes.
Regulatory compliance is vital in preventing financial crime, but it is not a magic wand, especially in a fast-paced economy. Financial institutions should consider the risks they face and take the appropriate steps to mitigate those risks and safeguard their consumers.
The reaction of banks to Cryptocurrency
When it comes to bank reactions around the world, there has been a bit of a split. Some countries are adamantly opposed, while others believe it will open up a plethora of opportunities.
Both China and Vietnam have outright prohibited the use of Cryptocurrency. According to a recent declaration by the country’s central bank, Bitcoin and other virtual currencies are not accepted as legal tender in Vietnam. The statement suggested that utilizing Cryptocurrency could result in fines ranging from VND 150 million to VND 200 million.
However, Tony Richards, the Reserve Bank of Australia’s Head of Payments, believes that this strategy is unnecessary in Australia. “Digital currencies do not pose to raise any serious regulatory difficulties,” Tony argues, citing the bank’s payments policy mandate. Instead of regulating cryptocurrencies, he thinks regulating the sector that supports them would be more beneficial. He also suggests that cryptocurrencies and blockchain could present banks with chances.
The Bank of England has stated that if a central bank were to issue a digital currency, it would have numerous implications for monetary policy and financial stability. Despite this, the bank has stated that it is investigating the feasibility of a central bank-issued currency.
A cash transaction effectively addresses the issue of trust. You have the money from the sale if a customer hands you a banknote. There is no intermediary. However, there are still issues. A customer might, for example, give you a forged banknote.
Card payment must be processed by a card network like VISA or Mastercard and a banking network for authorization, clearing, and settlement. Trust is built by relying on well-known financial institutions to do many checks while the transaction is in progress.
The objective of the authorization step is to confirm a customer’s identification as the owner of the funds they are attempting to use and the funds’ availability.
When you insert your card into a terminal and type your pin code during a transaction, the payment information and your card information are transferred to the merchant’s bank, subsequently sending the information to the card network. In turn, the network will request authorization from your bank. If the information is correct and you have sufficient cash, your bank will authorize the merchant through the same intermediaries.
This whole process happens almost instantly, and you can leave the store with your purchases. However, the procedure goes on in the background. The monies are still in your account even though authorization has been granted.
The clearing procedure entails exchanging transaction-related data to confirm the amount of money debited from the customer’s bank and credited to the seller’s bank. After each day, the merchant sends all permitted transactions to the merchant’s bank and the information to the card network.
The card network verifies the data, transmits purchase information to customers’ banks, and then sends reconciliation data to the merchant and consumers’ banks.
The partner banks will settle the payment. The actual transfer of monies takes place every day on an aggregated net basis during settlement. The card network calculates the net settlement position that the customer’s bank must pay to the merchant’s bank and sends it to both banks and a new actor known as the settlement bank. The settlement bank pays the merchant’s bank, and the settlement bank pays the customer’s bank.
The customer is debited, and the merchant is credited. The complete procedure (from authorization to settlement) usually takes 24 to 48 hours. It is a time-consuming, information-intensive procedure that involves many counterparties who must develop and transmit data in a specific order. However, because this system is well-established and trustworthy, people have placed great trust in it. Indeed, countries like Sweden are seeking to create cashless societies.
The card network plays a crucial role in this paradigm. Because there are so many players engaged, each with its information system, communication can be challenging. The automated system must collect all transactions, and the network must operate a gateway. It facilitates monetary settlement between and among its client banks, develops rules and methods for network participation, creates formatting standards for information traveling over the network, and transfers data between customers’ banks and merchants’ banks.
In other words, it establishes the standards and infrastructure for the parties involved to share information.
The process of transmitting Bitcoins across the Bitcoin network takes a very different route.
First, use your digital wallet interface to enter the recipient’s Bitcoin address (which is comparable to a bank account number in a bank transfer) and the value of Bitcoins to send. In a card transaction, this stage is analogous to the merchant payment terminal preparing the payment information.
When making Bitcoin purchases in-store, retailers will typically scan your items and create a QR code that you can check with your phone’s digital wallet, which will immediately fill in the amount to pay and the merchant’s address. The wallet then communicates this information to the network, digitally signing the transaction with your “private key.” The objective of the digital signature is to establish the lender’s ownership of the funds, similar to when a customer enters their pin code or signs the receipt in a card transaction.
A few nodes will receive the transaction before passing the details to other nodes, and your transaction will be spread across the entire network in a matter of seconds. All nodes may independently validate the transaction, ensuring that you have the Bitcoins you want to send and that you have not sent them before. The authorization stage in card payments is identical to the processes outlined above in Bitcoin transactions.
The miners will then compile a batch of transactions and attempt to solve a computationally demanding issue. The first person to solve the problem informs the network that it has been solved.
All other nodes can readily verify whether or not this miner is speaking the truth, and if so, this new batch––a block––is added to the blockchain. This phase is comparable to the settlement phase in the card transaction example because it is during this phase that the money changes hands. Other nodes’ verification ensures that the blockchain cannot be tampered with. Modifying the chain would need a significant amount of computer power, making it impossible to do so.
Changing the block containing your transaction gets significantly more difficult as more blocks are added after it. The merchant wallet will see the payment as confirmed once the block containing the transaction is added to the blockchain and registered in the distributed ledger, and the merchant will be the new owner of those Bitcoins.
The length of time required to complete the process varies based on a variety of factors. However, mining a block takes an average of 10 minutes. So, even if you wish to wait for five more blocks (six confirmations––the community standard) for the transaction to be genuinely effective, you may anticipate it to happen in about an hour.
What distinguishes the Bitcoin system from the traditional banking system?
There is one major factor at the heart of every transaction system: trust. You need to know that you will receive the money if you agree to sell a thing in exchange for funds. Is the customer in a position to pay? Is it possible for him to cancel the payment once it has been initiated? Let’s compare cash and credit card transactions to Bitcoin transactions.
Ethereum and Litecoin are two additional coins that provide anonymity.
Traditional fiat currencies include the Euro, Pounds, and US Dollar. A single entity controls traditional currencies. It implies that the system is overseen by a central authority figure, like a bank or a government entity.
On the other hand, Bitcoin is a decentralized cryptocurrency with a peer-to-peer network. No central authority or banks operate as regulators when it comes to Bitcoin transactions. It is crucial to note that traditional currencies are subject to stringent bank and government regulations.
Transaction costs and flexibility
Traditional monetary and banking systems are usually only operational during specific hours and on particular days of the week. Transactions are restricted, and you must rely on a bank to complete transactions.
An international transaction can take weeks to complete, and there is a significant chance you will be charged a hefty transaction fee as well.
Making a national transaction in a typical banking system will take 2-3 working days and substantial transaction costs. The transaction charge for foreign transactions will be much more significant, and the transaction will take 15 days to complete. There is no transaction charge for conducting a national trade with a cryptocurrency system like Bitcoins. As a Bitcoin system operates 24 hours a day, the transaction will also occur in seconds or within 24 hours. A minor transaction fee will be charged when making an international transaction.
On the other hand, it is possible to complete Bitcoin transactions 24/7. You will not need to depend on a bank to conduct cryptocurrency transactions. Some Bitcoin exchange sites may provide a lower transaction fee, but you will not be charged any transaction fees at all in most situations. Because of the low prices and rapid transactions, many people are interested in investing in Bitcoin. Bitcoin has also been dubbed the “future of money” due to these factors.
There is a possibility that cryptocurrencies and the banking system may merge in the future, imposing laws and restrictions. However, when such a merger occurs, the process will drive the existing banking sector to adopt blockchain technology. Despite the regular swings in the Bitcoin system, many people want to invest in Bitcoins because of the speed and low transaction costs. Citizens may exchange Bitcoins for any currency, which saves both time and money. Many developing countries are preparing to implement blockchain technology in their businesses.
If you want to use traditional fiat currencies, you may be asked to provide personal information such as your full name, residence, phone number, and other sensitive information. This makes it simple for hackers and scammers to access your bank accounts using that information. Double spending is another issue that fiat currencies and the modern financial system can face. This occurs when a user makes many transactions with the same amount of money. This is due to the inefficient and slow financial system.
Every transaction in the Bitcoin network, on the other hand, is recorded as a block in the blockchain network, which is a vast public ledger. The data that will be made public will not be at all personal. Perhaps the trades are a little too loosely controlled. Bitcoin has also been used for illicit purposes. Any government authority does not supervise the transactions that are added to the blockchain. It is a network that is fully decentralized.
On the other hand, Bitcoin is far more secure. The transactions have been made public, which implies that they are transparent. The parties engaged in each trade can keep their identities hidden. You will be able to keep all of your Bitcoin funds in a digital wallet, and no trader will be able to access it without the private access key or password.
The high volatile nature of Bitcoin and other cryptocurrencies is well-known. Investors and traders are constantly looking for ways to profit from the crypto market’s volatility by buying the instrument when the price is low and selling later when the price rises. This is comparable to the Foreign Exchange market, where traders profit by exchanging different fiat currencies.
However, the crypto market has attracted a large number of investors and dealers. They believe there are more opportunities here. With the help of automated trading robots, even those with minimal expertise and knowledge of the crypto market may trade profitably. If you want to start a Bitcoin trading journey, there are a few things you should know.
As we have seen, traditional fiat currencies have many issues that Bitcoin can help us solve. Bitcoin is a lot easier to use as a payment mechanism over the internet. The flexibility of Bitcoin and its growth potential have attracted a large number of investors and traders. Bitcoin could become the worldwide currency of our globe soon if it continues to expand.
What are the benefits of Bitcoin over the traditional banking system
While some of the Bitcoin system’s potential benefits, such as anonymity, transparency, and independence from governments and central banks, appear ideological, Bitcoin offers practical efficiency and trust benefits.
The ability of cryptography to run and operate without a single point of failure that hackers may exploit would be the primary benefit. Another advantage is that most cryptos are built on a peer-to-peer settlement system and are fully operational every time, including holidays and weekends.
Businesses and individuals that operate in locations where government bodies control banks and financial institutions would benefit significantly from the financial freedom and independence that cryptocurrencies provide.
We may also suggest that utilizing and trading crypto increases customers’ financial understanding because they access and control their assets. Once the private key is gone, no one will refund any transactions or retrieve user accounts.
Intermediaries are reduced
When sending Bitcoins to another party, only your wallet and the Bitcoin network are required as intermediaries for the money to be effectively transferred. Because nodes and miners are only minor components of the network, adding or removing them has little effect on how it works. On the other hand, the card payment system necessitates a minimum of four intermediaries, and often more in practice.
As a distributed system, the Bitcoin protocol allows all system components to access and verify all pending and past transactions simultaneously, resulting in time efficiency. And no mistakes may happen along the way; as long as you input the correct address when initiating the transaction, the cash will arrive at its intended location. Not only does the traditional payment system include additional intermediaries, but it also multiplies the number of back-and-forth communication exchanges that must occur in order. It takes time, and mistakes might happen along the road.
Single Point of Failure and Distributed Trust
However, Bitcoin’s main advantage is how it handles transaction trust and removes single points of failure. With the old system, you must trust that the rules and mechanisms will not cause problems and that each counterparty will perform as expected. If one counterparty in the chain is compromised in some way, the entire chain is affected.
The collection of rules and systems that underpin Bitcoin make fraud, manipulation, and mistakes impossible. Anyone in the world can access and review Bitcoin software because it is open source. No security fault has ever been discovered in Bitcoin’s ten-year history. No one has yet found a means to alter a signed transaction or the blockchain.
Furthermore, because there is no single point of failure, the beauty of a distributed system is that you do not have to trust any of its components. No one would not jeopardize the network if one or a few nodes were compromised. To change ongoing transactions or the blockchain of previous transactions fraudulently, one would need to control the majority of the network’s CPU power. Your digital wallet, which contains your private keys, is ultimately where the risk rests.
Users with access to your private keys can spend the funds in your wallet. This is why offline wallets, sometimes known as “cold storage,” are routinely used to protect against hacking. However, your transaction is secure from the time it is signed. There are no single points of failure, and you do not have to put your faith in anyone.
What are the advantages of decentralized technology for the banking system?
Given the unique characteristics of decentralized systems, it is only natural that the banking industry will be at the forefront of decentralized technology adoption.
The government and the big players created banking institutions to bring people together and make all trade and business easier. On the other hand, a blockchain is a tool that can perform the same thing on a global scale. In addition, it is secure and transparent.
Blockchain has enough potential to revolutionize the way people do business all across the world. It can improve trade efficiency by automating and streamlining manual and paper-based operations. A public blockchain can be an excellent cooperation tool because it is decentralized and uncontrollable by a single person.
Decentralized and Centralized Transactions
Banking is one of the most sensitive and vulnerable sectors of the financial sector when it comes to cyber-attacks. Because of the enormous quantities of money housed in its databases, several banks worldwide have reported severe cyber threats in recent years, including direct attacks on centralized systems that resulted in billions of dollars in damages.
As a result, governments have issued strict instructions, and major institutions have begun to look into ways to leverage advanced decentralized asset solutions such as blockchain. The real benefit of Bitcoin transactions is that they do not have a single point of failure.
Most cryptocurrencies use a peer-to-peer settlement method and are available 24 hours a day, seven days a week, including holidays and weekends. When compared to banks, the prices are lower, there is no need for an intermediary, the service is available and operating 24 hours a day, seven days a week, and the supply is fixed. Cryptography also better aligns with ideological ideals.
Decentralized transactions have disadvantages over centralized transactions
Payments are not reversible, which is the fundamental disadvantage of Bitcoin transactions over bank transactions. And while there is no way to retrieve a wallet that has been misplaced, any bank account can be recovered using specific procedures and recommendations. Another significant disadvantage is that Bitcoin values do not remain consistent in the global market; they fluctuate every second. Not all websites accept these digital currencies; only a few do. There are not many suitable investors either.
Crypto Regulations: Empowering or Restricting?
As previously stated, cryptocurrencies exist outside the banking system, and their restrictions have led to many users viewing them as a more convenient means of conducting transactions. People prefer crypto transactions over regular bank transfers for a variety of reasons. The costs are minimal, there is no need for a middleman, the service is available and running 24/7, the supply is set, and crypto matches better with ideological aims.
Regulators, on the other hand, appear to be catching up with the Cryptoverse’s rapid development. The forthcoming know-your-customer (KYC) compliance standards of the intergovernmental Financial Action Task Force of the European Union offer a vision of an all global system for crypto transactions in which no single user is unaccounted for.
Some see the lifting of restrictions as an abhorrent monitoring system against the censorship-resistant ideals that Bitcoin was founded on. Despite the hostility surrounding the topic, many see this as a chance to close the gap between traditional banking and Cryptocurrency to change the financial system.
The length of time will tell if these new laws will help Bitcoin acquire public approval or help banks reclaim their dominance.
Is it possible to combine banking and Cryptocurrency?
Even if the future does not promise the integration of banking and cryptosystems, it is clear that while cryptocurrencies must adapt to new rules and regulations, banks must learn to play the new game. Banks must abandon some of the institution’s more traditional operational procedures, taking a more fluid role. Perhaps incorporating blockchain technology into their current operations would assist banks in keeping up with and modernizing their operating models.
Emerging Markets Fintech
The way mobile phones have transposed consumer behavior exponentially and how people access the internet is also why, in the chart above, they distinguish between developed and developing countries, with the latter receiving Fintech 3.5.
China (69%) and India (49%) are the countries with the most Fintech usage nowadays (52%). China, India, and other emerging nations never had the opportunity to create Western-style physical banking infrastructure, making them more receptive to new ideas. In the case of China, fintech adoption is far higher than the worldwide average (33%) and the average adoption among emerging nations (46%).
Both the decentralized bitcoin system and the traditional trading system have their advantages and shortcomings. However, decentralized financial systems give traders more benefits as they are not restricted by anybody and perform unlimited transactions at any time of the day.