Bank of England toughens hawkish pivot to ease inflation pressures4 February 2022
NPL outlook: €200 billion in new bad loans across Southern Europe over next three years9 February 2022
Cryptocurrency: the future is decentralised
2021 was a breakthrough year for the institutional adoption of cryptocurrencies. The sector has matured well beyond its early reputation as a payment method for criminal activity into a US$2 trillion asset class comprised of an eclectic mix of blockchain solutions for real-world problems and industries across finance, payments, digital ownership and scarcity, arts and collectibles, gaming, supply chains, healthcare, public services, and even governments.
The long-term fundamentals driving the adoption of digital assets are compelling, but the sector’s notorious volatility is currently plain to see. Many corporates will require assistance to see through often binary narratives. On the one hand, proponents argue that cryptocurrencies markedly increase capital value over time, as demonstrated by an average of 139% per annum increase in value for Bitcoin (BTC) over ten years, compared to cash.
This week, a large global accountancy firm has completed an allocation of cryptoassets to its corporate treasury, the firm’s first direct investment in cryptoassets. The allocation includes Bitcoin (BTC) and Ethereum (ETH), as well as carbon offsets to maintain a net-zero carbon transaction to deliver on the firm’s stated environmental, social and governance (ESG) commitments.
The value of traditional or ‘fiat’ currencies, it is argued, are in a long-term downtrend, driven by the exponential increase in the money supply through central bank’s quantitative easing policies since the global financial crisis and general inflationary pressures. This argument has strengthened since the onset of the coronavirus pandemic two years ago. Advocates say adding digital assets offer corporates an asymmetric risk-return investment over time, a superior operational strategy for payments, and a natural hedge against the declining purchasing power of fiat currencies in an inflationary environment. On the other hand, critics warn digital assets are highly speculative, with no intrinsic value, and are in a bubble, waiting to burst. Moreover, the inflation-hedge argument is currently being challenged with prices across the sector falling from the all-time highs of the asset class at a time of multi-decade high inflation prints in the US and the UK. Proponents will counter this with the argument that volatility is to be expected and embraced given the scale of the increases in value.
Bitcoin, the original pioneering cryptocurrency, fell to a six-month low on Friday 21 January as tapering programmes and inflation jitters sparked a sell-off in risk assets globally, while ongoing regulatory concerns in certain jurisdictions overshadowed underlying long-term fundamentals. A deeper analysis of the macro-environment for the cryptocurrency sector will be left for a future article. This article aims to provide a broad overview of the evolution and composition of the US$2 trillion asset class for those who know they know too little and more importantly need to know more. This article will be the first in a new series to focus on what corporates need to know about the cryptocurrency sector, even those not yet considering digital assets as part of their own or their clients’ balance sheet strategy.
Bitcoin was invented by Satoshi Nakamoto, a presumed pseudonym, in 2008. Bitcoin is a decentralised digital monetary system. It allows the instantaneous teleport of value anywhere in the world without a trusted intermediary via a peer- to-peer (P2P) network which prevents double-spending. Bitcoin solved this through the invention of the ‘blockchain’ system, which allows the validity of transactions to be securely verified by anonymous third parties. Transactions are sent to the entire Bitcoin network of nodes, called miners, which use computational power to solve mathematical problems to verify if the transaction is valid. Miners are motivated to be honest because they stand to earn Bitcoin once a consensus on validity is achieved.
Bitcoin is classified as digital property and is the world’s first digital asset with no sovereign backing, intrinsic value, and centralised issuer or controller. In this sense, Bitcoin is like email for money. It was initially received with scepticism and took around five years to achieve a network effect. Thirteen years later, the world’s first cryptocurrency has since amassed hundreds of millions of users and, at its peak in November 2021, more than US$1.2 trillion in monetary value, on par with the market capitalisation of silver and 10% of gold’s US$11.5 trillion market capitalisation.
Embedded into the first-ever Bitcoin transaction code was The Times headline: “Chancellor Alistair Darling on brink of second bailout for banks.” It was emblematic of the problems caused by the centralised financial system, for which Bitcoin and blockchain technology was proposed as part of the solution. In its source code, Bitcoin stipulates there will only ever be 21 million coins created. To date, a total of 18.9 million Bitcoins have been “mined”. However, estimates suggest that around 20% of the current Bitcoin supply might be permanently lost. The limited supply has created a digital scarcity and a natural deflationary asset class, which has inspired comparisons of Bitcoin to a “digital gold”. Between 2012 and 2021 the price of Bitcoin increased by more than 540,000%, according to CoinDesk data. Bitcoin’s price fell 52% below its November all-time high, to briefly tap just below US$33,000 on January 24, according to Coinbase, but has since rallied back above US$42,000.
MicroStrategy, the US software firm, owns more Bitcoin than any other company in the world. Michael Saylor, MicroStrategy’s CEO and one of the world’s leading Bitcoin evangelists, says Bitcoin’s strength is “pari passu to a commodity, to land, to gold … the great invention is the creation of common property in cyberspace, it took us 13 years to get that universally acknowledged, so that makes Bitcoin the safe haven for a public investor or public company”. Saylor also refers to Bitcoin as a “pristine asset” and the “ultimate store of value”.
Saylor says crypto curious corporates should educate themselves and not invest until they have developed a firm conviction. “Do your diligence, be very thoughtful about which vendors you work with and take a long-time horizon,” he said in a recent Bloomberg interview. Saylor, along with many leading crypto commentators, predict BTC will reach US$1 million by 2030.
Bitcoin is the world’s first truly global payment system, distributed across hundreds of thousands of computers and servers all over the world. More than 9,000 projects inspired by Bitcoin have developed, creating a vibrant and diversified ecology of cryptocurrencies, with a market cap that peaked above US$3 trillion in November 2021. Investment banks – including Goldman Sachs, JPMorgan, Morgan Stanley, UBS, UniCredit and Santander – offer various combinations of crypto trading, derivatives and custody services to institutions and private wealth clients. Ultimately, the use cases for Bitcoin – beyond a store and transfer of value – are limited, which takes us to the next major milestone in the evolution of the cryptocurrency market.
Ethereum: invention of smart contracts
Six years after the first-ever Bitcoin transaction, in 2015, Ethereum was created, marking the first second-generation cryptocurrency. Ethereum has a programmable language that allows anyone to customise the terms of value transfer, advancing utility beyond a store of value. Ethereum’s innovation was the birth of smart contracts, fully executing and self-enforcing contractual clauses integrated as lines of code and executed over the Ethereum network. Together, blockchain and smart contracts have solved the problems of digital ownership and scarcity.
dApps and deFi
Smart contracts spawned further rich and diverse ecosystems, supporting the creation of decentralised applications (dApps), which are autonomous applications that run automatically on a P2P blockchain network. dApps use smart contracts to programme digital assets in an environment free of control or interference by any single authority, ensuring increased user privacy protections. For example, in finance, dAapps birthed decentralised finance (deFi), which offer ways to save, earn interest, lend, borrow and make private payments – with no centralised entity and no personal data required.
NFTs: solving for digital ownership
In arts and collectables, smart contracts have solved digital ownership problems through non-fungible tokens (NFTs), which are cryptographic assets on a blockchain with unique identification codes and metadata that distinguish them from each other. This allows the full value of a piece of digital art to be preserved, despite the rapid proliferation of high-quality copies. The immutable blockchain-protected unique code embedded into digital art will permanently ensure copies will not trade or exchange at a price equivalent to the original.
Innovations have spiralled from here. An NFT can also signify a network membership, whether a sport, corporate, charity, academic, social or political affiliation. In this way, NFTs can signify community membership that provides creators and community members with new ways to build and monetise shared digital networks. They can serve to identify each other and themselves. Networks that coalesce around defined NFT communities with shared interests present opportunities for members to identify themselves and each other, and to further their shared goals, whether commercial, social, political, academic, or artistic. Corporations may aspire to create value through NFTs and connect with existing NFT networks that offer a new way to market their services and to target customers.
Metaverse and Web 3.0
The metaverse came to life in Steven Spielberg’s 2018 science fiction movie, Ready Player One. It depicts an entirely liveable world where people can interact via digital avatars. This 3D virtual reality environment comes to life through smartphones and virtual augmented reality headsets to create interactive digital spaces. Most prominently, metaverse applications have centred on immersive gaming experiences. But the possibilities stretch far beyond. People worldwide can meet in the metaverse to conduct business meetings, conferences, shop online, property tours and holiday sales. In healthcare, companies are exploring the use of virtual reality experiences to aid mental health therapy (imagine recreating patients’ past experiences to soothe old-age loneliness or help heal trauma). Facebook rebranded as Meta to signal to investors and users the social media giant’s faith that the metaverse will underpin the next generation of the internet.
In a curious sign of the times, former UK deputy prime minister, Nick Clegg, now a senior Meta executive, was recently interviewed in the metaverse by the Financial Times.
The metaverse is tied to the development of Web 3.0, which some call the decentralised internet. Web 3.0 will process information with near human-like intelligence through artificial intelligence (AI) and machine learning (ML). Web 3.0 pioneers predict applications will accurately understand everything conveyed via text, voice or other inputs, providing a vivid and personalised user experience. In addition, Web 3.0 will make the internet accessible to everyone anywhere through the proliferation of new and inexpensive smart devices, providing truly ubiquitous access to all the internet’s resources at the blink of an eye.