“I think whatever Jamie (Dimon) does or doesn’t do will be as relevant as what the postmaster general did or didn’t do about e-mail.” — Wences Casares in Nathaniel Popper’s book Digital Gold
“We are having some pretty good weather. What do you think about bitcoin?”
“The markets have done well this year but what about bitcoin?”
“How about those Eagles! Did you see bitcoin yesterday?”
“My back hurts, but I am excited about bitcoin!”
I have heard and been part of conversations like this for the last few weeks. In fact, almost everywhere I go bitcoin comes up. The fever is in full force. The bubble is building. Only the Tulip Mania seems to indicate bigger historic inflation of value. Cryptocurrencies have a market cap north of $175 billion today — more than the market capitalisation of IBM.
But putting the conversation on the value of bitcoin aside, in general what is blockchain and bitcoin and what are some implications?
What is happening?
In my opinion, the real story is not about bitcoin itself but the technology it is built on — blockchain. Basically, blockchain is like a set of accounting books that has no central authority that maintains it. It is, in fact, a software service that offers decentralised applications and these are enabled by crypto assets (think Bitcoin) that incentivises some entities (miners) on the internet to contribute the necessary resources of processing, storage and computing.
What is the real benefit?
A main benefit of blockchain technology is its decentralised function. This is very useful to people who require some form of censorship resistance which tend to be people that are either off the grid or who want to be off the grid. Thus, a big legitimate question would be why one would need to do this. This, of course, is a huge concern for regulators and governments. There are many cases where efficiencies can be gained and costs reduced by eliminating costly middlemen but in a lot of areas we are not there … yet.
For some industries such as stock-lending, securities clearing and maybe reinsurance contracts, a lot could be done to standardise processes and speed up the entire verification process. If common adoption and agreement gains traction, these benefits will be very tangible and intermediaries along the supply chain would become less valuable or irrelevant.
Ask yourself if the current system is slow, expensive, over complicated or fragmented? If so, there is a greater chance that crypto assets and blockchain technology could offer disruption and benefit.
Peter Berezin of BCA Research summarises the potential macro implications well for the first two below:
1. Inflation: Generally, inflation develops as demand outstrips supply. With the parabolic move in the value of cryptocurrencies, a vast trove of wealth has essentially suddenly appeared. What happens with this wealth can affect the general level of inflation through two channels. Mr Berezin suggests that “the proliferation of virtual currencies could boost the demand for goods and services, either through the wealth effect channel (people who acquired bitcoin in its early days feel richer today), or via the currency substitution channel (if people start transacting in bitcoin, they may try to dispose of their excess dollars, euros, yen, and yuan either by spending them or depositing them in banks, leading to higher loan growth)”.
Although possible it is unlikely, in my opinion, that inflation will evolve from this as the bitcoin is not widely used for actual commercial procurement so the demand transmission effect would be muted. Furthermore, I don’t think people trust bitcoin to the degree that they do other fiat currencies given its enormous volatility.
2. Gold: Mr Berezin suggests the implications for gold would be mixed depending on the feelings of investors. On one hand any inflation that may develop as a result of the surge in cryptocurrencies would likely offer a bid for gold. On the other hand, if investors see bitcoin as a store of value, they may substitute gold with these assets and in turn negatively affect demand for precious metals. There may indeed be some substitution from gold to digital currencies as both seem to appeal to groups who eschew centralised and authoritarian oversight.
3. Disruption: Imagine a world where there are friction-free transactions over the internet. Where middlemen and intermediaries are removed. With blockchain, theoretically, there would be no need for a whole host of intermediaries such as banks, brokers or payment networks. The sheer scope and scale for potential disruption is a bit mind-boggling especially when one considers the size of the industries involved.
To be fair, some point out that the services being developed are worse than the centralised ones we have now and that they are, in effect, not nearly as efficient. Current centralised systems, in many cases, offer almost unassailable speed, cost scale and experience. It is likely true then that because of huge scale and entrenchment, any disruption will be slow to materialise.
This does not, however, suggest that there won’t be any, especially in many inefficient and costly systems we currently have. The key to investing in the winners and losers involved will come down to one’s ability to assess true disruptive potential in specific applications that are a source of end-user frustration or unneeded complexity and cost.
A recent survey by Barbican Insurance Group on the future of London’s insurance and reinsurance industry “found 76 per cent of those responding said that market-changing disruption in the London Market was either ‘very likely’ or ‘inevitable’ over the coming decade. Sixty per cent said that the market is likely to be either ‘greatly’ or ‘very’ disrupted by external companies such as Amazon, Google and Tesla over the same ten-year period”.
In fact, 39 per cent of respondents suggest that blockchain securing is the most exciting innovation. Clearly, blockchain technologies are on the radar for Bermuda’s most important industry. With that, of course, is the threat and/or opportunity of serious disruption.
Recent moves to secure our place in the area of fintech are not only a positive move but, in fact, a critical one. If you are not part of the solution, you are the problem.
Reinsurance and insurance companies that don’t have any fintech strategy or have not even considered this area are, in fact, at risk and ultimately may become marginalised and irrelevant in some areas if substantial progress is made.
Bermuda has no choice but to get in the game and try to become a significant player. Winning may be costly in terms of the dislocation technology brings — think job automation and marginal employment reduction to the traditional sector — but failure to engage could be catastrophic.
With some success in attracting legitimate crypto assets and the associated service industry it is likely to need, we may finally diversify somewhat into a new world industry that offers a more diverse set of jobs and employment opportunity for Bermuda.
I would suggest, however, in a world where the winner takes all we have stiff competition coming from Silicon Valley and leading platforms at Overstock.com which are formidable indeed.
We are also entering the game a bit late — let’s see what happens over the next year as a flood of initial coin offerings hit the market with some outrageous proofs of concept.
I recall seeing this before around the start of the century … I am getting déjà vu.
Popper, Nathaniel. Digital Gold: Bitcoin and the Inside Story of the Misfits and Millionaires Trying to Reinvent Money (p. 306). HarperCollins. Kindle Edition.
Global Investment Strategy — Special Report, September 15, 2017, BCA Research Inc, by Peter Berezin, chief global strategist ( https://www.bcaresearch.com/ )
Reinsurance News website: “76% expect London re/insurance market to be disrupted in coming decade” ( https://www.reinsurancene.ws/76-expect-london-reinsurance-market-disrupted-coming-decade/ )
Nathan Kowalski CPA, CA, CFA, CIM is the Chief Financial Officer of Anchor Investment Management Ltd. and the views expressed are his own.
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