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Digital ledgers vs Dinosaurs: How the blockchain could destroy high street banks

dino wars

FT columnist David Stevenson writes for Glint on why cryptocurrency will endure because of its digital ledger technology and how it might be about to condemn high street banks to the history books

I have an admission to make – a few months ago I decided (possibly foolishly) to buy a few tracker shares in ethereum. By way of background, a few weeks ago my office kicked off its annual stocks competition. The idea is to select a long and short combination of underlying shares or tradeable assets. My short choice was a UK small cap in the collectables space while my long choice was a racy UK oil stock. But something much more interesting struck me about many of my peers’ choices: There seemed to be an overwhelming consensus on shorting bitcoin and, as a contrarian, this uniform cynicism obviously piqued my interest.

I wasn’t alone in my contrarianism though. The most technologically aware person in the office was aggressively long ethereum. Pete – the tech supremo – gave lots of convincing explanations about why ethereum was the better digital currency. The technical language sometimes blends into the background but the long and short (!) of it was essentially that because ethereum is connected to the blockchain, and because it is NOT bitcoin, it could easily emerge as the default cryptocurrency. The biggest digital currency of all, of course, is still bitcoin with a rough market capitalisation of US$185 billion, followed by ethereum with US$84 billion and then ripple with US$35 billion. These three cryptos account for more than two-thirds of the entire cryptocurrency universe by value. A year ago, the top three made up an ever larger 94% share of that universe.

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At this point, the vast majority of people my age – being honest, the dividing line seems to be around 45 years old – roll their eyes and, in a perfectly rational manner, argue that a currency is usually boring and backed up by meaningful institutions such as central banks. By contrast, cryptocurrency’s shocking price volatility is the exact opposite of what most sensible people want out of currency. But ethereum – which I would argue is like that other notional currency: gold – isn’t really the same as a dollar or a pound in my pocket, i.e. a predominantly trade based exchange currency. It is a notional currency but in reality, it’s a store of value and expectations, nothing less, nothing more. Like gold, it can be used as a trading currency but that’s very far from being its primary purpose.

This isn’t a message many want to hear. In fact, over the last six months, we’ve seen a concerted attack on all cryptocurrencies by every rational economic actor, and a few irrational ones. Not unsurprisingly, prices have crashed but not quite back to the levels widely predicted, which was next to zero according to the legion of uber-bears. This (relative) price resilience in the face of an almighty (rational) onslaught is, I think, fascinating. It shows the huge weight of money that is still flooding into digital currencies overall. Innovations in structure and the rise of futures markets around cryptos which allow people to long and short it, are, of course, the primary factors that have geared up the levels of investment but, while that innovation has facilitated greater demand, it is itself the result of demand.

Demand command

I’d cite one recent survey as (limited) evidence. It comes from respected media relations firm Citigate Dewe Rogerson and is entitled Investor Perception: Crypto-Currencies. The survey’s authors talked to a wide range of financial professionals and found that 56% intend to buy more digital currencies over the next 12 months, compared to 31% who plan to retain or reduce their exposure. Despite the recent volatility in the market, just 8% intend to sell all their cryptocurrency holdings.

Are cryptocurrencies a poisoned chalice?

Are cryptocurrencies a trap?

Some findings from this report stand out for me. The first is that we all collectively expect a veritable tidal wave of regulation for cryptos – the report reckons that 62% of financial professionals interviewed expect a dramatic increase in the level of regulation around cryptocurrencies over the next 24 months.  This sounds convincing to me; regulators have clearly been caught off guard by digital currencies and feel that they ‘need to be seen’ controlling this wild west frontier. Whether those new regulations will achieve their desired purpose is anyone’s guess but regulations do often help ‘normalise’ alternative asset classes.

The last set of numbers within the survey point to what I think is the most obvious weak point for all cryptocurrencies – that they all provide a dreadful customer experience. I thought it was noticeable that only 22% of the Citigate survey panel thought there would be a dramatic increase in the use of digital currencies as payment or money transfer methods over the next five years.  My guess is that the other 78% of that sample have realised what any visitor from Mars would have known from day one about bitcoin: it’s a complete bugger to use.

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One useful statistic on bitcoin’s lack of ‘user friendliness’ – in 2016 only five of the Top 500 US retailers accepted bitcoin and last year this dropped to just three. It’s also worth noting that bitcoin’s operating costs are insanely high. Remember that it costs roughly 2 cents to process each cash transaction, 12 cents per credit card and 26 cents per online transaction, whereas it costs US$2.80 for a blockchain settlement. This transaction in turn takes at least 10 minutes to verify compared to major credit card outfits which settle upwards of 65,000 per second (using only around ½% of the energy required by blockchain).

So, RIP cryptos? Not quite. I have a hunch that cryptos will also be outlived by their blockchains – or, more precisely, their distributed ledger systems.

Blockchained melody

These systems might even end up destroying the current monetary system as we know it. Or that at least is the conclusion of a fascinating recent analysis by Michael Howell of Cross Border Capital, entitled Lonely Bytes – Cryptocurrencies & The Future of Money: A New Technology Solution Desperately Seeking A Problem? This London-based investment research house reckons that distributed-ledger technology (DLT) offers huge attractions to the existing central banks in helping them digitise their existing monies.

In short, blockchains and DLTs will up end the traditional banking model via emoney and put central banks back in control of ordinary transactions and credit creation. Here’s the most incendiary part of the analysis by Cross-Border – it is worth quoting at length because of its revolutionary idea.

“This single digital ledger, in economists’ jargon, describes a narrow banking model, much like Peel’s 1844 Banking Act in the UK that legally split the Bank of England Issue Department from the Banking Department in order to more clearly identify the gold backing for the note issue. With a recognised central authority policing settlement, the plodding and costly blockchain verifications can be easily swapped for instantaneous and cheaper digital settlements. These e-dollars and e-pounds simply become the digital equivalent of paper notes, but available via, say, smartphones. (Note that alongside this emoney, notes and coins may still physically exist.) The net balances of e-money will attract zero or low-interest rates from the Central Bank.”

The real victims of DLT will be high street banks. According to Cross Border “the dinosaurs out there are what we term ‘bank money’ and the traditional high street banks. They face extinction. Traditionally, these banks developed as ‘safe’ places to physically deposit cash, with safety determined, first, by the quality of the assets that ‘secured’ their deposits and second, by their unique access to Central Bank funding in extremis.”

Do high street banks risk becoming financial fossils?

Do high street banks risk becoming financial fossils?

Since central governments are already effectively underwriting high street banks’ credit creation processes, and emoney is spreading like wildfire, why bother with high street banks for the payment function, especially when they charge so much for so little? Why not use central banks, emoney and DLTs to manage the whole financial ecosystem?

The bottom line? Money market funds will compete for deposits, and, in turn, fund specialist lenders (e.g. car finance, mortgages, student loans) while dinosaur high street banks edge to extinction as wholesale money markets and specialist lenders replace them.

This is, I think, a revolutionary set of conclusions. But as Cross Border observes, this new world puts credit risk even closer to becoming central systemic risk. Can we really trust the promises made by central banks for our money held via DLTs and blockchains? How will central banks work to create credit within this new distributed system and how will this inform day to day decision-making on who they lend to?

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David Stevenson writes the Adventurous Investor column for the Financial Times, for whom he has also written several books. He has previously worked for the BBC, ITV and Channel 4 and has advised a number of firms on investment and communications, including HSBC and EY