4/20/2021: Market Update by Jack Ablin, Chief Investment Officer at Cresset
Blockchain, the distributed ledger that boasts immutable accounting, is gaining trust among its users. Hosted by a decentralized network of computers worldwide, any of the ledger’s millions of users can instantly verify transactions or affirm the authenticity of ownership of digital assets, whether they are cryptocurrency or digital art. Born in the ashes of the financial crisis when public trust in the US financial system sunk to an all-time low, blockchain technology helped usher in bitcoin, an alternative currency designed as a trustworthy store of value beyond the reach of the global central banks. Back in 2008, the idea of uploading one’s wealth onto a global network of anonymous computers was far-fetched. Bitcoin began trading in 2010 at an initial price of about 30 cents. Early buyers were speculators who were fascinated with the prospect and promise of a digital currency. Skeptics worried about the possibilities of a cyber hack, or whether the ledger would simply lose track of their bitcoin holdings. The underpinning of blockchain was that the database contained the payment history of every bitcoin in circulation and confirmed who owns what at any given point in time. Its distributed infrastructure and underlying complexity would thwart hackers.
Besides cryptocurrency, blockchain has a variety of other applications thanks to its ability to serve as a distributed ledger. For example, non-fungible tokens (NFTs) can uniquely identify digital content, like art, music and videos. Last month, an NFT attached to a digital collage created by the artist known as Beeple, sold at Christie’s for $69 million. Using blockchain, NFTs contain all relevant knowledge about a work of art, its origin and its owner, including all its transactions. Besides verifying ownership and authenticity, blockchain technology enables artists to receive predetermined royalty payments on all future sales. That is something unheard of in the physical world and will likely generate interest among content creators.
As trust in blockchain technology increased, the collective market values of cryptocurrencies like Bitcoin, Ethereum and others grew to over $1 trillion. Bitcoin optimism hit a crescendo last week when Coinbase, a cryptocurrency exchange, splashed onto the public market through a direct listing with a valuation of nearly $65 billion. Coinbase makes it easy to transact in bitcoin and other cryptocurrencies, like what brokerage firms do for stocks and bonds. Bitcoin enthusiasts believe that Coinbase is a watershed event for cryptocurrencies, as it is likely to help attract big-name players into the space. Thanks to blockchain, bitcoin’s success is striking fear among global financial institutions and sovereigns. They worry if bitcoin or another cryptocurrency become widely adopted, the entire banking system could become irrelevant. Institutional participation has been a major driver of the soaring bitcoin price in 2021. Ironically, JPMorgan, BNY Mellon and Morgan Stanley have announced plans to get involved – undercutting the original premise of digital currencies that live outside the global banking system.
While financial institutions see a balance of threats and opportunities, governments – who have gotten accustomed to controlling their countries’ currencies – view stateless digital currencies as a challenge to their sovereignty. Because bitcoin transacts outside of the banking system, policymakers worry that the digital currency could be used to circumvent capital controls, encourage money laundering or fund illegal purchases. India, a country that recently remonetized its paper currency to discourage black market transactions, is expected to enact a complete ban on cryptocurrencies. China is taking an even more aggressive approach.
The country that introduced paper currency recently announced that it is testing the digital yuan in several provinces. The move, designed to address bitcoin’s growing popularity, will undo one of bitcoin’s attributes, anonymity. Beijing believes that the digital yuan will cement the world’s second-largest economy as a digital leader across many industries while centralizing control of payments, something that bitcoin threatens to subvert. The move could be an opening salvo in a race toward digital fiat currency.
Policymakers on both sides of the Sino-American gulf fear that cryptocurrency could undermine their government’s power if people shift their payments onto the blockchain. Because digital currency transactions, including those of the digital yuan, occur outside the SWIFT system, a messaging network used to transfer money between commercial banks, US regulators do not have the ability to monitor money movements. Such transactions could facilitate illegal activity and evade US sanctions. For example, China’s support of North Korea would go undetected if it employed digital currency.
The Federal Reserve is researching a digital dollar as the financial services industry braces for disruption; banks and credit card companies are nervously watching digital dollar developments. The Federal Reserve Bank of Boston and the Massachusetts Institute of Technology, its research partner, plan to unveil their findings as early as July. Neither the Boston Fed nor MIT have indicated whether the digital currency would employ blockchain technology. A digital dollar could have profound effects both domestically and abroad as Americans change the way they use money. Commercial banks and credit card companies foresee a threat to their profits if consumers transact outside of their networks. For users, transaction settlement could happen instantaneously, without having to wait for the money or worry about fraud. Currently, banks take days to give consumers access to checks deposited to their accounts to allow time to verify their authenticity. Banks are notorious for charging stiff overdraft fees for returned payments. Additionally, a cyber dollar would give transactional access to millions of Americans without bank accounts who are forced to pay check-cashing fees.
Lawmakers, US Treasury officials and the Fed have not yet approved the rollout of a US virtual currency, which could still be years away. Nor have they decided how it would interact with the existing global payments network. The prospect of a digital dollar eliminating paper currency would have other broad-reaching effects. The digital currency could be more easily tracked, shining a spotlight on illegal payment activity, for example. Without a physical alternative which could be stored under the mattress, the Federal Reserve could impose negative interest rates without endangering a run on the banking system. The proliferation of state-sponsored digital currencies could undermine Bitcoin, Ethereum and others which behave more like a speculative store of value than an alternative currency, due to volatility levels four to five times those of gold and the dollar. We fully expect the US to unveil a digital dollar in the coming years. Thanks to blockchain, the news will not cause bitcoin to evaporate.
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