Bank 4.0 Read online

  Those involved in cryptocurrencies like Bitcoin and distribute ledger technology will often tell you that it’s going to change the world. Not because they are all “true believers”, but because they’ve seen the possibilities of a world that isn’t constrained by regulation built for 19th century banks on top of legacy systems built decades before the internet existed.

  As discussed in earlier chapters, the first layer of changes we saw in banking were channel-led. We first talked about internet channels, then mobile channels, then omni-channel banking. As users started to get frustrated with bank speak and bank interfaces we started to talk about usability, the premise that we could design better user experiences, make screens easier to read and apps easier to use. This led us to understand that emerging technologies might change access to banking in fundamental ways. Suddenly the fastest growing financial institutions in the world were based on technology interfaces and experience design. The rules around financial inclusion were being completely revolutionized by simple value stores accessible through a basic mobile phone. Next, just as the FinTech world seemed to be stabilizing around best-practice user experiences, a second stage of innovation kicked-off—FinTech and technology startups focused on rebuilding the core infrastructure and back-end upon which banking operates. Upgrading the pipes and rails. Finally, we started to realize we might remove traditional interfaces all together.

  In July of 2017, the then largest ICO to date raised an incredible $232 million in funding for Tezos3. Tezos used both BTC (Bitcoin) and ETH (Ether) for its raise. Tezos, reportedly, wasn’t aiming to raise $232 million in funding, it was aiming for $30–50 million, but they took in 65,693 XBT/BTC and 361,122 ETH in just days. As I write this chapter, Bitcoin has been on one of the biggest rollercoaster rides we’ve seen, rising to top out at US$20,000 before Christmas 2017, then hitting a low of around $6,000 at the end of January 2018. At those prices the value BTC contributed to Tezos is still well over $400 million.

  Truth be told, Tezos raised so much money with their ICO they didn’t know what to do with all the crypto-cash. So they started their own VC fund4. Since then they’ve gone into a bit of a meltdown—I guess an unexpected windfall of $230m cash will do that to some founders.

  Today Tezos is old news. They no longer hold the record for the fastest $200 million ICO raised in history. In just 60 minutes early in August, Filecoin’s own ICO raised more than $250m5, and then in December 2017 EOS followed with a $700m ICO trebling the previous record. As I write this I’m painfully aware of the fact that I’ll be updating the figures in this chapter right up until the point it is published. Then, as soon as the book is published, these figures will all be out of date. We live in a very dynamic world in all things cryptocurrency- and ICO-related.

  For the first half of 2017, CNBC reported6 that ICOs accounted for more than $1.2 billion in startup fund raising, more than the total VC-based early stage funding for the same period. That is an incredible statistic. Why? Because that $1.2 billion in funding is up from just $78 million in 2016 (excluding the DAO’s failed $150m ICO), and in the United States, as mentioned earlier, for many of the startups that have raised capital via an ICO, it might all soon be considered illegal thanks to an Securities and Exchange Commission (SEC) ruling. Why? Because as with any technological advancement that allows rapid returns, there are numerous bad actors out there that will inevitably give a bad name to the honest guys trying to use an innovative method of raising capital to start their businesses.

  Imagine that a friend is building a casino and asks you to invest. In exchange, you get chips that can be used at the casino’s tables once it’s finished. Now imagine that the value of the chips isn’t fixed, and will instead fluctuate depending on the popularity of the casino, the number of other gamblers and the regulatory environment for casinos. Oh, and instead of a friend, imagine it’s a stranger on the internet who might be using a fake name, who might not actually know how to build a casino, and whom you probably can’t sue for fraud if he steals your money and uses it to buy a Porsche instead. That’s an I.C.O.

  —NY Times, “Is there a cryptocurrency bubble? Just ask Doge”, 15 September 2017

  All-time funding by ICOs hit $5 billion in December 2017, with a big surge in Q4. To put that in perspective, $4 billion of that total cumulative funding was in 2017 alone. Despite the SEC’s Investor Bulletin on ICOs in July 2017 and various governments cracking down on ICOs, things don’t seem to be slowing. If anything, they would appear to be speeding up.

  Figure 1: ICO Funding exploded in 2017 (Source: Coindesk ICO Tracker).

  Despite this flurry of activity and massive growth in funding, not all ICOs are successful.

  In 2017, Bitcoin Market Journal’s analysis showed that of approximately 600 ICOs evaluated by their team, only 394 of these completed their ICOs reaching their end-date. About 35 percent of these reported or published funding details. Thus, the assumption in that data is that almost two-thirds of ICOs in 2017 failed to reach their intended funding target. It doesn’t mean they failed completely, just that they didn’t hit their numbers. That is one explanation. The other explanation is that in an unregulated market, auditing of financial results is simply optional.

  There were some spectacular failures, though. Whether via failed technology, poor execution or outright scams, ICOs generally got a pretty bad rap as an asset class, primarily because it relies on self-governance, and there are enough bad actors that negative stories are not isolated instances. The most publicised failures of 2017 included:

  1.OneCoin—A textbook scam of the multi-level marketing Ponzi scheme variety. $350 million lost, and 18 founders jailed by Indian authorities.

  2.Enigma—Poor execution failed this cryptography and security service. The CEO was hacked losing $500k, which killed their security imprimatur.

  3.Droplex—A scam ICO that literally copied another company’s whitepaper (QRL) by doing a global find and replace. Still, they made off with $25k of investors’ cash.

  4.Coindash—A hacker boosted $10m off this Israeli start-up via a phishing site. Rumours of an inside job continue to plague their team.

  5.Veritaseum—YouTube ads pumped up this ICO before $5.4 million in coins were stolen and quickly converted to Ethereum. Claims that the Veritaseum team engineered the hack to pocket funds continue.

  6.Parity—Straight-up hack of the multisignature wallet by exploiting a flaw in the code and two-step verification process. White hat hackers were able to recover most of the stolen Ether.

  The one lesson learned from all this is that despite the promise of ICOs as a funding mechanism for start-ups, it is still “buyer beware” for now.

  Bitcoin and cryptocurrencies on a surge

  Bitcoin and Bitcoin Cash (BTC/BCH), Ether (ETC), Ripple Coin (XRP), Litecoin (LTC) and others were all performing at record highs at the close of 2017, with many traditional investors and traders looking on and shaking their heads. XRP was up almost 4,000 percent in the first half of 20178 alone, and today is listed on 30 exchanges around the world. But Bitcoin is the cryptocurrency that started it all.

  On 22 May 2010, one of the first real-world transactions on Bitcoin occurred and will forever be memorialised as “Bitcoin Pizza Day”, when a BTC user paid 10,000 Bitcoins for two pizzas from Papa John’s Pizza in the Bay Area. At Bitcoin’s peak pricing in December 2017, those pizzas would have been worth more than $200 million.

  In February 2011, Bitcoin wrestled with US dollar parity, coming close numerous times before finally settling on the milestone on 9 February. In June 2011, Bitcoin was trading at almost $30 per “coin”; then on 19 June the famous Mt Gox hack occurred, with the price of Bitcoin plummeting to $2 in the months that followed. At the time, the Mt Gox hack represented a loss of more than US$2 billion assets (or about 300,000 Bitcoins).

  For many, this was clear evidence that Bitcoin was subject to weaknesses due to its computer-based nature, and therefore doomed.

  However, the nature of Bitcoin wa
s changing—people were starting to talk about the future value of Bitcoin in lofty terms9. By 2013, Bitcoin had passed the $1,000 value mark, and topped out at $1,242 near the end of the year. But then all hell broke loose again as the Chinese government banned financial institutions from dealing in Bitcoins. The price of Bitcoin then steadily declined over 2014 and reached a level of trading around $200–250 throughout 2015. Many traders and analysts thought that Bitcoin had reached a stable point of trading and it was unlikely to revisit its heights of 2013. They were obviously wrong.

  In 2017 all crypto-hell broke loose. One milestone after another fell by the wayside as Bitcoin grew and grew and grew. John McAfee, the crazy former resident of Belize, came out and said Bitcoin would hit $1 million. More specifically, McAfee made a bet that either Bitcoin would hit $1 million, or he would eat his male parts live on TV. The illusive Satoshi Nakamoto’s personal net worth climbed past $1 billion, then $10 billion and then $19.4 billion based on his10 holdings of Bitcoin. You couldn’t turn on a finance show without hearing about Bitcoin. Jamie Dimon said Bitcoin was the greatest Ponzi scheme in history, and the same day JPMorgan Chase traded millions of dollars in Bitcoins. Ransomware started to pop-up globally, with the only way you could release your files being to send Bitcoin to the hackers. The world had gone Bitcoin crazy. Incidentally, if Bitcoin ever does get to $1 million per BTC, Satoshi would become the world’s first trillionaire (if Bezos doesn’t beat him to the punch).

  Then in January 2018 Bitcoin crashed, spectacularly. The same traders and analysts that were saying Bitcoin had stabilized in 2015, were now saying Bitcoin was heading to zero. Nobel prize winning economists were saying the bubble had burst and Bitcoin was going out of business11. At the time of writing, Bitcoin is slowly edging its way back up around the $7–10,000 range, while international markets have gone through their first series of corrections of 2018.

  Calling Bitcoin volatile would be an understatement. Some analysts are calling Bitcoin a crypto-asset class these days, not a digital currency anymore. Others are still telling us that it’s going to replace all the central banks in the world, while the predictions of a Ponzi scheme and bubble continues. The Bitcoin faithful even came up with their own term to describe the rollercoaster ride in Bitcoin valuations and volatility—HODL or “Hold On for Dear Life!”

  How on earth did we get here?

  Understanding Bitcoin’s rise

  If you haven’t read Dave Birch’s latest effort (Before Babylon, Beyond Bitcoin12) yet, please avail yourself of his comic and academic brilliance. One of the key points Birch makes in his review of the future of cryptocurrencies is that over time money has increased in both utility and function, and that money must become intelligent to retain utility and function in the medium term. Ultimately money is becoming a form of technology itself. Michael J Casey and Paul Vigna make similar arguments in their most recent book The Truth Machine.

  While this might sound a little bit like science fiction, Bitcoin and ICOs are simply part of the digital evolution of our monetary and trading systems. But there’s something else happening here beyond just the evolution of currencies or money.

  Bitcoin has proved a number of things. Blockchain was a stable technology, and although evolving, it had stood the test of time. Numerous infamous wallet thefts had occurred, some famous wallet owners had lost an old hard drive years ago and had come to the realization that they would have been millionaires had they not lost it. Mt Gox and other exchanges suffered spectacular thefts. But the blockchain never got hacked. It proved resilient.

  Blockchain is a new architecture enabling applications like Bitcoin and ICOs. Some say ICO token sales are the “killer app” of blockchain. But consider this: these applications have become almost self-sustaining today, with enough market capital that total failure (going to zero) is becoming inconceivable—there’s almost too much capital tied up for it all to disappear. Once Bitcoin surpassed the value of gold, from a trading perspective it had already became an asset class that many claimed would hedge against market changes. While volatile, its performance has made it a solid long-term bet, and if institutional investors continue to play in the space, it will just become a mainstream instrument.

  Is this a global capital markets evolution?

  The rise of Bitcoin needs to be seen in the context of the market as a whole. While stock markets around the world continue to reach record levels, there are signs of structural changes to capital markets and economies globally. Developed economies like the US and UK are not in sustained low-GDP increase territory. While not in recession, modern economies aren’t capable of the higher rates of growth we saw in the 20th century because productivity gains are slowing. We celebrate a GDP figure of better than two percent like it’s 10 or 20 percent today. The mainstream companies which fuelled economic growth, like GE, Exxon, and the banks, are still profitable, but compared with the tech giants like FAANG (Facebook-Apple-Amazon-Netflix-Google) and BAT (Baidu-Alibaba-Tencent), they aren’t going to see results like they had in the 80s ever again. Underpinning this are a few major macro trends:

  1.Productivity is all moving to technology, and so traditional players are either having to become “tech” or see revenues, stock prices and returns enter a slow decline;

  2.Austerity and multiple rounds of cost reductions are a road to nowhere economically;

  3.Early indications are that Brexit13 and Trump policies are slowing economies and industries (agriculture is the first to go due to immigration policy14), giving credence to the globalisation mantra as a prerequisite for growth;

  4.Energy markets are undergoing deep structural changes, and this creates a shift where oil is no longer the foundation of commodities markets and futures;

  5.Capital flows and market make-up appears to be transforming almost exclusively around technology ecosystems.

  Prior to the big correction of January 2018, the US stock market had gained $3 billion in value in 2017 and saw gains of 17 percent. But fully one fourth of that growth came exclusively from technology stocks, namely Apple, Microsoft, Facebook, Amazon, and Alphabet (Google’s parent company)15.

  An age of digital commodities, technology infrastructure, smart economies and new value systems is rising. The economy cannot possibly function today like it did in 1960, and thus protectionist efforts like Brexit and the Trump administration’s policies threaten to isolate their economies from the levers that will continue to create economic growth, namely investments in core technology advancements that underpin 21st century infrastructure and economies. I know this is debatable, but there are real structural changes here, and we’ve seen this before during the Industrial Revolution.

  China has made massive moves towards solar energy in the last two years. Indeed, in 2017 alone China installed more than 60 GW of solar capacity—that’s more than the entire US solar capacity—and China deployed it in just a single year. India is rushing to do similar, with both economies shedding reliance on coal as quickly as is viable. Coal is running at $40/st, at approximately the same price levels as it was back in 2001, and oil crude prices are at sustained lows. With renewables looking to overtake fossil fuels in the 2030s in terms of total generation capacity, and with solar this year becoming the cheapest form of unsubsidized electricity generation per kWh, we are looking at a slowly collapsing commodities market.

  Despite Trump’s efforts to bring back “big coal”, the US created more than 350,000 jobs in solar between 2016–1716. Coal jobs increased by 50,000 according to the administration, but the entire coal industry employs only 160,000 people in total according to Department of Energy figures—less than half the solar jobs just added in the last two years. Then in January 2018 Trump raised tariffs on foreign solar panels and started talking about levies on solar energy itself. This is one of the fastest growing industries globally and in the United States in terms of job creation, and the administration aims to slow it down to favour fossil fuels.

  In 2016, energy-based commodities
represented more than 50 percent of US trading volumes17. If those commodities are set to remain flat or decline, there will be a total decline in commodities trading and volume over the next 30 years in the trillions of dollars. Markets desire growth.

  Figure 2: Oil prices are in for sustained lows given that solar’s price is declining so rapidly (Graph: Brent Petroleum prices since 1987).

  Clearly while the stock market is growing, commodities overall (largely because of fossil-fuel commodities sustained slump) will not provide the growth opportunities they once did, save for perhaps rare earth metals. Hence it is reasonable to think that digital commodities and digital assets might move to fill the gap in available investment dollars or to make up a balanced portfolio for growth investors—especially with the strong returns we’re experiencing. If you’re an investor and you want growth, cryptocurrencies like Bitcoin are volatile, but they are going the right way in 3–5 year time horizons.

  Think of it like this: in the 1850s and 1860s, the growth economies were investing in electricity, railways and telegraph lines. In the early 1900s it was roads, telecoms, and factory-based assembly lines. In the 1960s it was electronics, computing and business services. Each of these competencies were the core infrastructure and talent components for industrial and GDP growth over the next 50 years—the ability to stay competitive. Economies that failed to invest in that infrastructure found themselves significantly behind the competition within just a decade or two. Developed economies were those that continually invested in the infrastructure required to make themselves more competitive.

  Figure 3: US Stock Market by sector, 1900–2017 (Source: Credit Suisse).