Bank 4.0 Page 17

  Are cryptocurrencies like Bitcoin part of the new, smart infrastructure the global economy is going to need to be viable in 2030, or could it all be a bubble, a Ponzi scheme and a scam?

  The whole “Bitcoin is a fraud” argument

  Figure 4: Bitcoin vs Jamie Dimon (Credit: MarketWatch, Getty Images).

  On 12 September 2017, Jamie Dimon, the CEO of JPMorgan Chase, proclaimed Bitcoin a fraud—and it wasn’t the first time. The price of XBT plummeted overnight and it was reported that traders at JPMorgan Chase had initiated more than $17 million worth of buy orders on Bitcoin immediately after. Some said Dimon was involved in a dump-and-pump scheme. After that Dimon said he wasn’t going to talk about Bitcoin anymore. But he did. In January 2018 he simply said he regretted making that comment—oh, and his daughter has some Bitcoin investment, apparently.

  In an internal JPMorgan report published on 8 February 2018, the leading US bank said that cryptocurrencies were “unlikely to disappear”. The report analyzed the future potential of cryptocurrencies in general, along with the incredible risk-adjusted returns that cryptocurrencies have provided as an alternative asset class over the last few years for investors, when compared with the S&P500 and stock markets in general.

  CCs [Cryptocurrencies] are unlikely to disappear and could easily survive in varying forms and shapes among players who desire greater decentralization, peer-to-peer networks and anonymity, even as the latter is under threat… The underlying technology for CCs [cryptocurrencies] could have the greatest application in areas where current payment systems are slow, such as across borders, as payment, reward tokens or funding systems for other Blockchain innovations and the Internet of Things, as well as parts of the underground economy.

  —“J.P. Morgan Perspectives: Decrypting Cryptocurrencies: Technology, Applications and Challenges” (8 February 2018)

  Some, like Dimon, have over the last nine years regularly asserted that Bitcoin is a bubble, like the South Sea Bubble of 1720 or the Great Tulip Craze of the 1630s. These bubbles are often created with investment vehicles that are highly subject to market speculation, often with the creators making the big bucks as the craze reaches the broader market. The South Sea Bubble used network effect like Bitcoin and ICOs by giving British politicians, lords and even royalty access to a form of stock options, which encourage them to pump up demand for the stock (they could hold their stock without cash changing hands and sell it back to the company or to the public once the market price exceeded their option price). Ultimately, the claims made by the South Sea Company were found to be fraudulent, and an Act of Parliament helped introduce the modern stock exchange to protect the market from these types of frauds.

  The total market capitalization of cryptocurrencies today is fluctuating between $300–500 billion, or in the range of the value of Wells Fargo as a company. Bitcoin alone exceeds the market cap of McDonalds, CBS, 3M, Netflix18 and others in today’s terms, and it’s closing in on Disney’s current market capitalization. However, rather than being purely an asset class in a speculative bubble, ICOs are now distributing Bitcoin’s value across tokens that are linked to a wide range of companies—operating in a very similar way to the way securities are issued on an exchange.

  The problem for regulators is that Bitcoin, alt-coins and ICOs have become almost self-sustaining in the same way that the stock market is self-sustaining. As long as enough investors participate, and their exposure is limited or diversified, the likelihood of a complete collapse of Bitcoin or Ether is about as likely as the complete collapse of a secondary stock market today.

  That’s not to say that the occasional bad actors that issue their own ICOs won’t affect the price of Bitcoin or ETH. There are plenty of stories of unscrupulous actors that have disappeared with their ICO “winnings”, and the fact the SEC is gunning for them. The collapse of numerous token-based companies and funds are certainly more likely than the collapse of a publicly traded company. Despite all of that, the fact that tokens enable emerging start-ups to raise capital without listing, and without giving away equity, is simply too compelling an idea for many founders. Thus, it is likely more capital will flow into the ICO market over time, and ultimately in 10 years, the total ICO market will surpass some of the world’s smaller stock markets in terms of market capitalization.

  Venture capitalists have been investing in innovation and disruption for a very long time, but as an industry they rarely innovate themselves. If you’re in the blockchain or bitcoin space, our view is that we’re trying to decentralize the world, we’re trying to democratize the world in a way that creates a level playing field where everyone has equal access. Crowdfunding was the first major leap in the democratization of the world of early-stage finance. I believe the tokenization of it—what we’re doing—is the next, even larger leap.

  —Brock Pierce, Bitcoin Foundation and EOS

  Some regulators will certainly ban ICOs, some will even ban cryptocurrencies altogether. But others will see this as a competitive differentiation in a globalised economy that is restructuring around digital assets and commodities.

  The trick here is that the ICOs and cryptocurrencies represent a sort of systemic shift similar to what occurred after the South Sea Bubble collapsed, not during the South Sea Bubble itself. This is the formation of a new marketplace built without the legal and geographical hurdles of the stock markets that operate globally today. ICOs on top of cryptocurrencies are simply an IP-optimized system designed for value exchange in a real-time world, where the value is decentralised, based on computing power and network effect, not central banks and government legislation. ICOs are, like most FinTechs and technologies, an attack on friction—the friction of raising capital.

  Figure 5: Regulatory responses to ICOs and Cryptocurrencies over the last 12 months (Source: Nikkei.com, others).

  I personally believe the regulators who win will be those that enable a light-touch process for legal ICOs, encouraging investment, but with enough protection to weed out the bad actors. The investors who win will be those that invest in cryptocurrencies for the long-term and pick tokens that are clearly linked to the performance of the company they’re invested in, and not designed just as a way to raise funds sans equity. As with the best markets, the best performing companies will win for both their investors and for their founders. Bad actors won’t be able to kill this. But they will most definitely force us to regulate the ICO market, just like the South Sea Bubble created modern stock markets.

  It’s not going to be a total crash with ICOs and cryptocurrencies disappearing—it’s just going to be the formalisation of the ICO market by regulators, backed by cryptocurrencies as both alternative asset classes, alternative value exchange systems and payments networks. So maybe HODL on to those Bitcoins and Ethereum for a bit longer.

  The structural implications of DLT

  Hearing about the whole history of the blockchain tied to Bitcoin, the growing ICO market and the stories of banks scrambling to implement their own blockchain intiatives, you’d be forgiven for thinking that blockchain was solely the domain of the finance sector. The reality is that blockchain initiatives have already touched dozens of industries, from government through to diamond mining, from energy to smart infrastructure.

  Figure 6: Different flavours of Distributed Ledger Technologies by consensus mechanisms (Source: KPMG Research/Dave Birch).

  Distributed ledger technology (DLT) is now being implemented by banks around the world. We’re starting to see trade finance and cross-border transactions moving to blockchain POCs. The types of blockchain, or distributed ledger, technologies are varied. In fact, some private blockchains may not be considered “distributed” at all, as Dave Birch’s flow chart shows (Figure 6). A private shared ledger may be heavily restricted in respect to use, so in the classic public models like Bitcoin’s blockchain, the restricted use of the ledger doesn’t really lend itself to being called distributed at all.

  There seems to be no end of applications fo
r blockchain or DLT technology. And blockchain is having a direct impact on the banking sector.

  In 2017, Ripple announced more than 100 banks had joined RippleNet to modernise global and cross-border payments transactions. That’s still a far cry from the 11,000 banks using the SWIFT network, but it’s 100 more than a few years ago and growing rapidly. In a 2017 report by IBM, “Leading the Pack in Blockchain Banking: Trailblazers set the pace”19, 15 percent of the top 200 global banks said they had rolled out full-scale, commercial blockchain applications in 2017, and 65 percent were expected to have blockchain projects in production by 2020. Large institutions with 100,000 employees or more were consistently those leading the charge, according to IBM’s research.

  So what prompts banks to work on blockchain or distributed ledger technologies? Often it is future-proofing their business in respect to key elements of the back office, such as transactional flexibility and speed and interoperability with emerging networks, but in many cases it is because emerging blockchain technologies offer security and auditability that existing bank databases and payments networks don’t have.

  But it’s not just banks that are seeing the benefits of distributed ledger technologies. Companies like the Sun Exchange are building their entire business smart assets, smart contracts, and ICO tokens on blockchain. Everledger is tracking diamonds from the moment they’re extracted from a mine in Zambia, to the engagement ring sold in Tiffany’s on 5th Avenue in New York. Hanson Robotics and Singularity AI is looking at managing emergent machine cognition on the blockchain. In the future a baby might have his identity tracked from the moment of birth through his schooling, his first bank account, his marriage and death—all on the blockchain.

  In 2017 Vladimir Putin proclaimed that the Russian government would be re-engineered upon blockchain technology, starting with transportation services. This comes just a few months after Vitalik Buterin from Ethereum met with Putin at the St Petersburg Economic Investment Forum in a closed-door meeting. Dubai’s ruler Sheikh Mohammed set 2020 as the date for all government transactions to be done on blockchain infrastructure. At the 2018 World Economic Forum, governments around the world announced that a globally recognised traveller and identity program would be implemented on blockchain, which could one day spell the end of physical passports. Brazil and Canada are also talking about national identity programs on the blockchain in line with this initative.

  Figure 7: Core benefits of private blockchains compared with current transactional systems (Source: Gilbert+Tobin).

  The world appears to be in love with the concept of the blockchain. Below are just a few of the areas where active blockchain implementations and start-ups are operating today in the non-financial space.

  Figure 8: Blockchain applications.

  If you thought blockchain was about cryptocurrencies, you’re wrong. If you thought blockchain was a finance thing, you’re wrong again. If there is a database somewhere in the world that needs a distributed presence, strong auditability, and/or automated management, then it’s likely we’ll see the blockchain become the foundation of those datasets over the next couple of decades.

  Blockchain is still in its infancy, even in the banking world. If you step back from the present, you could envisage blockchain as an element of first-principles thinking and as a redesign of basic transactional services that power the financial services market. It offers the potential to create broad interoperability across new identity systems, technology services, financial products and payments networks. It is a way to break through the current system constraints of legacy “pipes and rails” that the banking system has established over decades. While the likes of SWIFT and NACHA talk about their own blockchain attempts, the reality is that the fastest growing networks in financial services today are not connected to incumbents, but are new systems developing on top of mobile and internet protocols.

  Why your core-system has a shelf-life

  Today the largest super-wallets in China, India and Africa are effectively closed loop systems that are holding deposits in the trillions. These mobile wallet value stores are essentially what we used to call a bank account. Even though we’ve had alternative value store mechanisms like airline mile programs, transport cards, etc for some years, the sheer scale of these alternative wallet ecosystems, and the fact that they are interchangeable with cash and card payments, make them extremely bank-like in nature. Just 10 years ago the only players in the very space that M-Pesa, PayTM, Alipay, Venmo, and WeChat Pay operated were bank-owned, with the one notable exception of PayPal, of course.

  As we’ve already pointed out, however, PayTM, Alipay, M-Pesa and Tencent don’t have banking core systems underpinning their mobile wallets. At least not for the ledger operations—they have to store all their cash deposits they take in accordance with local regulations in an actual bank account with a partner bank, but within the closed loop system they are core-less.

  As IoT devices, ICO tokens, e-money licenses, cryptocurrencies and super-wallets become more and more common, a great deal of day-to-day banking activity, particular around deposits, payments and investing, will be core-less and bank-less. Now you could argue that this is just crying out for regulation, to force these organisations to become chartered or formal (licensed) financial institutions, but that still won’t require them to put in place a banking core system. This is because their digital value stores aren’t part of a universal banking model, they aren’t replicating the products that banks, card networks or investment houses are built on today. They are surfacing the same utility as banks with core systems, but that only requires a strong experience layer, and not a core system.

  Ultimately, as banks are forced to compete on utility and build more and more technology experiences to surface that utility, they’ll be beefing up a middleware layer that looks more and more like blockchain platforms and the likes of Ant Financial or Tencent’s WeChat. Essentially, they’ll be stripping the core back to its very core (excuse the pun). Yes, the ability to offer interest rates will be there, the ability to store value will still be there, and access to credit will be there. But the core systems that reinforce branch-analogous products will be used less, and more of the middleware will be used to surface banking experiences across mobile, voice, augmented reality glasses and the like.

  What do you get when the “bank” is not delivering any of the old products it used to deploy in the branch; when it is just a concentrated core of banking utility, its processes around capital adequacy still enforced by regulators; its identity outsourced to brokers and government blockchains; and its risk operations managed by Artificial Intelligence?

  The core banking system will largely have disappeared, replaced by improved utility and ubiquitous banking experiences. At a minimum it will just be part of a much larger technology-and-experiences delivery stack.

  I know we’re talking about a decades-long shift here, but think again about the organisational structure, technology architectures and competencies to compete in this world side-by-side with core-less players like Ant Financial. Does your current core system offer a competitive advantage against these non-bank FIs?

  But what about challenger banks? The challenger banks we see are mostly still operating under the assumption they’ll have a super modern, real-time core with a kick-ass front end to differentiate. But some neo-banks, like Stirling and Revolut, are now starting to construct alternatives to these models, like marketplace banking. My own challenger bank, Moven, doesn’t have a core system—we just have a big middleware layer.

  It all comes back to first principles. If you were building a bank’s architecture from scratch today based on everything we know now, would you build it based on a traditional core system designed in 1960, but updated for real-time operation? Not if you understand banking 4.0 is about experiences surfaced through technology, and not the digitisation of branch-based banking products. Blockchain will be a necessary, core-building part of the architecture required for 21st century real-time
banking experiences. Old-style core banking systems will not.

  Endnotes

  1Distributed Ledger Technology.

  2Source: IDC Data (that’s over 3,000 smartphones sold every minute, 1.7 billion annually).

  3Ethereum was actually the first organisation to issue an initial coin offering.

  4Source: Business Insider—“What does a tech startup do after raising $232 million selling digital coins to investors? Set up a VC fund”.

  5“$200 million in 60 minutes. Filecoin ICO Rockets to Record amid Tech Issues”, CoinDesk.com—https://www.coindesk.com/200-million-60-minutes-filecoin-ico-rockets-record-amid-tech-issues/.

  6Source: CNBC, August 2017—https://www.cnbc.com/2017/08/09/initial-coin-offerings-surpass-early-stage-venture-capital-funding.html.

  7See https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_coinofferings.

  8See CNBC https://www.cnbc.com/2017/07/21/ripples-xrp-digital-currency-rose-3977-percent-in-the-first-half-of-2017.html.

  9Source: Business Insider article—“Bitcoin could go to $1 million”, Henry Blodget, 8 Nov 2013.

  10Assuming Satoshi is actually a man, or a person. Some believe Satoshi is a creation of NSA. I have heard that Satoshi is actually four separate individuals who collaborated on the first whitepaper, one of who is no longer alive.

  11Nobel Laureates Robert Shiller and Joseph Stiglitz both predicted big crashes in Bitcoin; see—https://www.ccn.com/nobel-laureate-economist-predicts-bitcoin-crash-wont-go-to-zero-it-will-just-come-down/.

  12Available on Amazon and wherever good books are sold.

  13See: Independent.co.uk—“UK crops left to rot after drop in EU farm workers in Britain after Brexit referendum”, 5 February 2018