Blockchain and cryptocurrencies enter the mainstream

May 31, 2018
Chris Wheal

Big banks and other large financial institutions may finally be taking Bitcoin – and cryptos in general – seriously.

Many in the banking world have shown profound scepticism about the long-term future of digital coins themselves. Last year, JP Morgan chief executive Jamie Dimon famously referred to Bitcoin as a “fraud”, a comment he said he later came to regret.

However, there are signs that the big banks are finally getting more interested in the cryptocurrencies themselves. Last month, investment banking giant Goldman Sachs revealed it was looking at setting up a trading unit for Bitcoin.

Just days later, the New York Times reported that Intercontinental Exchange (ICE), the owner of the New York Stock Exchange, was planning to launch a platform that would enable institutional investors to trade Bitcoin.

Goldman

Goldman Sachs logo

Change of heart

This is a sure sign that Bitcoin – long depicted as the currency of shady, underworld dealings and speculation – is finally being accepted by some of the biggest names in finance.

It’s unlikely that this change of heart is due to some philosophical conversion. After all, the decentralised nature of Bitcoin was conceived to challenge the power of the traditional banking system.

Instead, the reason is that hedge funds and other players are demanding Bitcoin related services. There’s money to be made and Goldman and the like want a piece of the action – they can hardly ignore the demands of their customers.

Blockchain interest

For some time, it’s been evident that the banking world has a strong interest in blockchain, the technology that makes Bitcoin and other cryptos possible. Blockchain means cross-border financial transactions can be executed in a matter of seconds versus a few days for traditional payment systems, and at a much lower cost.

This though does not necessarily entail using the cryptocurrencies themselves. For instance, in May, HSBC and ING completed the world’s first trade finance transaction using the Corda blockchain platform developed by enterprise software firm R3. This was in relation to a shipment of soybeans transported between Argentina and Malaysia.

More than 200 firms have signed up to Corda, including financial institutions and trade associations, in the hope of exploiting the potential offered by blockchain.

The attraction of blockchain has also spurred more than a hundred banks to sign up to the technology offered by crypto firm Ripple for international transactions. While Ripple has its own digital currency, XRP, its payments network enables banks to make payments in any currency, including traditional fiat currencies such as the dollar and euro.

Earlier this year, Santander revealed it was launching an app for customers to make cross-border payments using Ripple’s blockchain technology, though this will just use conventional fiat currencies rather than cryptos.

ICE owns the New York Stock Exchange, pictured

ICE owns the New York Stock Exchange, pictured

Digital gold

Moves by Goldman Sachs and ICE to launch operations that directly involve Bitcoin are in an entirely different category. It could herald a wider change of direction on the part of the big banks.

“I would not describe myself as a true believer who wakes up thinking Bitcoin will take over the world. For almost every person involved, there has been personal scepticism brought to the table,” says Rana Yared, managing director at Goldman. Goldman will begin trading Bitcoin futures contracts on behalf of clients and plans to offer a new type of Bitcoin future, a non-deliverable forward.

The investment bank is seeing demand from various clients who want to hold Bitcoin as a store of value, who view it as a kind of digital gold. As just a limited amount of Bitcoin can be virtually mined, many are attracted to the digital currency for its scarcity, in much the same way as investors are attracted to the yellow metal.

While some 17 million Bitcoins have been digitally mined to date, only 4 million more are available for mining under the crypto’s existing protocol. “It resonates with us when a client says, ‘I want to hold Bitcoin or Bitcoin futures because I think it is an alternate store of value,” commented Yared.

Bitcoin

Bitcoin as digital gold

Wider adoption of blockchain

Goldman’s move is a culmination of the growing interest from hedge funds and other big investors in digital currencies over the past couple of years. However, evidence of Bitcoin’s wider adoption in fact came in December 2017 when the Chicago Mercantile Exchange and the Chicago Board Options Exchange launched Bitcoin futures.

No wonder Jamie Dimon began to regret the comments he made just a few months earlier about Bitcoin being a fraud. There was also a clue as to where Goldman stood in the Bitcoin debate back then as it distinguished itself as the first bank prepared to clear the new Bitcoin futures offered by the Chicago exchanges.

It was soon joined by investment banking rival Morgan Stanley in the clearing of Bitcoin.

Volatility of Bitcoin and altcoins

What happened next led some to write off Bitcoin. Having rocketed from $6,750 at the beginning of November to a peak of $19,343 by mid-December, the crypto subsequently experienced a sharp and unforgiving sell-off. By early February it had plunged by some 60% from the December peak to trade at around $6,914.

While Bitcoin is still some way from the dizzying heights of December, at just $7,500 today, the recent move by Goldman provides some cause for optimism over the longer-term price outlook. It may be some time before Bitcoin gets back to the $19,000 level, but some of the best minds on Wall Street clearly think the crypto has a viable future.

Jamie Dimon

Jamie Dimon

ICE adds to cryptos’ credibility

The digital exchange ICE wants to go a step further than the Chicago exchanges that already offer Bitcoin futures. ICE hopes to launch a platform that would effectively enable institutions to hold large amounts of Bitcoin tokens in an account, providing further evidence that Bitcoin itself is gaining traction with big players.

It is thought to be working on a plan that would see participants use swap contracts to purchase Bitcoin.

The ICE initiative appears likely to widen Bitcoin activity among important financial institutions, giving the crypto more credibility. This can only be good news for the crypto from a long-term price perspective.

Store of value

Given the dearth of transactions performed in Bitcoin, demand for the crypto still hinges on its attraction as a store of value. But the fact that big names such as ICE and Goldman are busy planning new Bitcoin-related products and services indicates that many serious investors think there will be some decent gains to be made in the future.

For sophisticated investors, this has something to do with what’s termed as diversification. Their portfolios will mainly comprise of traditional investments such as blue-chip equities and major government bonds.

Exposure to Bitcoin will be relatively small in comparison. But having seen the dramatic price surge in Bitcoin over recent years, they don’t want to miss out should the crypto enjoy another bull run. Even if held in a relatively small proportion to their traditional investments, very strong gains from Bitcoin could pull up the average percentage return of their entire portfolio.

Diversification

Diversification

Worries

But why the scepticism in the banking world on Bitcoin anyway? Some would say the banks have been worried about decentralisation and a competing financial system based on blockchain that could eventually erode their positions.

However, various figures both inside and outside the banking world have put forward theoretical arguments as to why they think Bitcoin is doomed. For example, world famous economist Kenneth Rogoff recently said he expected Bitcoin to be trading at a “tiny fraction” of its current price a decade from now. He points to sketchy demand for Bitcoin as well as the threat from further regulation.

On the demand side, he points out that Bitcoin has little use as a transaction vehicle, the purpose it was originally intended for when it was conceived.

In comparison, gold has even less use as a transaction vehicle, and while it is used to make jewellery and has applications in the technology industry, around 40% of the demand for gold is for investment purposes given its long-standing attribute as a store of value.

Regulation of cryptocurrencies

So, what of the regulatory threat to Bitcoin and other major cryptos? Much of the sharp sell-off experienced by Bitcoin earlier this year was attributed to growing fears over regulation. China and other Asian countries took measures to regulate the crypto while there was talk of the EU and US following suit.

At present, all eyes are on the US where regulators are still deliberating on how best to deal with cryptos. There is a general feeling that the US may well decide to take a different approach towards some cryptos than others.

Digital coins that are deemed to be more centralised in their nature, such as Ripple’s XRP, could well end up being more tightly regulated than the likes of Bitcoin, which can be freely mined.

Rogoff

Kenneth Rogoff

Institutional players

Much of what ICE and Goldman are expected to offer institutional players is already being offered, yet on a smaller scale. At the same time, bigger names like these two coming into the space in a serious way should still attract more high-profile investors to Bitcoin as well.

One such firm already offering crypto services to institutions is LedgerX. It describes itself as an institutional trading and clearing platform that has received approval from the US Commodity Futures Trading Commission (CFTC) to trade and clear swaps and options on digital currencies.

As such, LedgerX claims to be the first “federally regulated exchange and clearing house” to list and clear fully-collateralised, physically-settled bitcoin swaps and options for the institutional market.

LedgerX’s chief executive and founder Paul Chou, himself a former Goldman Sachs trader, presents its services as means for hedge funds and the like to “bypass the banks”.

“It’s extraordinary that people can send us millions worth of BTC on a Saturday night, have it available within hours to support complex trading strategies, and when they are done have it sent back as BTC. They haven’t touched the banking system once throughout the entire process, something which I think is unique in the history of US federally regulated derivatives exchanges and clearing houses,” says Chou.

Catch-up

Rather than being pioneers in crypto then, it sounds as though Goldman itself is playing catch-up to avoid being left further behind in the crypto revolution along with its other major banking counterparts.

Still it’s significant that Goldman is choosing to act now. It certainly does not appear to be fazed by any perceived regulatory threat to Bitcoin. Equally, it recognises that some of its clients see Bitcoin as a viable store of value.

Another platform, known as Celsius, invites individuals to borrow dollars against their crypto holdings. They can also earn interest. But it also interacts with the institutional money chain.

“Hedge funds, family offices and crypto funds still want to play in the world of cryptocurrency. Fortunately for us, they are willing to pay high fees to do so, so many of them want to short the market. We’re happy to help make the most of their greed by taking up to 50% cash deposits and charging them interest when they hedge. This lets us pass most of the earnings back to the community and lend more dollars to the rest of the Celsius community,” says the firm.

Banks move into crypto

Given the threat to traditional banking activities posed by the likes of LegerX and Celsius, it seems just a matter of time before more banks move into the crypto space.

As to the future of Bitcoin itself, opinion remains split. Many well-respected figures who were prominent in the prior century have been the most vociferously opposed to the digital coin. In contrast, millennials and the new wave of fintech protagonists that have come to prominence in recent years tend to be Bitcoin’s strongest supporters.

The latter group tend to praise Bitcoin as a way to circumvent the power of traditional banks. All this against an environment of general dislike towards the banking sector, just a decade on from one of the worst financial crises in history.

If more banks get to grips with Bitcoin and begin offering crypto services themselves, this theme may become less relevant. An increasing number of big investors don’t want to miss out on the potential of “digital gold.” Whether they choose to go long or short, it looks like Bitcoin’s here to stay.

Chou

Paul Chou

Bitcoin and crypto proponents

Cameron Winklevoss, entrepreneur and founder of Winklevoss Capital Management: “We believe bitcoin disrupts gold. We think it’s a better gold if you look at the properties of money. And what makes gold, gold? Scarcity. Bitcoin is actually fixed in supply so it’s better than scarce … it’s more portable, its fungible, it’s more durable. It sort of equals a better gold across the board.”

Alex Mashinsky, chief executive of Celsius: “Now we’re seeing the results of over 500 years of institutional centralisation, and there are big gaps and discrepancies in terms of wealth distribution and access to financial services. Cryptocurrency is universal, quick, safe, and a worthy challenger to a system which relies on people trusting incompetent institutions with their money.”

Valery Vavilov, co-founder of Bitfury: “These are early days in blockchain, and we believe the future of Bitcoin and the entire blockchain ecosystem shines bright.”

Michael Novogratz, chief executive of Galaxy Investment Partners: “It’s almost essential for every investor to have at least 1% to 2% of their portfolio in cryptocurrencies.”

Zhao Changpeng, chief executive of Binance: “We did not expect this kind of growth to be honest.”

Mashinsky

Alex Mashinsky

Bitcoin naysayers

Bill Gates, Microsoft founder: “As an asset class, you’re not producing anything and so you shouldn’t expect it to go up. It’s kind of a pure ‘greater fool theory’ type of investment.”

Warren Buffet: “Stay away from it. It’s a mirage, basically…The idea that it has some huge intrinsic value is a joke in my view.”

Nouriel Roubini, economist: “I would separate the blockchain from the bitcoin. Blockchain creates an enormous chance to increase productivity in many companies and I think the technology to be something very good. But the Bitcoin and other cryptocurrencies – this is something entirely different. In my opinion, there is a gigantic speculative bubble related to the Bitcoin.”

Jack Bogle, founder of Vanguard: “There is nothing to support Bitcoin except the hope that you will sell it to someone for more than you paid for it.”

Gates

Bill Gates

Post written by Chris Wheal
Chris Wheal is editor of OpenLedger's news and features service. An award-wining business journalists himself, he runs a team of freelance journalists from across the UK and north America.

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