Financial infrastructure for a technology poised to disrupt finance?
We have seen many headlines of financial giants entering the crypto space in one way or another. Some from the recent past:
- $7.2 Trillion Fidelity Will Help Customers Invest in Bitcoin (story)
- The NYSE’s Owner Wants to Bring Bitcoin to Your 401(k) (story)
- Yale University Said to Invest in $400 Million Paradigm Crypto Fund (story)
Any such news is met with a mixed reaction from the crypto community, ranging from euphoria to apathy all the way to scepticism and even despair. What is the real deal here, and does crypto need patronising from these companies?
To really understand what is happening here and the impact on the industry, we need to look deeper and from different perspectives. It is way more nuanced than what we may think.
Watchers on the Wall
Most Wall Street veterans in the crypto space generally welcome such news, or are the ones making these happen. After all if you want the institutional money to flow in the space, you would need the checks and balances the institutional investors have come to expect (or need due to regulations).
Take the example of custody. Many companies (Coinbase, BitGo, Gemini, Fidelity, ICE…to name a few) have jumped in to provide custody services for institutions. A qualified custodian is needed to be able to comply with the regulation whereby the holding of the actual asset (physical or digital) has to be independent of the financial advisor. This is a well-intentioned regulation to avoid advisor fraud. Other examples of such pieces are futures, regulated exchanges, upcoming ETFs etc.
With each such piece of infrastructure, Wall Street moves one step closer to understand the space, the asset and the opportunity. It opens the door a little bit more for the institutional money to come in. Banks and financial institutes can treat crypto just as any other currency and the rest of the financial machinery keeps moving. Right???
Critique from the Community
Cryptocurrencies, at least the ones that matter, are open and permission-less by nature. This means that anyone — individuals, businesses, bots, aliens…. can equally play a role in the ecosystem without discrimination. They can participate and innovate on top of it. So why is there scepticism when it comes to a bank getting interested in crypto or a fund offering an investment product or an FS advisor putting out a crypto service?
For one, this is the first time we have a true scarce-digital-bearer-asset which is very different to what the industry is accustomed to. And as Caitlin Long explains very well in her article, the wrong kind of financialization is when existing precedents are applied to these fundamentally different assets.
Cryptocurrencies are equity-based assets, which means they are no one’s liabilities — they are not IOUs, and they have no counterparties. Examples of other equity-based assets are land, physical commodities and personal property.
Debt based assets on the other hand are permitted to be leveraged — the piling of IOU upon IOU upon IOU on top of debt-based assets. Fractional reserve banking is possible in traditional markets as there is a lender of last resort who can print more if needed. There is no such thing possible in equity-based assets. Think of it like selling the ownership of piece of ‘land’ to more than one and which is settled in ‘land’ not dollars — so when the redemption happens the piece of land is owed back not the dollar equivalent. This is clearly a recipe for disaster.
The same applies to hard money like bitcoin. If companies try to do it, they will not only burn themselves but in the process also hurt a lot of gullible people. And when this happens, it will not be difficult for the regulators to point the finger at crypto as against the ones who have misused it. Overall such steps will hurt everyone involved and therefore the caution and critique from the people who understand the difference.
So how will Cryptofinance move forward?
If the aim is to provide a viable alternate financial platform through cryptofinance, it should allow for true commerce and risk management for individuals and companies of all shapes and sizes.
A shipping company should still be able to have insurance against their business risks. A small cafe chain should be able to hedge against the price of another currency in which they buy their raw material. A new business should be able to borrow money to fund the next phase. A local established firm should be able to invest its current funds in order to ensure cash flows in the future when they may hit troubled waters.
For such real world applications, cryptocurrencies pose a certain set of challenges. But they also offer opportunities of the kind we have not seen before. Programmable money provides for tools such as bank-less personal wallets, recovery seeds/mnemonic codes, multi-signature controls, immutable time-stamping, smart contracts, trust-less payment channels, sovereign grade security, cold storages, etc. And many more are being developed.
The key to a cryptofinance future, therefore, lies in exploiting these tools and coming up with solutions to real world problems. Let us look back at the qualified custodian example. In this case a self-custody solution using multi-signature and cold storage of assets should do the trick. The owner of the asset will always be in control of the asset with their key even though the financial advisor has one of the keys or a watch only address. When a transaction is proposed, the owner will be notified and will have to sign the transaction before any part of the asset is moved. You end up achieving the same (or I will argue better results) by instead using math and technology. Remember a custodian still poses a risk as we have discovered a few times like in the case of Dell shares here.
You cannot really force high speed internet on top of dial up connections. It won’t cope with applications like on demand HD video streaming, mobile apps and other things which could not have even been imagined. In the same way, the infrastructure crypto needs will be developed natively using cryptotech and not by copying solutions made for the analogue world.
#crypto #blockchain #cryptofinance #fintech #bitcoin #cryptotech #innovation #DLT
This is part two of a series on ‘8 things you should be excited about in crypto (but probably don’t even know)’. An attempt to bring out the gems of the technology in a space where these can easily get lost in attention grabbing headlines.
References:
- Catlin Long’s article on Bakkt: https://www.forbes.com/sites/caitlinlong/2018/08/03/ice-creating-new-cryptocurrency-market-a-double-edged-sword/#70ebe6831015
- Photo Credit: <a href=”https://www.freepik.com/free-vector/financial-flowchart_1048733.htm">Designed by Macrovector</a>
