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Cryptos Have Big Upside Once Regulatory Gets Their Story Straight

Whenever China, USA, India or any big nation make a policy announcement on crypto, it causes a big price movement. India is rumored to contemplate banning crypto investing. Is it for protection? And if so, for whom? For investors, or the rupee?

Shanghai Skyline with Pudong in the background

Wearing the trademark jacket named after him, Mao had just proclaimed the establishment of the People’s Republic of China (PRC) on October 1, 1949. It will take another 2 months for the Communist to chase out the last of the remnants of its civil war rival, the Kuomintang onto the island of Taiwan, which would eventually become the Republic of China (ROC). Easily confused names, but make no mistake the ideologues between the two couldn’t have been more different under the looming shadows of the polarizing cold war.

Shortly thereafter, Mao and his team faced a litany of pressing decisions, especially while waging a war with Generalissimo Chiang of the Kuomintang. The two are still steadfastly at war with each other. The communists quickly decided not to take back Hong Kong from the British which was a crucial decision for the fate of Hong Kong. And China.

Immediately Hong Kong became a socioeconomic experiment on steroids. Boxed in by neighboring PRC, the open sea of the Pacific would serve its vital lifeline and explosive growth. The native Cantonese in Hong Kong would produce an interesting and quirky culture of a condensed laissez faire that has never been seen before in history. The UK and the local Hong Kong government took on a hands-off approach, but wisely interjected with money for public housing and education in order to supply a growing work force and population.

Besides interesting, Hong Kong is intense, crowded and cosmopolitan — driven by an unsurpassed entrepreneurial spirit. It’s physical locale, cultural identity, political position, and unique combination of characteristics was a near perfect combination. Had Hong Kong been ceded to, say the French instead of Britain the results would have been much different. Just compare the differences of the nearby Portuguese-influenced Macau and Hong Kong and you will understand the marked differences. Macau is still a wonderful destination, but its economy, based on casino gaming, is contrastedly different from Hong Kong as a financial and service capital.

During the post-war era, Hong Kong became a manufacturing center starting with textiles and then moving up the chain in finished apparel, plastics, and electronics. When Deng opened up China in the late 70’s, Hong Kong was in a perfect position to shift manufacturing over to the mainland, while transforming itself again to the more lucrative trading, services, and financial sectors. When Britain handed HK back to China, the one country two systems was a perfect symbiotic relationship. China leveraged and capitalized Hong Kong’s acumen on business dealings, finance and guanxi¹.

China is the beneficiary of Hong Kong

Hong Kong Skyline

When I first set visited mainland China in 1993 it was an eye-opening experience. My business partner and good friend, Dr Hall P Tam, took me across the river from Shanghai to nearby Pudong. We got out of the taxi and Dr Tam told the driver not to leave.

“What the hell are we doing here? What is this?”, I asked.

“This is it. What do you think?”, was his jubilant reply.

It was a rice paddy. And in 1993, that was the future site of the Shanghai Commodities and Futures Exchange.³

At dinner that night, I could only complain that I could not envision it happening. The dirt roads, the lack of infrastructure, and the socialist mindset, just to name a few, would make this an impossible project. Dr Tam said that the rice paddy is analogous to the buttonwood tree that served as the backdrop of the Dutch named Waalstraat² and eventual site of the New York Stock Exchange. But as I quickly learned, the provisional mindset was of my own — not the Chinese.

Why Hong Kong Mattered

My first question was why build a commodities exchange in Shanghai and not in the more active Hong Kong? Born and raised in Hong Kong, Dr Tam was of Shanghainese descent but received his post-doctorate at Columbia. He eventually became naturalized as a US citizen. He had a perfect perspective on the nuances of Chinese history and politics.

While Hong Kong was arguably a Chinese crown jewel, it is nevertheless a by-product of the west, being that of the British. While China was still an emerging and developing country at the time, Hong Kong did not have the cultural and historical legacy to be the flagship city of the future and great Chinese revival. “We have a clean slate to build it the way we envision it. With some input from the party, of course.”, as his eyes glistened.

What China did well was to realize that they needed Hong Kong. The Chinese’s main focus was still on the commodity side of the exchange. However, I felt that the financial futures were much more interesting and had greater potential. I was looking at the Chicago Mercantile Exchange as a model in the 80’s which was experiencing tremendous liquidity in options and futures trading. Fast forward to 2008 and the exchange eventually dropped “Commodity” from the name and is now the Shanghai Futures Exchange. I guess I wasn’t wrong all the time.

Who Will Lead in Crypto?

The next chapter in money and finance will be more complex as the evolution of cryptocurrency is going to completely re-draw geopolitical lines. Nation states have two main controls — guns and money, and cryptos like bitcoin are putting the latter at great risk. And nation states do not have an inkling of how to deal with the impending changes.

China has dropped the gauntlet by issuing the digital yuan but it is really nothing like bitcoin as it is not even on the blockchain. More importantly, it is the monetary control of the e-yuan that makes it an apples to oranges comparison to bitcoin.

Meanwhile the US has adopted a wait and see approach. That is not unexpected since the US dollar is the king of fiat currencies. Oil is denominated in dollars and it serves as the de facto reserve currency on international trade. The closest challenger is the Euro (€). But the US just pulled a rabbit out of the hat when the Office of the Comptroller of the Currency says that banks have to treat open, permissionless block chains like they treat the current SWIFT system. It’s an effective countermeasure to marginalize the e-yuan and without having to issue its own CBDC. Yes the Boston Fed is undertaking a study on CBDC issuance but that’s just buying time.

When I was at the SF Fed, its former president and future Fed chairperson, Janet Yellin, made a visit to the SF bank. I had just authored a paper for the Fed on cryptocurrency and spoke to Ms. Yellin. My manger pre-spanked me before the reception by reminding me that the Fed is ultraconservative. Do not break anything and do not mention Bitcoin.

I like and respect and Ms. Yellin very much. She is brilliant, a good listener, and very reliable. Janet and I are from the old country, New York, and she actually asked me for my views on the future of cryptos. But her body language was that cryptos would not be relevant.

Under President Biden, Madame Yellin is now the Secretary of the Treasury, and I would be surprised if significant regulatory initiatives would come out under her watch. Even though President Biden has nominated the technically-savvy, MIT professor, Gary Gensler as the SEC chair, I do not believe it will change Washington’s stance on crypto conservatism.

As Bitcoin passed the $50k mark, many nations will see this as a once-in-a-lifetime opportunity to make significant headways. Yet with so many moving parts, that it’s very difficult to gauge which way is the best way to go. The indecisiveness is factored in as a discount to the current valuation of bitcoin and all other non-stablecoin cryptos.

Regulatory Issues

Money-laundering and terrorism financing, and illegal trade are a given that regulation will never be tolerated by any scrupulous nation. Other crypto issues are more difficult to gauge. Here are a few of the issues:

  • Taxation
  • Currency controls
  • Self-custody (non-custodial) wallets
  • Legal tender payment
  • Cross border remittance
  • Reporting
  • CBDC

In future articles I will be addressing such topics in greater detail. Just to give an example, the US is rumored to crack down on self-custody wallets. That means that you must verify and report the owner of any wallet that you transact with. Not only does that go against the principles of crypto being open, trustless and decentralized, how do you report against a smartcontract?

Conclusion

2020 was an interesting year, and while the Covid-19 pandemic is an ongoing tragic mishap, it actually accelerated the trend towards crypto adoption. Not so much because it is no-touch currency but because of the massive stimulus popularly referred to as printing money. Big financial institutions like PayPay jumped into the fray. Facebook’s watered-down Libra, rebranded as Diem tested the regulators and failed. Celebrity names such as Elon Musk has made large crypto positions.

Expect 2021 to be even more dramatic on multiple fronts. Nations are looking at each other and trying to game the system. Who wants to play cop, and who wants to play robber? It even begs the question: are nation states a structure past its useful prime?

References

¹Understanding the concept of ‘guanxi’

² Waalstraat (Wall St)

³The Shanghai Commodities and Futures Exchange officially dropped Commodities from its name in 2008.

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