Bitcoin and cryptocurrencies: an update

Cryptocurrencies: a caveat and an update

In this update to his recent post on Bitcoin and cryptocurrencies, John Clamp argues that it’s too early by far to rule out a sea change in finance resulting from blockchain technology. That having been said, the horizon is not without its cloudy quadrants.

Critics abound

When it comes to fundamental ‘memes’ such as money many observers scoff at Johnny-come-lately pretenders to the throne. That’s not surprising. After all, it’s not like governments and central banks aren’t pushing back, and while some traders have been let off the leash, other investment houses aren’t touching cryptocurrencies at all. Fiat money has powerful backers, and they’re not going to go down without a fight.

Bank of England, City of London

The Bank of England in Threadneedle Street, City of London. Deputy Governor Sir John Cunliffe called Bitcoin ‘a commodity’, to distinguish it from central-bank-backed fiat currencies.

First, critics point out the size of the asset class. Bitcoin overall is worth a miniscule amount of money, even at prices of around $1000 each. It is too insignificant a market to wield any macroeconomic weight. There’s even a debate about whether it can legitimately be called an ‘asset’. With a 21 million cap on its possible total numbers, all Bitcoin could ever be worth amounts to just $21 billion at a grand each. There are $200bn dollars worth of Jacksons ($20 bills) in circulation right now.

Steep falls

Recent volatility in Bitcoin’s value has resulted in a 40 per cent fall in value from its height. (This update is dated January 18, 2018, the day on which South Korean regulators again signaled their intention to intervene with, and possibly shut down, Bitcoin exchanges. On this day, the coin was at $11,560, having recovered by 18 per cent from prior days but still heavily down on its December acme of $19,000.) The South Korean threat is one to take seriously because that small nation accounts for 15 per cent of daily Bitcoin trading by volume.

The current total value of all cryptocurrencies held has still not topped $200 billion, which is a drop in the ocean compared to the many trillion-sized asset classes knocking about. What’s more, they’ve not attracted institutional investors such as pension funds or insurance companies.

This means that

  • If it’s a bubble, it’s a pretty darned small one
  • No one, apart from foolhardy private investors, will be ‘number-oned’ (given a very short haircut) if things go south

However, the report mentioned in the link above quotes analysts at Capital Economics hedging when they suggest that blockchain tech does indeed have the potential to change the tectonics of finance:

‘Not only could it transform the financial system – by removing the need for banks to act as intermediaries – but it could have applications elsewhere, for example, in maintaining tax and hospital records. A particularly interesting element is smart contracts, which could transform supply chains and trade finance.’

There’s an explicit admission that the role of ‘intermediary’ (i.e., the banking system) in payment for goods and services is vulnerable to technological innovation. It always has been before, so why not now? Banks might still play a role selling investments, but they could be elbowed out of our day-to-day financial lives. Even those who argue that federal deposit insurance makes fiat currency a safer bet need to acknowledge that there’s nothing stopping insurance companies from offering privately administered insurance to back out Bitcoin balances.

Disappearing deposits?

In other words, it won’t all be doom and gloom for finance companies. It could get gnarly, though: deposits may be a relatively small proportion of bank’s total incoming cash, but they’re classed as core liabilities which can still be used to leverage much larger multiples of borrowed money. The latest (third) version of the Basel banking regulations stipulates that banks must retain no less than 4.5 per cent of their balance sheets as so-called ‘high-quality liquid assets’ (HQLAs). These are chips ready to be cashed in and used to stave off a run on the bank.

The leverage ratio compared to total capital must be in the range of 10–13 per cent. In other words, banks can borrow up to ten times their total capital value. US regulators’ requirements, similarly to many national variations, are stipulate that banks must hold up to 10 per cent of their assets in relatively high-class instruments.

In the pre-2008 bubble, banks with leverage ratios of 2 per cent were not uncommon. This meant they could borrow up to fifty times more than they were worth, and led to the huge speculative bubble in arcane, supposedly high-return, low-risk ‘mortgage-backed securities’.

Okay, these days banks are able to borrow less money to ‘play with’, but their capital ratios are still pretty low. In days of yore it could be as much as 50 per cent.

Whom do you trust with your pay check?

If substantial quantities of people refuse to deposit their pay checks in bank accounts at any point in the future, it could be painful for banks used to simply taking that cash as a birthright and then using it to leverage themselves to the hilt.

Imagine your friend gave you a hundred dollars to hold. You use that $100 to borrow $1000 dollars. You go to a casino with that $1000, but even if you lose your shirt and then some, the government guarantees that the original $100 goes back to your friend. Federal deposit insurance works something like that, except that it only has your back up to $250,000. Still, who the hell has $250,000 in cash sitting in the bank accruing just 0.05 per cent interest?

The long view

Bitcoin and its ilk remain highly volatile, small-scale financial phenomena. For this very reason they’re being pooh-poohed by mandarins such as the Bank of England deputy governor Sir John Cunliffe, who told BBC Radio:

‘This is not a currency in the accepted sense. There’s no central bank that stands behind it. For me it’s much more like a commodity.’

Over at the New York Federal Reserve Bank, meanwhile, chief executive William Dudley declared Bitcoin more of a ‘speculative activity’ than a currency.

They would say that, wouldn’t they? In the short term, they’re no doubt right. There’s no immediate prospect of Bitcoin replacing the dollar. However, we live in a 21st Century where our attention span is so diminutive that if something fails to make an impact in weeks, we discount it altogether. History shows that shifts in what we use as money can be gradual, taking centuries to bed in. Just because ‘Crypto 1.0’ isn’t taking over from the dollar already, it doesn’t mean paper fiat money’s days aren’t numbered. There are 11.5 billion $100 notes in circulation. That’s a bucketload of cash. Well over a trillion dollars. About fifty times Bitcoins potential worth at $1000 a coin.

It’s a fairly safe bet that cash is with us for some time to come.

A selection of further resources





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