One of the ongoing problems regarding the adoption of cryptocurrencies by mainstream financial firms was on full display at a fintech event hosted by the Depository Trust & Clearing Corporation (DTCC) in New York this week.
The problem was highlighted by a fairly innocuous sounding question from the moderator: what is the problem that cryptocurrencies are trying to solve for?
Let me run you briefly through the answers that were given.
First up was Bob McElrath, blockchain architect at Fidelity Digital Assets, who said that the problem cryptocurrencies – the poster child of which is clearly bitcoin – are solving is mistrust of traditional financial institutions.
“The purpose of BTC really is a hedge against very large-scale failure, it’s a hedge against government failures, it’s a hedge against industry failures. That’s its purpose,” he declared.
McElrath noted that it could have a lot of other purposes, but that this asset class is new and so people are still figuring out how to use the assets.
A little more confidently, he added: “As a unit of account and an investable asset, it’s certainly there as a store of value.”
Next up was Justin Chapman, head of market advocacy and research at Northern Trust, who preferred to focus on digital assets more broadly rather than cryptocurrencies in particular. These assets, he said, enable financial firms to have trust throughout the lifecycle.
Expanding on this, Chapman said that the ability to have one version of the truth that can be shared and operated on, that is digitally audited and doesn’t require any significant reconciliation as a result, is very valuable. Giving an example, he said that distributed ledger technology (DLT) could create a bond issuance where the whole lifecycle to its completion and termination could be defined up front so that all the way through the transaction the back office settlement and operations activities required by the current models are not needed.
So basically, smart contracts for solving the problem of inefficiency in the back office.
What would Satoshi say?
Next, the moderator turned to the two platform providers on the panel and, noting that they both offer trading solutions, altered the original question slightly by asking what their clients are looking for.
Paul Chou, chairman, CEO and co-founder of Ledger X, was quick to jump in by stating that his clients are looking for uncorrelated investment opportunities.
He then added: “A lot of the ethos of bitcoin has been: how do we decentralise things so that there’s no central point of failure, then I’m not putting it into this one big bank or one big institution that we have to have faith in until it doesn’t work.…The decentralisation of money holding is a bigger thing that I think is really important. I think that’s probably what Satoshi would have wanted.”
Kelly Loeffler, CEO of Bakkt, which was launched by the Intercontinental Exchange (ICE), didn’t give any clues about why the platform’s clients might want cryptocurrencies themselves, but instead said that they’re looking for a safe, regulated way to access these assets.
“Our futures contract will be physically deliverable into bitcoin. I think what’s unique about this, is that it gives institutions a way to buy this for the first time in a federally regulated market and cleared through a federally regulated clearing house and custodied at a qualified custodian. That really doesn’t exist in that space today. I think the main thing we’re trying to do is provide that safe harbour through known, existing regulation,” she said.
To be fair, Loeffler did state later on during the panel discussion that she saw payments as one potential use case for digital assets.
No killer app yet
So let’s just break down a few of these comments quickly.
I get that the Global Financial Crisis (GFC) shook many people’s faith in the financial industry, but I’m just not convinced that today’s institutional investors are so worried about government or industry failures on a day-to-day basis that they would necessarily want to invest in cryptocurrencies as a hedge against them.
The idea that cryptocurrencies are a store of value is, at this point in time, still fairly laughable (see graphs). And because they’re not a good store of value, it’s hard to see Loeffler’s use case for payments being valid any time soon – who wants to buy a $5 Starbucks coffee with a digital asset that might be worth $15 in a week’s time?
The problem of inefficient back and middle office functions in financial services is a very real one, but based on Chapman’s comments, I don’t see why we need cryptocurrencies to solve this problem – it would only require DLT. Or at least, that’s what I thought until at the same fintech event, the keynote speaker, Neha Narula, the director of the Digital Currency Initiative at MIT Media Lab, argued that creating a single, shared data model and automatically executing business logic (eg. smart contracts) is actually better done through a centralised system.
Ledger X’s Chou is correct that some investors will see cryptocurrencies as an opportunity to put uncorrelated assets in their portfolios, but this alone seems unlikely to drive widespread adoption. Further, I remain sceptical that if you surveyed senior figures at institutional investment firms, they would cite banks holding their money for them as a major problem, and even more so that they would care about what Satoshi Nakamoto, the creator of Bitcoin, would have wanted.
This is the problem as I see it: these comments came from four people who know their subject matter well (unlike many of the so-called crypto “experts” trying to foist themselves upon journalists these days) and yet they still seem to have largely different ideas about why, fundamentally, a financial institution would want to access and hold cryptocurrencies.
This is symptomatic of the cryptocurrency space more generally, where there are so many voices touting different arguments for why institutional money should want these assets, none of which feel overwhelmingly compelling right now.
This problem is not necessarily an existential threat to cryptocurrencies in the long-term. There can, of course, be multiple valuable use cases for these assets (I just wrote an entire section on the oft-cited Internet comparison, but started going down a rabbit hole and so I deleted!), some of which just need further refining and others which may not have been thought up yet. But in the short-term, I think this is a real challenge for the institutional adoption of cryptocurrencies.