Cryptocurrency is taking the business world by storm, paving the way for digital currencies as the payment method of the future. Decentralized from banks, cryptocurrencies use encryption to regulate funds and verify transfers. The allure of cryptocurrency lies in their anonymity and security, allowing users to store money safely without providing any personal details (McGoogan & Field, 2017). Although, the lack of governmental authorisation means that banks are highly unlikely to join the “Cryptocurrency Renaissance” (Etsebeth, 2017) by endorsing it as an official currency.
Aside from Bitcoin which launched in 2009, multiple cryptocurrencies have emerged, including Ethereum, Ripple and Litecoin (Scott-Briggs, 2016). Bitcoin is the most developed and commonly use digital currency, valued at over $234 billion as of January 2018. Introduced by Satoshi Nakamoto, Bitcoin promises lower transaction fees than traditional banks, and uses peer to peer technology to facilitate instant transactions (Investopedia, 2015).
Other popular cryptocurrencies use decentralised computer encryption to support peer to peer payments, and are all alternatives to the flagship system. Essentially, all currencies offer similar benefits, but may include original features unique to their brand. For example, Litecoin offers faster payments, and Ripple allows consumers to use other forms of money aside from cryptocurrency. Another system, Ethereum, includes terms of a transaction into a “smart contract”, better protecting users from fraud. Currently, the CoinMarketCap publically lists over 850 different cryptocurrencies, and this myriad of options allows potential investors to tailor their choices based on their individual requirements (Greene, 2017).
Investors are drawn to cryptocurrencies for their high returns and endless possibilities. However, high expected return correlates with high risk, and thus, digital currencies are notorious for being volatile, risky ventures. Of course, being a new system, many consumers struggle to understand how cryptocurrencies work (Helmore, 2017), yet they are willing to take the risk in raising funds for new ventures. The process of introducing a cryptocurrency into the market occurs via an initial coin offering (ICO), where the required initial investment amounts may differ.
The market for ICOs is indeed booming, with new ventures creating hundreds of new assets (i.e. coins or tokens) that, in turn, can be used to power yet-to-be-developed peer-to-peer block chain networks. Speculators are attracted to the potential of building on decentralised blockchains, and this is what drives the funding of ICOs.
However, independent of governmental control and held amongst the people for the people, there would be little opportunity to regulate any transaction without compromising the integrity and technology of the software that supports cryptocurrencies. The only option – to introduce capital controls – would be difficult, costly and time consuming to enforce (Financial Times, 2017). As a result, regulating cryptocurrencies would be virtually impossible.
Blockchain, the underlying technology of Bitcoin, is now a very attractive prospect to financial institutions and asset managers. This technology, by having the potential to disrupt and enhance processes and systems, is now drawing significant focus as well as investments from many financial institutions, including asset managers. Given the technology’s potential to both disrupt and enhance processes and systems, many firms are dedicating the resources necessary for understanding blockchain and integrating it into their business.
Benefits of blockchain
Functionally, blockchain technology is a shared record or distributed ledger that is highly flexible with a plethora of potential use cases within the asset management lifecycle. In the real world, it can be used to streamline portfolio management, speed the clearing of funds and settle trades quicker. This, in turn, will ease the compliance burdens associated with know your customer services and antimoney laundering checks. By eliminating redundant functions, using blockchain in a business can reduce operational expenses and increase opportunities to enhance the client experience. While hedge fund managers may not use blockchain technology to replace current systems, they will find it can be leveraged to reconcile information across existing platforms or enable new infrastructure for new markets and products. (Ernst & Young, 2017).
Challenges of blockchain
As asset managers are still in the early stages of exploring blockchain and its applications in business, many are not yet familiar with how blockchain functions technically or how to reap its benefits. A few key challenges include:
1. Insufficient business problems to solve solely by blockchain technology. There have to be business cases to drive tech growth.
2. Scalability is a hurdle not yet passed for widespread adoption. To date, blockchain has seen limited deployment in situations requiring large volumes of data; the linear nature of technology limits its ability to handle such a high volume.
3. Product complexity can be difficult to integrate into the blockchain. After complex products are rolled out, parameters can be difficult to change later using a distributed ledger.
4. Regulatory and legal hurdles, as well as data privacy and high costs of replacing legal infrastructure.
Furthermore, the universal acceptance of blockchain technology by governments could potentially strike fears of undermining a country’s sovereignty in economic policy. This comes since monetary and fiscal policy is so reliant on the widespread acceptance of a domestic currency where the government has a monopoly over its production and distribution (ResearchGate, 2001). In a cashless society, the relative prices of good would remain constant according to the law of one price (Investopedia, 2015) – that is, when arbitrage opportunities due to price differentials across countries eventuates in the equalisation of pricing. In such a scenario, if the people were to prefer cryptocurrencies over their domestic currency, governments would be more vulnerable to the adverse shocks of capital inflow and outflows without a single common currency adjusting accordingly as an automatic stabiliser pursuant to the country’s economy.
Another issue concerning cryptocurrency is that since it is decentralised and anonymous, money cannot be tracked. Being unfettered by government control, this leaves cryptocurrencies susceptible to being used for illicit activity on the dark web as there is less of a paper trail that could assist in solving cases (DailyFX, 2017). As such, in a cashless society, illicit activities may become more economically rewarding to pursue given the lower risk of being caught.
To sum up, the technology surrounding blockchain is powerful when understood, and it does have numerous advantages. It increases the efficiency of transactions, reduces the holding cost of money (in the form of cash) and keeps relative prices constant across the globe, thereby accelerating globalisation. However, it poses a threat to the government as the single unitary authority on money within its own borders. In the face of widespread adoption of blockchain, many economies will face the threat of a loss of confidence in their respective domestic currencies, and thus, lose their autonomy in fiscal and monetary stabilisers. As such, the transition could momentarily destabilise economies. However, in the long run, it should improve economic efficiency from the lower holding and transfer costs of money whilst facilitating more global transactions.
Financial Times, 2017