There has been a lot of coverage in the press about Bitcoin and other Crypto-Currencies lately, sparked by the decision of the Chinese government to close down exchanges in their country and comments by high-profile financial leaders. When trying to understand why people say or do things, consider their motives.
For example, while Jamie Dimons most recent commentary on BitCoin reflects pure self-interest, it may well turn out to be true. His prediction that if crypto-currencies get too big that governments will close them down, reflects both the interests of banks as well as the government. The governments interest is rooted in the Federal Reserves mission to utilize monetary policy to influence the economy towards low inflation economic growth. If the US dollars supremacy as a reserve currency was threatened by competing cryptocurrencies, it is not hard to predict that they would want to take action to ban them. The same is true for the Treasury Department, which continues to finance massive budget deficits at extremely low (negative?) real interest rates. This is enabled by the significant global demand for US dollars. If THAT were threatened, either by a loss in confidence in the dollar, or because of competing currencies gaining ascendance, it would threaten this ability driving up the cost of servicing our multi-trillion-dollar debt. The result would be a massive spike in the budget deficit and widespread financial dislocation, so it is pretty simple to understand the motivation.
So, while Bitcoin and other crypto-currencies are a long way from posing such a threat, it is important to understand that Mr. Dimons observation is not a hollow one. Sadly, there is even historical precedent for the action he suggested. It occurred in the Great Depression, when the US Government, needing desperately to monetize the budget deficit created by the New Deal, effectively banned the use of gold. They acted first to confiscate US citizens holdings of gold at the (then) statutory price while banning private transactions in gold. Next, having procured the gold from its own citizens at an artificially low price, they revalued the price of gold HIGHER in dollars, to decrease the cost of servicing the governments debt. Since that time, many have suggested that the action should have been ruled unconstitutional, and that it could never happen again, but it is impossible to ignore the historical parallel.
Will the government act to do something similar to bitcoin? I dont know, but at least we should all understand why they might. We should also be cognizant of why people like Jamie Dimon must be expected to “dismiss” bitcoin in their rhetoric.
An important use-case for blockchain enabled cryptocurrencies (such as BitCoin) is to facilitate “trusted” transactions between parties that have no knowledge of, or ability to trust one another to make good on their part of the transaction. The ability to do so, for a fraction of the cost that card companies and banks charge, is both exciting and terrifying, depending on ones position. Even the simplest credit card transaction costs 2% to process, with extra fees for both financing and currency exchange. (This makes sense, since banks have no method of ensuring trust; their methodology is to insure the network against violations and profit if their losses are less than they charge for the insurance.) Debit cards are cheaper, and online versions even more so, but they still have limitations, particularly when a transaction is in a foreign currency to the cardholder. If, however, transactions can be processed on a blockchain enabled currency that can guarantee that the both sides of the transaction are genuine, it would potentially lead to major reductions in these costs.
Thus, while it is exciting to contemplate, for those of us who see the potential for crypto-currencies, it is not so wonderful if you run a firm that profits from that friction. Despite the likelihood that reducing global transaction costs will spur economic growth, it is equally likely that current businesses that rely on those frictions will be impacted severely. As we have seen in the equity market, automation and efficiency creates massive pressures on the profit margins of intermediaries, and JP Morgan is one of the largest financial intermediaries on the planet.
So, if you want to see a major spike in economic growth, caused by reduction in frictional costs of transactions, then cryptocurrencies excite you. If, however, you run a BANK that extracts economic rent from transactions, cryptocurrencies threaten your business at a foundational level…
It is worth, however, pointing out that none of this commentary holds any certainty or even an opinion on the current crop of crypto-currencies. As I said previously, It is too early to tell, however, if Bitcoin or Ethereum (or others) are going to be the equivalent of Google or will be the equivalent of Pets.Com, but the one safe bet is that a lot of money is going to be made by those that predict the answer correctly… It is also important to note that the Initial Coin Offering (ICO) boom hold many parallels to the internet bubble, particularly the OTC stocks that dominated message boards in the late 1990s and early in 2000.
There are several ICOs which have raised $100 million or more without either an operating business or even the developed technology to support one. This is clearly an issue, with eerie parallel to OTC BB stocks like NetTaxi, that had many of us on the Solomon Smith Barney trading floor excited in 1999. That stock rocketed from virtually valueless, to a market cap over $500 million before crashing back to oblivion, based on claims of internet community development and payment processing. It never made money and was out of business shortly after the bubble burst, like hundreds of other companies. What is interesting is that our current securities regulation did nothing to stop that mania, and while I expect the regulators to look into the ICO market, it is hard to understand the risk differences between ICOs and OTC stocks, particularly those on the “pink sheets.”
This does not, however, mean that the ICO mechanism is a scam or ponzi scheme. It is, at its foundation, a means for democratizing the initial funding of ideas. Its roots are in the current system, where private equity and venture capital funds have become a network of elite financiers, that has almost eliminated the ability of the general public to get access to early stage investments. Consider the returns that early stage investors made in stocks like Xerox, IBM, Apple, Cisco, and Amazon; investors were able to turn a few thousand dollars into a massive fortune if they bought early and held for a long time. Now consider that companies such as Facebook, Tesla, or Twitter waited much longer to go public due to the ready financing of both venture capital and private equity, and the problem becomes clear.
Despite all being large, multi-billion-dollar companies, the latter three provided far inferior returns post debut on the public markets. The simple fact is that technology companies are waiting longer than ever to go public, meaning that the public has no access to the most significant returns. While Facebook has returned over 500% and Tesla over 1500%, Twitter has lost money for investors that bought on the IPO. Compare that to Amazon, which has returned over 62,000%, Cisco which has returned 33,400% or Apple which returned over 25,000% to investors, and it is easy to understand why ICOs, which promise “ground floor” investment opportunities, have such strong appeal.
This does not mean that all, or even a significant number of ICOs are good investments, but it does mean that the demand will be strong. Thus, if and when the regulators get involved, the key is going to be improved disclosures of risks, documentation of business prospects, and requirements for corporate governance including coin holder rights at some level. This applies mostly for ICOs meant to be investments in future growth, as opposed to those ICOs being launched for new currencies / payment methods as well as those Application Tokens which are meant to pre-pay for services on a new blockchain or network. While all are potentially valid reasons for an ICO, it is clear that the main driver of the large valuations has been speculation. Thus, speaking for those of us who understand the benefits of the emerging blockchain technology, I hope to see limited, intelligent regulation, which can help this market mature, as opposed to the heavy handed prognosis of people such as Mr. Dimon.
