Download – Disruptive tech 2021 – 5 / 6 观点
Bitcoin prices reached an all-time high of $61,749 on 13 March 2021, the Treasury decided to take stablecoins seriously by launching a consultation into their regulation in January 2021, and the value locked in decentralised finance (DeFi) applications has now grown to over $50 billion. What's next for the future of the disruptive asset class?
The market cap of transactions involving Non-Fungible Tokens (NFTs) has skyrocketed from $41 million in 2018 to $338 million in 2020. An NFT is a type of cryptoasset which is unique (ie non-fungible), meaning it can be used to represent an interest in a particular item in the real world, a digital asset, or a blockchain-specific item such as an artwork. Some individual NFTs, like this CryptoPunk Alien that sold for $7.56 million, have brought eyewatering returns for sellers.
The majority of NFTs have so far been used in creative arts, but as an NFT can represent the ownership of any unique item, it is only a matter of time before NFTs represent contract documents, transferable warranties or unregulated assets such as bottles of rare fine wines. This begs the question: what does this mean for wider financial services? No doubt, this is something that regulators will be scratching their heads over as adoption increases.
With all the obvious risks of using cryptoassets in a quasi-financial system based on openly-accessible networks and pre-coded protocols, it was perhaps inevitable that insurance would raise its head. With projects such as Nexus Mutual's Armor.fi, it is possible to have one's own cryptoassets protected through the purchase of insurance tokens. Interestingly, it is also possible to stake these tokens with Armor.fi to earn a portion of the policy yield from customers.
Although the operation is a little different, this is a mechanism by which retail investors can buy into a (limited) reinsurance market. The reinsurance market is one that is traditionally the home of institutions and hidden from the public. How many other closed markets could crypto make available to a wider audience?
Smart contracts executed on blockchains allow wider access to trading synthetic derivatives alongside tokenised commodities and shares. For example, through Synthetix anyone in the world can buy a synthetic share of a company, a barrel of crude oil, or a tracker of the FTSE 100 index, all on the Ethereum blockchain 24/7 as these automated marketplaces are always open.
Funds and shares may be synthetically replicated, allowing investors to effectively avoid stamp duty, placing transactions out of the reach of regulators. Unless individuals honestly account for their gains, it is difficult to see how HMRC would be able to take enforcement action on tax evasion through such global decentralised marketplaces.
Interestingly, the tokenisation of traditional investments also presents opportunities for established institutions. The Perth Mint in Australia, a state run mint, has released its own approved Perth Mint Gold Token on the Ethereum network. This, in theory, provides the mint with global reach and, unlike traditional vaulted gold schemes, allows investors to buy the precious metals in any fraction of an ounce without having to bear the burden of storage costs.
Private companies run schemes, such as Tether Gold and Paxos Gold, which work the same way. Their tokens can be used as a stable token on DeFi applications, and deposited with cryptoasset-friendly finance institutions, meaning that investors may even earn interest on their gold. Being able to earn interest on what is traditionally a burdensome asset to own is an attractive proposition and, if it gains enough adoption, is likely to be replicated for other tokenised commodities.
The Kalifa Review on UK FinTech recommended that the UK release its own central bank digital currency (CDBC). This would be a stablecoin: that is, a cryptoasset token which is tied in value to a real-world asset, in this case Sterling. We have written about this topic before but it seems that with the Kalifa Review and Treasury consultation, the time may soon arrive where stablecoins are issued under the authority of the Bank of England.
As Andrew Bailey, Governor of the Bank of England, said in his speech on 3 September 2020, wide adoption of a CBDC would raise challenges for both the 'money' and the 'payment' aspects of regulation. This could breed opportunities for innovative payment service providers and it makes sense that Visa chose this year to become the first major payments network to settle transactions in the stablecoin 'US Dollar Coin'.
The UK is not the only country to be thinking this way. Sweden is already within the first pilot phase of its own e-krona. Given that stablecoins can be purchased globally, it is not surprising that Central Banks want to embrace this technology for fear of getting left behind by private stablecoin-issuing institutions, or decentralised ones such as MakerDAO.
The question is: with the most ubiquitous stablecoins in circulation (USD Coin, Binance USD, Dai and Tether) being tied to the value of the US dollar, have Central Banks arrived too late to the party to see widespread adoption?
The use of DeFi has skyrocketed since early 2020 in terms of total value locked in the protocols. DeFi protocols work in a similar fashion to the way traditional banks operate within money markets but investors can access the protocols without an intermediary, giving them access to interest rates on dollar-tied stablecoins alone of between 7% and 20% APR equivalent. With interest on cash deposits remaining low (typically less than 1%), the attraction of DeFi for more adventurous investors becomes obvious.
Conventional banks' interest rates for savers are held at rock bottom levels by the Bank of England, so returns on the scale of DeFi protocols are completely out of reach and there are other advantages. While servers housing blockchains on which DeFi protocols run must be located somewhere, the decentralised applications themselves do not require premises. There are no staff overheads, and few, if any, regulatory obstacles to clear.
Given trust in financial institutions is relatively low, it is reasonable to assume that DeFi's popularity will continue to grow in 2021. DeFi's lack of regulation may be outweighed by the potential returns in the eyes of some investors. At the time of writing, there is a significant knowledge barrier to entry, and there will only be so many potential customers that retail banks can lose to these automated competitors. If, however, uptake increases, regulators may be forced to consider how they can protect retail investors.
Organisations such as Celsius, BlockFi and Nexo offer a hybrid working model between traditional banking and DeFi. Under schemes referred to as 'CeFi' (centralised finance) in crypto-enthusiast circles, cryptoassets are used as collateral and handled centrally by an institution; the institution invests the depositor's cryptoassets or borrows against it, paying interest in return. With rates on offer between 8-10% (on stablecoins tethered to regular fiat currencies), CeFi offers a lightly-regulated hybrid between a conventional banking model and a true DeFi model.
It is difficult to say how these kinds of scheme will fare when cryptoassets enter their next bear market. But given that traditional institutions such as JP Morgan and Goldman Sachs have shown recognition of cryptoassets as an investible asset class in their own right, it is entirely possible that the successful banks of the future will expect to offer cryptoasset accounts and participate in global cryptoasset markets.
Back in 2018, we wondered whether or not cryptocurrency would survive another 12 months. We do not wonder anymore. NFTs, asset tokenisation, DeFi, CeFi, recognition by institutional players, even insurance – there seems to be no end of uses for cryptoassets in financial services.
The original Bitcoin whitepaper envisaged a world where financial intermediaries would no longer be required. With Bitcoin now routinely being valued at over $60,000 for a single token and piquing the interest of some of the biggest investment firms in the world, it appears Bitcoin has gone mainstream, seemingly at odds with the Satoshi Nakamoto vision.
Even Li Bo, deputy governor of the People's Bank of China (which recently launched a pilot project on Central Bank digital currencies), referred to Bitcoin and stablecoins as an "investment alternative". Ray Dalio, the founder of US investment firm Bridgewater Associates, has reportedly stated that "Bitcoin has proven itself… as money with imputed value", making it an investible asset.
However, with the DeFi protocols and CeFi companies seemingly coexisting reasonably comfortably, it looks increasingly like there is room for both the classic institutional models of finance and the anarcho-capitalist ideals of the crypto communities.
Whatever happens, we can be confident that blockchain technology will continue to disrupt traditional ways of operating in the financial markets, providing both threats and opportunities as development continues.
To discuss the issues raised in this article in more detail, please reach out to a member of our Technology, Media & Communications team.