Written by our Director of Equity Advisory, Jeremy McKeown, the HyperNormalTimes provides in-depth and considered long-term commentary on major macroeconomic and market-shaping themes.

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October 14, 2021

Should the BBC Regulate the Internet?

Crypto technologies offer a prospect of radical improvements in financial services. However, while the financial stability risks are still limited, their current applications are now a financial stability concern … …bringing the crypto world effectively within the regulatory perimeter will help ensure that the potentially very large benefits of the application of this technology to finance can flourish in a sustainable way…. John Cunliffe, Bank of England, October 2021 

John Cunliffe, Deputy Governor of the Bank of England, gave a speech yesterday warning that crypto assets might need regulating to prevent them from causing financial instability. His central assertion is that a collapse in the value of crypto assets due to their lack of intrinsic value could spark a financial crisis how the failure of subprime assets caused the global financial crisis. Because of this potential risk, he feels crypto-assets will soon require regulation. This view is more informative about his world of centralised banking than it is about the decentralised world of crypto-assets.

The first point to make is that subprime assets are regulated products supplied by regulated entities. They also have intrinsic value. They are asset-backed and generate income. However, none of this mattered between 2007 and 2008. Following a 40% decline in these assets’ perceived value, some highly leveraged and regulated entities (Bear Sterns, Lehman Brothers, Northern Rock and Merrill Lynch) became insolvent. This significant drawdown in value was not unprecedented in the history of financial markets. But due to this seismic shock, the lesson we live with today is that the regulated world of centralised money is fragile, as we still pay the price of its lamentably poor oversight.

Just as Lehman Brothers disappeared into the annals of history, leaving us with the bill, Satoshi Nakamoto published a paper called Bitcoin: A Peer-to-Peer Electronic Cash System. These were not coincidental events. Nakamoto’s paper explicitly referenced the bailouts and inherent instability of fractional reserve banking. Hardly anyone took any notice.

Over the past thirteen years, the two financial systems of centralised and decentralised money have existed in separate worlds. The price that the traditional world of regulated banking paid to rehabilitate in society has been to neuter itself from risk, and therefore growth. Indeed so frustrated have governments and their central banks become with the banks, they are now looking at ways of by-passing them all together via the introduction of Central Bank Digital Currencies. But I digress.

In the same period, Bitcoin emerged from the shadows of Nakamoto’s white paper and has done rather well. When the internet reached 16 million worldwide users in 1995, no one was interested. By 2000 global internet usage had grown from 0.5% to 5%, 360m people were connected and everyone knew about it. The growth in unique bitcoin addresses is following a similar path to that of the internet. Bitcoin is probably somewhere like 1997 in internet terms.

Of course, this does not mean that bitcoin will supersede fiat currency and overrun the analogue banking and finance industries. But what is clear is that just like the internet’s architecture, bitcoin’s architecture is very resilient (perhaps even anti-fragile). In contrast to the fragility of the fractional reserve banking industry overseen by the Bank of England that requires episodic socialisation of its toxic by-products, bitcoin has grown despite (or maybe because of) repeated setbacks.

In 2021 bitcoin mining and ownership has been outlawed in China (and not for the first time). As of January this year, China had the largest share of bitcoin mining capacity in the world. Today it is North America. Over this period, the bitcoin price more than halved from $60 000 to $29 000. However, what is notable is that in this drawdown, not a single owner, miner, trader, or exchange operator demanded a bailout, and none defaulted due to margin calls or over-leverage.

Bitcoin and other crypto-assets create credit by a system of trustless over-collateralisation, the exact opposite of the basis for fractional reserve banking. Bitcoin’s price volatility might be a negative feature, but it is understood. While most observers wrote it off in 2017, when the price fell from $20 000 to $3 000, bitcoin’s underlying network adoption continued to grow.

I have no idea where the worlds of centralised and decentralised money will end up. I hold bitcoin among other real assets mainly because I don’t think centralised money and banking have a track record or future I can afford to completely trust. I hope I am wrong. But investors need to assess and prepare for uncertainty, including the potential for radical uncertainty.

The Bank of England regulating crypto assets would be like allowing the BBC to regulate internet in the 1990s.

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