HyperNormalTimes

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 24, 2020

The Digital Acceleration Includes Money

2020 has been a year of digital acceleration. We have seen this most visibly in areas such as e-commerce, video conferencing and movie streaming*. I believe we are also witnessing an even more profound digital acceleration. We are witnessing the digitisation of money. This has implications for what money is, the way we use it, who controls its flow and how its flow is intermediated. One of the (unintended) consequences of this development will be the increasing scarcity of Bitcoin and other decentralised cryptocurrencies. Bitcoin and decentralised finance are moving into the mainstream.

I own Bitcoin mainly as an insurance policy against the tail risk of the implosion of the global financial system. The risk of a rapid debasement of the global financial system has, in my opinion, increased due to the debt hangover from the GFC now being compounded by the unprecedented levels of debt incurred during the COVID-19 pandemic. While I hope the insurance premium will not be something I have to rely on, I  also suspect that Bitcoin’s decentralised architecture and limited supply will prove to be an attractive store of value over the longer term. I believe that my strategy is likely to have limited downside.

However, I have also felt slightly ashamed of my association with Bitcoin because of the widely held perception that it is an electronic Ponzi scheme, or simply a unit of currency for cyber criminals. The central view is, if you invest in this asset, you are either crazy or crooked. Bitcoin is regarded as a sub, or maybe counter, culture. It is not for discussion in polite circles. However, like Brexit, Bitcoin is becoming more widely accepted.

Over recent weeks there have been a number of events that each alone would not amount to much, but collectively aggregate to a meaningful trend leading towards a future where currency is digital. These include:

1. MicroStrategy Moves its Treasury Reserve Assets into Bitcoin.

Michael Saylor is not one of the well known US tech leaders. He is however an interesting and notable character. He is a graduate of MIT and wrote an insightful book in 2012 about the impact of the smartphone, called The Mobile Wave: How Mobile Intelligence Will Change Everything. He is also the founder and CEO of NASDAQ listed business intelligence software and cloud services provider, MicroStrategy Inc. In the scheme of NASDAQ technology stocks, MicroStrategy is a tiddler, with a c $1.8bn market cap. Due to its SaaS model MicroStrategy maintains a strong cash balance sheet position to provide reassurance to its blue chip customers and partners. In July this year MicroStrategy announced that it was reviewing alternative assets (other than dollar deposits and bonds) that it might consider as more resilient stores of value for its balance sheet reserve. A few weeks later in a further update the company announced that it had purchased $250m of Bitcoin followed by a further investment of $175m in September. Michael Saylor, who had gone on the record in 2013 saying that Bitcoin was an unsustainable fad, told CoinDesk “I want something that I could put $425 million into for 100 years”. Overnight Saylor became the hero of Bitcoiners on Twitter. (The HODLers). If you have the time (and it is well worth the investment) take a look at this interview he gave to HedgeEye TV. It is a fascinating development of the idea that Bitcoin is the next transformational digital network or platform asset with the same geometric growth potential of Facebook, Amazon and Google from a decade ago. This guy is bullish, but having just invested half a billion dollars into a digital asset, so he should be.

2. Square Invests $50m into Bitcoin -

Jack Dorsey is best known as the CEO of Twitter. He also is CEO of less well known payments provider Square (interestingly Square is more than twice the size of Twitter, with a market cap of nearly $80bn). Earlier this month Square followed MicroStrategy with an investment into Bitcoin by releasing the following statement: Square announced today that it has purchased approximately 4,709 bitcoins at an aggregate purchase price of $50 million. Square believes that cryptocurrency is an instrument of economic empowerment and provides a way for the world to participate in a global monetary system, which aligns with the company’s purpose. The investment represents approximately one percent of Square’s total assets as of the end of the second quarter of 2020.  Interestingly Square went further and issued a white paper on the way they executed their strategy to invest in Bitcoin and how they intend to account for their investment in order to allow other companies who might be considering a similar move to follow suit. Unlike MicroStrategy, Square is already commercially active in Bitcoin. Last year Square reported fourth quarter Bitcoin revenue of $178 million and gross profits of $3 million, up 50 percent over the prior period. This represented 50% of the total revenue for the period for Square’s cash app. Square can see things about Bitcoin that most others cannot.  Gartner analyst told CoinDesk: “If Square succeeds in growing its bitcoin business across the globe, especially in areas where fiat currency is not easily and readily accepted by merchants, and in hyperinflationary countries, the company will have a major advantage over its payment processing competitors”. This is a powerful statement, hyperinflationary countries might be just a handful of outlier countries today (Bitcoin’s popularity in Turkey is not a coincident), but what happens in a scenario of sharply rising global inflation?

3. PayPal to Accept Cryptocurrencies -

This week PayPal, the $240bn NASDAQ listed ubiquitous online payments provider announced the launch of a new service enabling its customers to buy, hold and sell cryptocurrency directly from their PayPal account, and signaled its plans to significantly increase cryptocurrency’s utility by making it available as a funding source for purchases at its 26 million merchants worldwide. PayPal’s CEO, Dan Shulman went on to say that:  The shift to digital forms of currencies is inevitable, bringing with it clear advantages in terms of financial inclusion and access; efficiency, speed and resilience of the payments system; and the ability for governments to disburse funds to citizens quickly. PayPal boasts 350m users worldwide, beginning in early 2021, they will be able to use their cryptocurrency holdings as a funding source and will be able to instantly convert their selected cryptocurrency balance to fiat currency, with certainty of value and no incremental fees. In one move this potentially removes a major push back on Bitcoin and cryptocurrencies, their perceived lack of liquidity or acceptance as a medium of exchange. Bitcoin moves from being a digital store of value, to becoming as good as a dollar bill in terms of being a medium of exchange (well actually better because it is, you know, digital). Similarly to Square, PayPal also outlined the work it has undertaken talking to regulators, central banks, blockchain security and compliance specialists, allowing others to follow its path towards the adoption of fully digitised money.       

4. Central Bank Digital Currencies -

Governments and their central banks are not blind to these developments. There are increasing noises coming from central banks from around the world that they are developing plans for Central Bank Digital Currencies (or CBDCs). The BIS (Bank for International Settlements) has said that it is working with ten major central banks including the ECB, BoE, Bank of Sweden and Bank of Canada to develop common systems and protocols for CBDCs and also have ongoing discussions with private providers of cryptocurrencies and payment service about there implementation. It seems that China is furthest advanced among the larger nations and is currently carrying out regional trials of its Digital Yuan. However, the first Central Bank to launch an operational CBDC came this week was the National Bank of the Bahamas launched the Sand Dollar. (Interestingly the Sand Dollar is pegged in value to the Bahama Dollar which is itself pegged to the US $, effectively making the Sand Dollar the first Digital US$). Meanwhile the Fed, responsible for the world’s reserve currency, has been researching a Digital Dollar for several years. Fed Chair Jerome Powell said recently that private initiatives such as Facebook’s Libra (stablecoin) project, have highlighted the need to lower the cost of cross border payments, and furthermore the onset of the pandemic has highlighted the need to get financial assistance directly and quickly to the poorest in society, (thus doing away with the need for helicopter pilots to deliver helicopter money). However, the Fed is also saying that more work needs to be done in terms of the security of the technology and the risks associated with its introduction. One of the reasons for the Fed’s hesitancy is the risk to the existing retail banking and payments ecosystems in a world where everyone effectively has an account with the Federal Reserve. This week the IMF seemed to weigh into the debate with a keynote speech from its Director General, Kristalina Georgieva, calling for a new Bretton Woods moment. While the speech did not make direct reference to CBDCs (there was mention that digitalization helps with financial inclusion as a powerful tool to help overcome poverty), its significance is mainly its direct reference to the the original Bretton Woods agreement. Bretton Woods first brought the IMF into existence to implement and control the world’s fiat money based banking and payments standards post WWII. A call by the IMF for a new Bretton Woods moment is a unprecedented. It is an admission that the current system isn’t working and a new system is required. Rather like the British Government calling for a New Norman Conquest.

Top Down and Bottom Up, Arriving at The Same Place

It is my opinion that the world is moving quickly towards the next phase of monetary order. Central banks are being tasked with the impossible job of providing direct financial stimulus to their citizens while at the same time manage growing government debt and contain the rate of inflation. The IMF  looks set to sanction a global financial and monetary order reset, probably involving the widespread issuance of CBDCs. This will enable governments and their central banks to directly control the expansion of money and credit as governments look for ways of deflating the debt they are incurring, hopefully without crashing their financial systems. While the central banks are all saying that they are only trialling digital currencies and they are mainly to be used as experiments, the reality is that CBDCs offer policy makers a step change in terms of their ability to control the monetary system and carry out their work more efficiently. With fully digital money negative interest rates can be imposed, tax collection automated, helicopter money and UBI payments targeted directly to those who qualify, and clearing banks become disintermediated (eliminating their threat to the financial system once and for all). There is a compelling case for government to digitise our money, the issue is whether they are able to execute this transformation without crashing the current system.

As we have seen above, in parallel to this top down central bank driven imperative, is a move to the more widespread adoption of decentralised cryptocurrencies from the private sector. This is not unrelated. Indeed the existential threat to fiat currency is what has driven MicroStrategy’s Michael Saylor to bet his “not inconsiderable ranch” on some blockchain code. It is why Square sees the value of Bitcoin in helping people avoid the imposition of hyperinflation, and has led PayPal to decide that its 350m customers require alternative ways of holding currency and financing their payments made to their 26m merchants. These corporates are dancing round the same handbag as the central bankers.

There are a large number of varied outcomes from the accelerated digitisation of currency. I cannot see a clear picture of how this plays out. CBDCs will be attractive and necessary assets for certain people and are useful for the implementation of government policy. Bitcoin and other cryptocurrencies seem destined to help build a world of instant verification, programmable money and smart contracts, all of which will help enable an AI driven high speed digital economy and the emerging spatial, robotic web. This in turn will put pressure on central banks and governments to keep up. How do you go about taxing something you can’t keep up with? This will be an ever increasing problem. How the different types of digital currency interact and how the market determines their relative value will be fascinating to observe. Whatever the outcome, I intend to hold my Bitcoin insurance policy for as long as possible. Michael Saylor makes a good case for it as a 100 year asset. I hope my grandchildren enjoy the legacy.

 

* To illustrate how the market is viewing the digital acceleration in 2020 compare share price performances YTD of Amazon (+80%), Zoom (+800%) and Netflix (+ 50%) to any of their non-digital competitors. Now look at the YTD performance of Square (+170%) and PayPal (+90%) compared to the performance of any bank. While this doesn’t prove anything about the relative value of any of these companies in the future, it does show the extent to which investors believe the rate of digitisation has accelerated YTD across many sectors, including money.

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