@Crypto Blah Blah and the Birth of Markets

Disintermediation.

And, desperation.

That’s what this is really all about. Together, these drivers produce an enormous amount of hype; a mixed wave of cryptocurrency insanity (and some blockchain legitimacy) washing over the global financial landscape…

These days, it seems possible to transform any topic, no matter how dry or serious, into an all-out circus. And, it can be difficult – even for those most disciplined at rationing their limited attention – to look away as the spectacle unfolds. I mean, who can resist a tale that includes cornering the market on graphical processing units (GPUs), “chestahedrons,” an Icelandic datacenter, the money flower, FUD and FOMO – among many other attention-grabbers?

The Disintermediation Driver

Now, typically, when the crowd rushes in one direction, I prefer not to follow – or, sometimes, head in another direction. Call it a bad case of intellectual claustrophobia. As a result, I haven’t been eager to weigh in on any of this craziness.

However, thankfully, the Swiss-based Bank for International Settlements (BIS) – sometimes otherwise known as “the bank for central bankers” – has come to my (and your) rescue. In Chapter 5 of its recently published Annual Economic Report – “Cryptocurrencies: Looking Beyond the Hype” –  one of the more thorough and sober analyses of the utility of cryptocurrencies is laid out.

And, despite a rather gloomy assessment – which an article in the 18 June edition of the UK’s Telegraph calls “the final authoritative nail in the coffin” – the BIS report does shed some positive light on the applicability of crypto’s underlying blockchain technology – which in more polite circles is sometimes known as distributed ledger technology (DLT) – to the reduction of various costs for transaction processing.

Of the more fascinating snippets from this report is the discussion on the “economic limitations of decentralized creation of trust” relative to the prevailing system of “centralized trust” we have today. For example, the current energy consumption footprint of the nascent global crypto market is already on par with the energy consumption of a mid-sized country like Switzerland.

Anyway, be sure to follow the links above to the report and article for a deeper dive, but here is the crux of the BIS position:

“For the trust to be maintained, honest network participants need to control the vast majority of computing power, each and every user needs to verify the history of transactions and the supply of the cryptocurrency needs to be  redetermined by its protocol. Trust can evaporate at any time because of the fragility of the decentralized consensus through which transactions are recorded. Not only does this call into question the finality of individual payments, it also means that a cryptocurrency can simply stop functioning, resulting in a complete loss of value. Moreover, even if trust can be maintained, cryptocurrency technology comes with poor efficiency and vast energy use. Cryptocurrencies cannot scale with transaction demand, are prone to congestion and greatly fluctuate in value. Overall, the decentralized technology of cryptocurrencies, however sophisticated, is a poor substitute for the solid institutional backing of money. That said, the underlying technology could have promise in other applications, such as the simplification of administrative processes in the settlement of financial transactions.”

Of course, most of us might expect a less-than-rosy assessment for the creation of decentralized trust from the mouthpiece of the centralized trust establishment, but that critique doesn’t necessarily mean they’re wrong. The BIS report illuminates several challenges in scaling the use of cryptocurrencies, and therefore, the limited potential they have to fully, or even partially, disintermediate fiat currencies managed by centralized intermediaries.

That said, a central bank-issued or other bank-issued cryptocurrency – like the Goldman-backed Circle’s crypto version of the US dollar – is a potential hybridized solution that could mitigate the weaknesses of the “permissioned” and “permissionless” DLT versions of cryptocurrencies.

Meanwhile, with so much successful innovation of late around peer-to-peer platforms, it makes sense to leverage technology to disintermediate excess costs out of the prevailing workflows, whether they be tangible or intangible. So, there is plenty of legitimacy to focus on in the underlying blockchain technology. This piece of the disintermediation trend definitely has legs.

The Desperation Driver

On the other hand, desperation is where some of the real craziness comes in. This part of the story comes in three flavors: those in search of employment; those in search of outsized profits in new, unregulated markets; and, those in search of volatility. I want to focus on the latter of these here (even though all three are interconnected):

You might think that some of the crypto-hype is warranted, since it is being legitimized in part by the credibility and prowess of the players who have recently entered this market over the past few months and recent years. From some big names in the venture capital arena – like, Marc Andreesen and the Winklevoss brothers – to some of the leading players in the banking and exchange world – like, Goldman Sachs, BMO Financial Group, Mitsibishi UFJ Finacial Group, Nasdaq, ICE, CME Group, CBOE, and TMX Group, to name a few – the growing institutional presence in the crypto market does suggest that some of the smart money is betting on growth and longevity.

Even proprietary trading powerhouse, DRW Holdings, is one of the leading players – with its Cumberland Mining unit  (established in 2014) – along with other high-speed, quantitatively-driven trading firms like Jump Trading, Susquehanna, Tower Research and Hudson River Trading (HRT). And, of course, the venture-backed startups in cryptocurrencies and blockchain technology are too numerous to list here.

But, why do these players legitimize a nascent, controversial and frankly, low-liquidity market today?

Volatility. More accurately, the hunger for volatility…

Here’s why, in a nutshell: First, of course, mainstream markets have entered a long, post-GFC phase of extremely low (or, suppressed) volatility, with few periodic exceptions. This suppression has played a significant role in killing off the traditional diversity of players in liquid markets to the point where there are now only whales swimming around hungry for snacks.  Some might say that there are no longer any suckers at these poker tables…

With this dynamic as a backdrop, consider that the best asset managers in the world prefer to construct their portfolios in such as way as to be long risk on both sides of a potentially volatile opportunity, like making a straddle out of a call option and a put option. In this way, they can capture (and even sometimes lock in) profits as long as the opportunity moves – and, as long as they can cover the cost of entering the opportunity (otherwise known in options-speak as theta) which they typically do by being short less volatile opportunities and/or actively trading around long-term positions.

Whether they satisfy this criteria only in the near-term or over a longer horizon, cryptocurrencies represent a new game – with lots of new poker players – that satisfies the opposite side of common factors, like decentralized vs. centralized, or digital vs. fiat, or even the disaster binary, new world order vs. old world order.

So, while the circus rages on – as exemplified by the bitconnect maniac in the John Oliver video below and the thousands of LinkedIn profiles that now (miraculously) include the credential “crypto / ICO / blockchain expert” – an increasingly sturdy scaffolding of real market infrastructure is being put in place so that no matter what happens next many of the more proactive incumbents have a chance to keep winning.

Besides, maybe its simply more fun – harkening back to so many days in the pre-GFC era – to build something new and exciting on a relatively blank canvas (even if a bit crazy) than to only be renovating the mature, heavily-regulated and lower-margin market infrastructures…


Some background, below, for those who want to explore some of the circus and the opportunities further…

And, as always, thanks for your attention. If you find value in this work, please like it, share it – talk about it – and, most importantly, send us feedback to feedback@alphacution.com…


By | 2018-06-19T22:54:51+00:00 June 19th, 2018|Alphacution Feed|

About the Author:

Paul Rowady is the Director of Research for Alphacution Research Conservatory, the first digitally-oriented research and strategic advisory platform uniquely focused on modeling and benchmarking techno-operational dynamics, and the business impacts of those decisions, in and for the global financial services (FSI) ecosystem. He is a 30-year veteran of the proprietary, quantitative / automated and derivatives trading arenas with specific expertise in strategy research / implementation, risk management, and technology development. Contact: feedback@alphacution.com; Follow: @alphacution.