Implications of brave new world of crypto, distributed ledger tech

Below is a commentary I wrote that was published?by The Straits Times here.

Crypto is having a moment. Whether you’re on the trading floor or at the kopi tiam, it seems you can’t escape whispers of Ethereum or Solano.

But while much of the focus is on the day-to-day price movements of bitcoins and other tokens, the more important story here is the rise of distributed ledger technology – or DLT.

Distributed, decentralized databases don’t sound particularly exotic. But the implications are both clear and wide ranging. Who needs an institutional middleman if two parties can match and transact without verification, trust or custodial concerns? The cost and time savings alone are substantial.

The benefits extend far beyond finance. We think cost-effective, rules based DLT networks will open the door to new transaction types, new behaviour, and new business models. The widespread adoption of DLT could boost global GDP by more than USD 1 trillion over this decade, according to a PWC forecast.

How might DLTs be used?

Finance is among the ripest sector for DLT-driven disruption, with clear application in markets which demonstrate some permutation of high inefficiencies, comparatively low volumes, limited price transparency, or rich transaction values. As finance professionals, we can see it being applied to private markets, syndicated loans, derivatives, and trade finance. Decentralized Finance (DeFi) is at the center of this, with programmable smart contracts that could automatically trigger contingent payments, lowering costs and boosting efficiency particularly for small businesses. In emerging or frontier markets, this could put an end to the lonely excel sheet – or worse, the paper ledger! With the right application, DeFi could help address inequality by reducing financial system frictions and broadening banking access for underserved communities.

We expect blockchain technology to also improve the speed and the costs of post-trade services, like settlement, custody, stock lending, and collateral management. Instead of multiple transactions, each with its own execution risks, a digital smart contract would instead automatically process complex multi-step financial requests as a single event in less than a second.

Blockchains could improve supply chains resilience and inventory management and expand the adoption and utility of Internet of Things connectivity. Healthcare, public services and arts and luxury goods could all benefit from DLT-driven changes to data ownership, authentication, provenance, and record management.

Aren’t regulators trying to shut down crypto?

Yes and no. China is the first nation to outright ban the use of bitcoin. It’s unlikely to be the last. And while the regulatory goals and severity will vary by economy, the days of laissez faire crypto appear to be behind us.

China has been maximalist in its regulatory approach, with successively harsher bans that have clamped down on all facets of crypto activity. The most recent came in late September, when the PBoC and nine other Chinese agencies declared all crypto transactions and mining activity illegal. International exchanges have been told that serving China-based customers will now be considered illegal.

The US by contrast has been more measured, with regulators and lawmakers split. SEC chair Gary Gensler last week likened stablecoins to casino chips, and the US Treasury is reportedly weighing more direct oversight and restrictions on these assets. But other voices, like Fed vice Chair Randal Quarles and Senator Pat Toomey, note opportunity in allowing private sector innovation. The speed of stablecoin growth and the steady adoption of crypto within traditional finance institutions does seem to have injected more urgency into the regulatory process.

Singapore, like a number of other economies, has sought to increase oversight and monitoring of crypto activity on platforms operating in its jurisdiction. Its 2020 regulatory framework has drawn participation from traditional financial institutions. Dominant crypto players have also entered the market, though platforms that run counter to local rules risk penalties and operation halts.

Isn’t crypto bad for the planet?

This is at least partially true. Bitcoin, the original crypto, is built on a proof-of-work system that has incentivized community adoption and participation. But it comes with a substantial ecological cost that has scaled up alongside its adoption and rising value. Bitcoin’s annualized carbon footprint is around 79 million tonnes, according to digiconomist, or roughly twice Singapore’s 2019 total emissions.

Ethereum’s annualized Co2 footprint measures at around 35 million tonnes, but this is expected to improve as it shifts to less ecologically taxing proof-of-stake model. For now, much of the invested capital in crypto remains aligned with activities whose ecological footprints and governance drawbacks outweigh the sporadic evidence of a positive societal impact.

For sustainability-minded investors, crypto’s ecological cost is a significant drawback and a major barrier to investment.

Investing in crypto and DLTs

Many of us are initially drawn to crypto coins by accounts of fast fortunes and soaring prices. Indeed, many crypto coins are programmed to be deflationary in nature, rewarding early adoption. The appeal can be hard to resist. We’ve seen very disciplined equity investors take outsized risks in little-understood token projects with uncertain utility or prospects.

In reality, direct exposure in crypto coins and tokens is suitable only for highly risk tolerant and speculative investors.

The volatility can make for fast-paced trading, and also the potential for permanent wealth destruction. A key challenge for would-be investors is the lack of a meaningful valuation model to forecast crypto prices. We can’t meaningfully tell you whether a crypto is cheap or expensive, let alone whether it will rise or fall in price. Another issue is historical data suggests bitcoin is not particularly useful as a portfolio hedge against risk-asset volatility or inflation.

There are more compelling ways to tap into the growth of blockchain and DLT. We see value in select enablers and service providers who will build the infrastructure, as well as platform companies that can leverage DLT within their industry. The latter is especially compelling, with businesses that adopt DLT into their industries today potentially setting up decades of growth ahead.

Finally, I would say before you jump on the crypto bandwagon, you should also examine your portfolio exposure to more established alternative assets. Do you have private equity, venture capital or hedge fund exposure? These may be investable areas with better risk-return characteristics to consider before taking a punt on the next Doge.

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