Category Archives: Opinion

Why Europe Bests the US at Attracting Crypto Startups

For years lawyers have warned of the risks associated with running a cryptocurrency business in the United States, especially when a token is involved. Regrettably, those risks are more apparent than ever.

As New York- and Austrian-licensed attorneys, we’ve talked countless clients out of publicly selling tokens in the U.S. or generally pursuing their businesses there. We’ve personally witnessed one of our European clients – a small fish by anyone’s account – fall victim to U.S. regulators’ zeal to shape the law through enforcement, presumably to establish precedent to go after bigger and badder actors in the distant future. 

Bryan Hollmann is of counsel at Stadler Völkel Attorneys at Law, a technology-focused law firm in Vienna, Austria. Oliver Völkel is a founding partner at the same firm.

The saying “the gears of justice turn slowly” is particularly true for U.S. regulators, who just this year have secured important court rulings against companies that sold tokens in 2017 and 2018. One thing is clear: Token issuers in 2020 and beyond cannot ignore U.S. securities laws without risking severe fines and litigation many years down the road.

Fortunately, the U.S. is not the only market in the world where companies can raise capital by selling tokens. We agree with U.S. lawyer Preston J. Byrne, who remarked in a CoinDesk opinion piece:

It is also true that there are, without a doubt, countries in the world that do countenance token offerings. Go there. U.S. securities laws are not meant to restrict the sale of tokens in those places.” (emphasis added)

New token sales

The European Union is one of the hottest regions in the world in terms of raising capital through token offerings, according to ICO Watchlist. And, as more and more companies choose to put the United States on the list of banned jurisdictions alongside countries like Afghanistan, North Korea and Syria, the EU is bound to become even more popular. 

In the last year, European-based projects like Polkadot (Switzerland) and Bitpanda (Austria) have sold tokens worth millions of euros through initial coin (ICO) or initial exchange (IEO) offerings. Leading blockchain projects such as Ethereum and MakerDAO are supported by Swiss foundations, and up-and-coming players like Bitpanda and Morpher (both of which are clients of the authors) are Austrian companies that have concluded financing rounds with prominent U.S. venture capital firms while maintaining their headquarters in Europe. On top of that, Bitpanda raised EUR 43.6 million in 2019 by selling BEST tokens. Morpher’s public sale of its own MPH token is currently underway.  

See also: EU Proposes Full Regulatory Framework for Cryptocurrencies

There are good legal reasons why companies are attracted to Europe. For starters, there is no Howey Test, which in 2018 led Securities and Exchange Commission Chairman Jay Clayton to declare that “every ICO [he’s] seen is a security.” Most European regulators, particularly those in the DACH region (Germany, Austria, Switzerland), distinguish security tokens and payment tokens from utility tokens and acknowledge that utility tokens, for the most part, are not subject to financial services or capital markets regulations. 

Unlike in the U.S., European regulators simply do not have a history of cracking down on token issuers. And token issuers are far less likely to get bogged down in private litigation in Europe than in the U.S.

Differing regulatory approaches

These differing regulatory approaches to token offerings can be attributed to historical financing methods used by companies in Europe and the U.S. as well as their distinct legal systems. In the U.S., equity offerings are still much more common than in continental Europe, where debt financing remains to a large extent the prerogative of banks and large financial institutions. 

If the present is any indication, our bet is on Europe having the upper hand.

Europe does not have as long a tradition of capital markets exposure as the U.S., and while European capital markets regulation was heavily influenced by the U.S., the need to harmonize the definition of “transferable securities” among the EU member states prevented the EU from employing the Howey Test outright when adopting the Markets in Financial Instruments Directive in 2004. In our personal experience, the constraints of the civil law tradition in continental Europe as opposed to the common law systems of the U.S. and the U.K. also prevent national regulators from introducing a Howey-like test via enforcement proceedings anytime soon, despite efforts to do so particularly with regard to token sales. 

In contrast to the U.S., the EU has made significant progress in codifying regulations governing token sales. On Sept. 24, 2020, the European Commission published a draft Regulation on Markets in Crypto-assets (MiCA), which establishes a disclosure regime for token sales, and lays the foundation for stablecoin issuers and cryptocurrency service providers to securely operate within the EU. The regulation is expected to enter into force in all EU member states by the end of 2022.

Once adopted, the legal framework will provide legal certainty for token issuers and will help establish Europe as the go-to jurisdiction for crypto businesses. Time will tell how the divergent regulatory approaches in Europe and the U.S. will shape the crypto industry going forward. If the present is any indication, our bet is on Europe having the upper hand.

Disclosure

Banks Need to Adopt Crypto, Now

This year, crypto adoption in mainstream fintech has accelerated sharply. PayPal (PYPL), Revolut and Square (SQ) made much discussed moves. Recently, AllianceBernstein, a highly respected independent research house, published a report stating it has “changed their mind about the role of bitcoin in asset allocation.” And Rick Rieder, BlackRock’s chief investment officer, went on record on CNBC the other day to say that “bitcoin could replace gold.”  

The crypto industry is prone to announcements about future announcements. In 2016, these announcements used to be “blockchain” proofs of concepts that were never intended to see the light of day. And in 2020, these could just turn out to involve banks paying lip service to crypto to look innovative and avant garde. 

Ajit Tripathi, a CoinDesk columnist, is the crypto co-host of the Breaking Banks Europe podcast. Previously, he served as a fintech partner at ConsenSys and was a co-founder of PwC’s U.K. Blockchain Practice.

But, while crypto believers like me have a tendency to selectively hang on to the positive parts of these announcements, institutional endorsements of crypto are not insignificant. At a minimum, it’s clear that most major investment banks are now covering bitcoin for their clients and a large number of corporate and retail banks are furiously exploring how they can take advantage of the commercial opportunity presented by this level of retail and institutional interest in crypto. 

On a recent Citi Digi Money client podcast, Citibank Research’s Ronit Ghose asked me if crypto is finally going mainstream and if it’s time for banks to adopt crypto. While I don’t have access to the original recording or transcript, I have tried to summarize my analysis here. 

The future of money

The fundamental question regulators and banks need to ask is not whether bitcoin will go to $50K or $500K or whether the U.S. dollar will crash next week. It’s “what will payments and investments look like in the future?” How will consumers experience “money” and how will such a system of money and finance be governed and supervised?

As my good friend David Birch has highlighted in his brilliant book, “The Currency Cold War,” the future of money will be built not with cards, SWIFT messages and interchange fees, but with programmable tokens, networked services and intelligent wallets.

Banks have a steep learning curve to climb and crypto and DeFi provides precisely that learning curve today

To state his case in my own examples: If my son wants to pay for digital goods on his Xbox, my wallet will automatically use Fortnite V-Bucks. If I am paying for groceries, the mobile wallet will automatically select Tesco reward points accumulating tokens. A JPMorgan equity token will automatically send me the dividend as Britcoin (GBP) on schedule and DalioCoin held in my neighbors’ trust fund will automatically be locked until an edtech oracle attests that their privileged child has safely landed at Harvard, at which point the token will start releasing FedCoin for his or her socials and boat rides, no questions asked. 

This synthesis of crypto and the mainstream financial system towards this future of money is what we all must keep our eyes on. That is the big picture.

To get there, banks have a steep learning curve to climb and crypto and DeFi provides precisely that learning curve today. Banks that jump atop the crypto train will find untold prosperity in the digital frontier, and banks that fear of the unfamiliar will be lost forever in the wilderness. Resistance is futile and the time for doing nothing with crypto was two years ago, not today. 

Let’s dive further into how the world of money is changing today and what it means for banks.

Crypto has found real world utility

Critics still say that crypto has no utility other than speculation. I don’t know if bulls**t is a printable word, but that is indeed what that criticism is. There are at last four distinct use cases we can identify in the real world. 

First, if we look at economies like Nigeria where central banks are unable to provide sufficient dollar liquidity to small and medium businesses, such trade is often facilitated by bitcoin. In effect, bitcoin has partially displaced the U.S. dollar as the currency of foreign trade and unless there’s digital dollar liquidity made available without the current tyranny of geopolitical sanctions, the digital yuan will likely do so completely in the future. This thesis deserves an entire article of its own and I will take the subject on in the near future.

Second, in countries like Argentina or Lebanon, where there is no social security net and the domestic currency is highly unstable, bitcoin has provided a “digital money mattress” for hundreds of thousands of consumers. This is a real, humanitarian use case that can be difficult for Western Europeans or Americans to relate to. 

The third use case is exchange of value among internet-based communities or what I call “Burning Man Money.”  Historically we have built money for a world that’s geographically divided but that’s not the word we live in anymore. Around two billion people live in internet-based communities that require internet-based money to exchange value. Often these digital natives interact with their internet friends on the other side of the planet much more often than they interact with their next-door neighbors. Gamers understand this use case better than anyone and the rest of us are increasingly beginning to. 

The fourth and most important use case is decentralized, internet-based finance. Measured even by a blunt metric like TVL (total value of crypto assets deposited), DeFi is now a $15 billion economy growing rapidly month on month. This is the main reason banks need to integrate crypto – to learn and prepare for rapid disruption. DeFi is integral to the future of money in that DeFi replaces fire-walled financial services that use fire-walled money with networked financial services that use networked internet money. Those who understand the internet understand what this means. 

Regulators have shifted

When it comes to regulation, we are not in 2019 anymore. The education and advocacy work we did as a community between 2015 and 2019 has helped regulators see both the inevitability and the economic benefits of internet based money and finance. 

I categorize regulators in three overlapping buckets. First, there are regulators that tend to offer a knee-jerk reaction to crypto and say, “This is not money we understand, this is not money to be controlled, so we have to shut it all down.” These regulators actually try to enforce draconian regulations with little nuance or discretion. 

The second and most common bucket is the regulators who are afraid of the uncertainty created by technology led disruption, but they recognize that there is a genuine consumer need for decentralised internet-based money. For example, regulators in Nigeria, India and China have made strict pronouncements to protect consumers from scammers like PlusToken and OneCoin while rarely enforcing the rules against businesses built on decentralized assets like bitcoin or ethereum.

The third bucket is forward-thinking regulators who understand that crypto innovation is a source of competitive advantage for the financial system they are supervising. Literally every regulatory body I have interacted with over the years has at least one or two forward-looking visionaries like the Securities and Exchange Commission’s Hester Peirce or the Office of the Comptroller of the Currency’s Brian Brooks, who have been engaging proactively with the industry to create a safe environment for crypto innovation to deliver consumer benefit.

Regulators are competing for innovation

Unlike the neolithic payments systems of the U.S., the European Union and India have shown that instant and free domestic payment systems like SEPA and UPI can be made to work well with existing technologies and frameworks. However, point-of-sale experiences remain firmly stuck in plastic and interchange fees and cross border payments remain a profound embarrassment for the entire global financial system. 

In Europe, we have tried to solve these problems by creating a rule, committee or think tank. Initiatives such as the EU-wide Payments System Directive 2 have been delayed or thwarted by legacy institutions often on account of somewhat valid cybersecurity and fraud related concerns.

In the middle of all this analysis-paralysis, there’s stiff competition for innovation. While the West tries to regulate, the East continues to innovate. On their own, bitcoin and cryptocurrencies may not have been enough of a wake-up call for Western regulators. But China’s central bank digital currency, i.e., the DCEP (or Digital Currency and Electronic Payments) system has forced the issue on digital money. U.S. and European regulators recognize that if the future of money is Chinese, then China will be the power that dominates trade and military power.

See also: Money Reimagined – Understanding China’s Fast-Approaching Digital Yuan 

China’s DCEP is a particularly interesting case because earlier this year U.S. sanctions practically debilitated Huawei. As a result, China recognizes it can no longer rely on an international system of money controlled by the U.S. or a domestic system of money controlled by Tencent and Ant Financial. Where does that leave a political system where the government is supposed to control everything? If it doesn’t control the money, it doesn’t control the payments, it does not have access to transactions. China’s DCEP is not an experiment; it’s imperative. 

Now that the China fintech FOMO trumps crypto FUD, regulators are taking a very different approach to crypto. The regulators are saying, “Look, if this thing is going to happen anyways, then we might as well bring it into a banking framework and regulation as opposed to saying, let’s keep this crypto thing out into an unregulated sector of money.” This is why the Bank of England’s Deputy Governor Jon Cunliffe recently pronounced that “it is not the job of the regulators to protect banks against digital currencies.” He will ultimately prove to be the first of the many to say central bankers that out loud.  

No one’s money

So whose money will we use as a settlement currency in a bipolar, or even multipolar, world? China’s money or America’s money? Odds are that we will need money that’s controlled by neither. That money is crypto. 

Bitcoin was originally built to serve as peer-to-peer electronic cash, but bitcoin is not cash because it’s not fungible. Further, bitcoin needs layer 2 solutions to process large-scale, internet-based payments. Banks and payments companies can help solve this challenge. If I want to move my bitcoin or pivot in a closed loop system where my bitcoin addresses are in two addresses within the same entity database, like PayPal, that you don’t necessarily need to move money across a blockchain, you can settle on a blockchain on a deferred basis. This way, Bitcoin or Ethereum can enable a cross-border, global settlement layer that allows cross-border transactions using digital assets that no sovereign state or private company controls. This trustless settlement layer is a necessity of a bipolar world where the U.S. dollar is no longer acceptable to other powers, e.g., China, as the only settlement currency. 

Crypto is the gateway

Fortunately, in the West, we still have free-ish markets where consumers and entrepreneurs do not wait for rule-making to make the world a better place. Crypto is changing as well. Crypto started with this vision of no credit, no debt. Some bitcoin maximalists naively believed that everyone was going to live off of bearer assets, but credit is fundamental to society and money. So crypto exchanges and firms like BlockFi ended up creating lending experiences that are not so different from the experience of fiat money-based services we receive from intermediaries today but they are a start. 

This synthesis of crypto and the mainstream financial system towards this future of money is what we all must keep our eyes on.

Like the rest of fintech, DeFi is not new finance. It’s a preview of the future of finance as the future of money is realized. Unlike fintechs who have been busy launching wooden and metal cards, the once ignored crypto fringe has moved rapidly towards programmable money tokens. More recently, intelligent agents like Yearn Finance, Aave and Nexus Mutual have started building financial intelligence, banking functions and complex claims directly into such tokens. At the same time, wallet providers like Coinbase, Metamask and Argent have started to enable access to sophisticated functionality provided by DeFi services. In a few years when the technology has evolved further and risk frameworks governing these decentralized protocols have matured, the 100x better experiences provided by DeFi will make it impossible for legacy systems to compete for consumer engagement or share of wallet.

That is the future of money and it’s happening right here, right now. Forced by customer demand for crypto, this is the future of money towards which Square’s Cash App, PayPal and Revolut have already taken the first step. If banks want to take their eyes off of this Napster movement, they will go exactly where Columbia Records and Blockbuster video went eventually – into profound irrelevance. Resistance is futile but it’s a choice, not destiny. 

Where should banks start?

The key for banks is experiential learning. They should start immediately by licensing technology and services from crypto custodians and offering digital wallets that provide integrated access to crypto and fiat money. This is something that Revolut has done particularly well using partnerships with custodians and exchanges. It’s not hard for banks to copy quite quickly subject to regulatory permissions and compliance approvals which can take time. This is like providing a locker for digital gold in the same way that banks provide lockers for jewelry and property papers today, just that these are going digital, starting with digital gold, i.e., bitcoin.

See also: Ajit Tripathi – Bitcoin Is Good for PayPal, but Is PayPal Good for Bitcoin?

The second step is to partner with crypto and DeFi startups, even if it’s in a learning or sandbox environment and experiment with programmable, digital money and wallets. What does this experience of self custody, or consumer controlled assets look and feel like? How do peer to peer, mutualized, permissionless, internet-based services work? What possibilities for automation, efficiency and transparency do such decentralized financial services present? This is an important learning exercise for DeFi innovators as well. 

The third step is to move from proprietary walled garden solutions to permissionless blockchain solutions. Permissioned ledgers were a good step for banks to experiment with shared operating models built on shared data and shared logic. That ship of “less closed but not fully open solutions” has now sailed. Now it’s time to take all that learning into an open, internet environment. 

Overall, to survive, banks have to go beyond superficial mobile apps and design payments and banking experiences for a far more internet savvy consumer who is ramping on to networked services that use programmable money. This is why integrating cryptocurrencies into banking apps and services is critical. A really good time for banks to start was last year. The next best time is today.

Disclosure

BitMEX Founder’s Charges Highlight Risks for DeFi

In October, the Commodity Futures Trading Commission (CFTC) and the U.S. Department of Justice (DOJ) filed enforcement actions against the entities and individuals that own and operate the Bitcoin Mercantile Exchange (BitMEX), a trading platform for cryptocurrency derivatives. 

The CFTC alleges that since 2014 BitMEX has operated an unregistered trading platform and violated CFTC regulations by, among other things, failing to implement required anti-money laundering (“AML”) procedures. The DOJ in turn is charging BitMEX’s three founders and its first employee with criminal violations of the Bank Secrecy Act (BSA) and conspiracy for willfully failing to establish, implement and maintain an adequate AML program.

Grant Fondo is a partner and co-chair, Meghan Spillane a partner and Galen Phillips an associate in Goodwin’s Digital Currency + Blockchain Practice. 

The BitMEX actions signal an expansion of regulatory scrutiny. These actions also emphasize that U.S. regulators will work together to hold individuals responsible for registration violations and inadequate compliance protocols.

While BitMEX is a highly centralized exchange platform where the founders allegedly still collectively exercise 90% ownership and control, the BitMEX actions also have implications for decentralized finance (DeFi). If DeFi platforms offer financial products to U.S. residents, such as derivatives, that would trigger registration or AML obligations for a centralized entity, what is happening to BitMEX suggests the platform and its founders may still face scrutiny from U.S. regulators. 

Background

Being registered in the Seychelles allowed BitMEX users to trade cryptocurrency derivatives. As of last year, according to the regulators, BitMEX has allegedly earned more than $1 billion in user transaction fees since 2014. The CFTC asserts BitMEX violated the Commodities Exchange Act by failing to register as a future commissions merchant.  The CFTC and DOJ also allege BitMEX failed to implement compliance procedures required of financial institutions active in U.S. markets, such as AML protocols. Users allegedly could register with BitMEX by providing a verified email address and were not required to provide any documents to verify their identity or location

Offshore registration and living offshore are not enough to avoid the jurisdiction of U.S. law enforcement.

The DOJ alleges BitMEX’s conduct constitutes a willful violation of the BSA. The CFTC and DOJ each assert jurisdiction over BitMEX based on allegations of defendants’ business in the U.S., and the soliciting and accepting of orders and funds from U.S. users.  The government alleges BitMEX’s “maze” of offshore entities was meant to obscure its significant contacts with the U.S. Despite being registered in the Seychelles, BitMEX allegedly has no physical presence there, but does have many subsidiaries and affiliates in the U.S.  The CFTC also points out:

  • Approximately half of BitMEX’s workforce is based in the U.S.
  • It developed and runs its website in the U.S.
  • One founder allegedly lived in the U.S.
  • Another founder, while residing abroad, owns his interest through a Delaware LLC and has a U.S. bank account
  • BitMEX actively solicited and marketed to U.S. residents through participation in industry events and the development of a bounty program for U.S. users

The government alleges BitMEX’s withdrawal from the U.S. in 2015 was a ruse and that U.S. residents’ continued access to BitMEX was an “open secret” because BitMEX only required IP verification upon creating an account and allowed users to sign in through the Tor Network and VPN. 

The government also alleges the defendants attempted to avoid U.S. law by incorporating in the Seychelles, allegedly barring – but knowingly allowing – U.S.-based users to participate, and deleting evidence of U.S.-based users.  The DOJ alleges these steps to circumvent U.S. law reveal the defendants’ willful violation of the BSA.

Key lessons

Blockchain-based platforms involved in both centralized finance (CeFi) and DeFi can learn the following from the BitMEX actions:

Offshore registration and living offshore are not enough to avoid the jurisdiction of U.S. law enforcement. In assessing whether U.S. law applies to an exchange or platform, regulators will look beyond form and determine whether the substance of an individual’s or entity’s conduct provides sufficient jurisdictional basis.  

Avoiding U.S. markets is only effective if you actually avoid U.S. markets. Though tautological, a business can only avoid U.S. regulation by truly staying outside of U.S. markets. According to the U.S. government, it is not enough to disclaim U.S. contacts and take half-measures to achieve that goal.  Notably, the government focused in this case on BitMEX’s continued marketing efforts in the U.S. 

See also: BitMEX Says It’s ‘Business as Usual’ Despite 30% Drop in Bitcoin Balance After CFTC, DOJ Action

Founders and employees may have exposure for a platform’s activity if steps are not taken to comply with applicable law. If a platform has contacts within the U.S. or has not taken affirmative, reasonable steps to exclude U.S. persons from the platform, U.S. regulators may seek to establish jurisdiction. Even absent centralized ownership or founder control, regulators may target individuals within the company, including those who developed or created the digital asset, protocol or platform, if it was designed and launched without taking into account compliance obligations.

The absence of immediate legal repercussions is not proof of an absence of liability. The DOJ and CFTC cite conduct from more than five years ago.  Law enforcement need not, and rarely will, charge a defendant at the first sign of potential illegality. Thus, compliance with applicable laws should be a continuing priority, regardless of whether a company faces immediate regulatory scrutiny.

BitMEX has developed a reputation as one the largest and most successful offshore digital currency exchanges.  The government’s actions show how U.S. regulators will work together in bringing enforcement actions, bringing scrutiny to even those that might initially appear beyond the reach of U.S. law.

Disclosure

Privacy, Power, Fiscal Policy, the Poor: 4 Reasons to Worry About CBDCs

It has become clear by now that central bank digital currencies, or CBDCs, will be in our future and the technology will fundamentally change the use of money and the economic system as a whole.

The world’s biggest economies and their central banks have announced they are working on CBDCs: the U.S. Federal Reserve, the Bank of Canada and the European Central Bank are trailing behind the People’s Bank of China, which already is testing its CBDC with more than 50,000 citizens. The Bahamas issued its central bank digital currency – the “sand dollar” – in October.

Dr. Wolf von Laer is the CEO of Students For Liberty, an international educational non-profit operating in over 100 countries. He holds a Ph.D. in Political Economy from King’s College London and a Master’s in Austrian Economics from Universidad Rey Juan Carlos.

CBDCs promise faster settlements, better security, ease of use, instant implementation of monetary policy (if you consider that an improvement) and transaction costs that are lower than cash. In the future, these advantages will be stressed ad nauseam by pundits and politicians to make the technology palatable to the whole population. 

While all of the advantages are true, it is also crucial to think through the implication of the technology and how it could negatively affect the economy and the citizenry. There are different types of CBDCs with varying degrees of risks, and it’s important to understand the subtleties of these systems. However, all CBDCs need to be centralized and manipulatable to some extent because otherwise monetary policy would not be possible. 

As a contrast, Bitcoin is booming due to its decentralized, open, public, borderless, neutral and tamper and censorship-resistant properties. Depending on the type of CBDC, CBDCs can become the exact opposite, especially if central banks offer accounts to the public at large, implementing what is known as a direct model of CBDC

This article outlines four scenarios of how CBDCs have the potential to undermine economic stability and eradicate privacy. 

Centralizing power in the economic system

Governments are fallible. In the U.S., think back to the launch of healthcare.gov or federal- and state-level breaches involving sensitive data in more than 300 million cases in the last 10 years. With CBDCs, the whole economic system could be brought to the brink by bad updates or data leaks of the centralized ledger, which won’t be protected by proof-of-work in the same way as Bitcoin. For Bitcoin, it took a decade to build a robust decentralized computing power to assure the integrity of the blockchain. Governments won’t go to such lengths, and they need to rely on different, more fragile ways of protecting the centralized ledger. 

CBDCs = a dystopian nightmare

Government tends to collect as much data about its citizens as they can get away with. This happens under the guise of safety, as in the governor of the state of Michigan’s decree to document every customer’s personal information to contain the spread of COVID-19 or under the pretext of nudging people to become model citizens in the case of China. Imagine a social credit scoring system coupled with a CBDC. All your purchasing decisions could influence your score on which you depend for everything. Donate to the “wrong” non-profit like WikiLeaks? Whoops, you cannot purchase train tickets anymore. Bought some interesting adult toys for your spouse? Oh no, your credit score might drop, or your application for the government job does not get accepted.

What sounds like a far-fetched dystopian nightmare is already a reality in China. If you hang out with the wrong crowd, your citizen score, which is crucial for purchases, jobs, travel and so much more suffers. Pair this level of surveillance with the ability to track any purchasing decision you make and you have the perfect recipe for Big Brother on crypto-steroids. 

End to the informal economy

More than 60% of all jobs around the world operate in the informal economy. This results from the lack of free-market institutions like the rule of law, property rights and stable money in many developing countries. But even in developed countries like the U.S., the informal economy plays a huge role. Here the International Labor Organization estimates there are at least 30 million jobs that rely on the informal market. That’s a lot of livelihoods threatened by CBDCs. The informal economy includes innocuous things like paying your neighbor to fix your roof or paying a teenager to take care of your yard.

See also: Ajit Tripathi – 4 Reasons Central Banks Should Launch Retail Digital Currencies

Many activities we all engage in fall within the informal economy, and they are efficient. They make life easier, they overcome useless red tape and they save money. The government does not like this because it cannot generate tax revenue. Having a government ledger that tracks every transaction would make it virtually impossible to do anything within the informal economy, and a huge chunk of the 30 million jobs would vanish. A CBDC paves the way for a cashless society, which is very much in the government’s interest. Thus, it could be the end of informal markets, which are often a safe haven for many people in light of an ever-expanding regulatory state.

Central banks and fiscal policy

Admittedly, the pandemic has made central banks’ work almost in unison with fiscal policy. Governments “stimulate” the economy like never before. Of course, they run massive deficits doing that. Due to depressed interest rates, bond yields are historically low and demand for bonds is low. Normally, what happens? Governments would not issue as much debt. But governments do not have to worry if there is infinite demand produced at the push of a button by the Fed. The Fed predominantly buys all of the new debt and then some in secondary markets. This is an indirect monetization of government debt.

Now, CBDCs could completely do away with fiscal policy. Central banks could immediately generate cash and hand it out to small and medium-sized businesses. People with higher savings could get higher interest rates than the ones who do not save. Fiscal stimulus and a multi-layered interest rate approach are all possible when the government has all of your financial data. Governments will argue this is highly beneficial. Still, it bears the danger of manipulation, economic mismanagement and leads to an even faster monetization of government debt, the cost of which we all have to face by holding money with less and less purchasing power.

There are many more reasons to be wary of CBDCs, but I hope this article encourages you to think through this technology’s effects and what it means for you and your future.

The article benefited from comments from Marcelo Prates. All remaining errors are my own. The article reflects the opinion of the author and not the opinion of Students For Liberty.

Disclosure

Latin America’s Big Blockchain Opportunity

When I lived in Chile during the 2000s, I would bring a book to the bank because there was always a one-hour wait just to talk to a teller. Registering a mortgage for a makeshift dwelling in Rocinha (a favela in Rio de Janeiro) was a seemingly impossible task, as there were no formal ways to secure title for illegal settlements on invaded land. Returning defective products to a department store in Peru remains a Kafka-esque exercise involving documents and stamps and an excruciating process that might as well have included a body cavity search.  

It is not surprising that Latin America and the Caribbean have long been left behind economically, eternally dependent on the industrialized, developed north. In 2008’s “Falling Behind,” Francis Fukuyama brought together scholars to unpack the reasons why the economic gap between Latin America and the United States had grown so wide when in the year 1700 they were so similarly situated. The authors determined that poor public policy choices – including state-based investment and other government interventions – were, in part, to blame.  

James Cooper is Associate Dean, Experiential Learning and Professor of Law at California Western School of Law in San Diego. He has advised governments around the Americas on disruptive technologies in the judicial sector for over two decades.

Economic nationalism, undertaken through import substitution, strict capital controls and stifling regulation, made financial institutions lethargic, their balance sheets anemic and their service ethic customer-unfriendly, the group decided. Banks, insurance firms, consumer credit institutions and cooperative agencies of Latin America have long suffered with such inefficiencies, and have faced runs on accounts during economic unstable times as well as hyper-inflation and massive thefts of account holders’ deposits. 

It is no wonder that several Latin American countries resisted for so long joining the World Trade Organization and entering into bilateral or multilateral trade agreements with the United States. It was protectionism, mixed with a dash of fear of foreign competition and a sprinkle of cronyism.   

In 2001, the Peruvian sociologist Hernando de Soto posited that reducing bureaucracy (such as registering land titles) and regularizing businesses could unleash trillions of dollars of investment throughout the developing world. By ending decades of state intervention in the economies and opening society to market economics, he argued, states could enjoy economies of scale, growth through competition and other benefits that often come with market liberalization.  

A few states – Carlos Menem’s Argentina, Augusto Pinochet’s Chile and Gonzalo Sanchez de Lozada’s Bolivia to name a few – did implement these market-friendly reforms and grew their economies to varying levels of success. What they all had in common was the privatization of public services, free-floating their respective currencies and reducing tariff and other trade barriers.

Regularizing businesses could unleash trillions of dollars of investment throughout the developing world

Blockchain technology is the natural next step in this process. And the forgotten continent is a perfect proving ground. By decentralizing the financial sector and putting trust in distributed ledgers, there will be less need for traditional, inefficient and corrupt intermediaries like the financial services behemoths that that have long mismanaged the economy and injured depositors’ interests.  

Blockchain scholars rightfully view Latin America and the Caribbean as a complex patchwork of finance cultures and challenges. Settle Network, operating in Argentina, Mexico and Brazil – the economic powerhouses of the region – sees the potential of moving remittances, registering land titles, and facilitating payments for the massive regional communities of unbanked and underbanked. Chile’s Kibernum provides blockchain solutions for the private and public sectors and is committed to corporate social responsibility, a luxury for many companies barely scratching out a living there. Kibernum’s Marko Knezovic sees an opportunity for blockchain to forge a new constitution in Chile, a process that “should be highly transparent and immutable.” 

In the Caribbean, the Bahamas has adopted blockchain technology with its new Sand Dollar, making it the first country in the world to deploy a central bank digital currency. The Organization of Eastern Caribbean States is following suit as part of its Digital Transformation Project, sponsored by the World Bank. The regional group’s Eastern Caribbean Central Bank seeks to increase access to digital finance through a blockchain-enabled digital common currency. 

Even Haiti, the Western Hemisphere’s poorest country, is getting into the action. Karl Seelig of Digital Davos and ChainBLX is providing the blockchain technology and investment platform for the Andre Berto Fund and its gold mining operations “investing in building multiple dimensional economies, fighting the exploitation of labor.”  This means supply chain tracking to ensure no child labor is used and a micro payment system to undergird more equitable economic growth.  

Latin America and the Caribbean remain the most unequal continent in the world. But with blockchain solutions, some of the region’s historic dependency and underdevelopment can be undone. At the very least, some of the long waits in line for bank services, to pay an energy bill or to obtain a government license can be avoided.

Disclosure

Bitcoin Is the Biggest Big Short

Short-sellers, who make money when the price of a targeted financial instrument declines, aren’t always popular with corporate or government leaders. Those on the receiving end of contrarian bets against stocks or currencies tend to portray them as sharks undermining people striving to build, grow and create value.

This, if you’ll excuse the pun, is short-sighted. 

Short-selling is a necessary part of any functioning, efficient financial system. It provides liquidity, ensuring there’s a seller on the other side of each bid. And when viewed in totality, those occasions where the short-seller ends up winning offer invaluable signals on how society should better allocate resources. 

I say this because at a time when its price is again soaring, bitcoin should essentially be viewed as a massive short position against the entire financial system. (Even bigger than the “The Big Short.”)

Bitcoin is more than a hedge against inflation. Indeed, amid an extended period of historically low rates of increase in the consumer price index, there’s currently no clear correlation between bitcoin’s rising price and mainstream measures of inflation. 

Rather, bitcoin’s core value lies in its decentralized governance design being divorced from the political system, a feature no other asset of its size and liquidity can claim, perhaps with the exception of gold. 

Its positioning against inflation is an outcome of that, not its essence. If people lose confidence in their government’s capacity to sustain the trusted, social covenant on which fiat money is founded, the value of that money collapses, resulting in hyperinflation. Because of its depoliticized status, bitcoin gains in value in that environment. 

So if you’re long bitcoin, you are positioned to benefit if the system of governance on which the entire world depends for security and well-being collapses. Still feel good about it?

I’m here to tell you it’s OK. Just as short-sellers of stocks have not destroyed the stock market, neither will bitcoin investors bring down that system. 

Instead, what they’ll do, I hope, is pressure policymakers to reform the system in ways that better serve their constituents and sustain the social covenant of money.

Reading the signals

I don’t know about you, I like thinking the success of a long-bitcoin bet can lie in driving a constructive improvement in the incumbent system rather than destroying it entirely. After too many episodes of “The Walking Dead,” I can say with assurance that dystopia is not for me. 

But let’s be clear: Bitcoin’s nice fat gains do reflect people’s rising fear that our century-old governance model for the global financial system is failing. 

There are reasons: unsustainable debt levels; anemic growth despite masses of quantitative easing; economic inequality; the COVID-19 shock; and how, in a decentralized, social media information system where truth is being questioned, people sense a loss of agency in their and their communities’ lives.

Part of the problem is that elite conversations around the solutions are mired in the assumption the old system of government will continue as is. This feeds an expectation of failure, which bit by bit leads more and more people to believe that, even if they’re not “all in” on a bet against that system, they should hold some bitcoin in case the worst arises. 

the-big-short

(Paramount Pictures)

With all of that just-in-case hedging activity, the global short position grows and bitcoin’s price rises.

We need policymakers to recognize what those market signals are telling them: that the existing model is both failing and fragile. Currently, they do not. Let’s hope they get it soon because we all should care that the solution is not violent, destructive revolution but constructive evolution.

A new reserve asset

This is not an anti-establishment argument. It’s most definitely not an endorsement of the nihilistic ethos of Trumpism. 

It’s a call to recognize that bailouts (socialized corporate losses) and monetary stimulus (put options for stock market speculators) have papered over deep problems in the economy and done little to raise the happiness of the world’s citizenry. It’s saying we need a new approach to secure an effective market economy, one that empowers everybody to seize opportunities on a level playing field.

And if we achieve that, if the national government-run system evolves to a point where it regains popular support, what role does bitcoin play in that modified system? What is its larger purpose beyond being a hedge against systemic meltdown? It’s hard to see where the sustained value would lie in an asset whose only purpose is to hedge against that worst-case outcome if that outcome doesn’t eventuate.  

I think bitcoin’s purpose lies in it becoming a kind of societal reserve asset. 

This is a concept beyond both the ideas of a government-held reserve currency and of gold’s long-running status as a citizens’ hedge against monetary meltdown. The early elements of it can be seen in how bitcoin has been incorporated into decentralized finance (DeFi) as a kind of uber form of collateral. 

While we might not use bitcoin to buy cups of coffee, for which dollars or yen or something else will suffice, it could become a fundamental store of digital value upon which the overarching financial system rests. 

Right now, if you look at the global bond market, that role is occupied by U.S. Treasury bills, notes and bonds. Those U.S. government debt instruments provide the base-layer collateral upon which Wall Street has built a hierarchical system by which financial institutions extend all other forms of credit to the outside world. 

But in the future, once crypto ownership and market participation is sufficiently wide and digital asset markets are sufficiently liquid and sophisticated that price volatility declines, bitcoin could play a similar role. Its protocol-assured scarcity, along with its programmable qualities and its future capacity to interoperate with central bank digital currencies, stablecoins and other digital assets, will ultimately make for a superior underlying store of value than anything a trust-compromised government can offer up.

Don’t be distracted by strong worldwide demand for dollars. Confidence in the U.S. government-led global financial system is eroding, as the bitcoin short position itself demonstrates. Once that loss of trust reaches a tipping point, society will need another form of base-layer collateral to replace U.S. government debt. 

Therein lies a post-crisis role for the world’s most important cryptocurrency.

Podcast: stablecoins in Africa and South America

This week’s accompanying Money Reimagined podcast looks at the adoption of cryptocurrencies and stablecoins in emerging markets, which over the past year has seen real signs of life. Is this finally the moment to realize one of the great hopes of this technology: to enable financial empowerment in developing countries where traditional finance is constrained? 

To explore that question, my co-host Sheila Warren and I are joined by Elizabeth Rossiello, the founder and CEO of AZA, which has for seven years been developing digital payment solutions in African markets, and Sebastian Serrano, the founder and CEO of Ripio, which has been doing similar work in Latin America for more or less the same amount of time. 

Joe six-pack, where are you?

It has been a huge week for bitcoin, whose price is now closing in on the all-time high it hit in 2017 and whose market capitalization has already surpassed the high of that period. But in one very important way, this rally is quite different from that of three years ago. There’s a relative absence of the “FOMO” crowd, the retail investors who don’t want to miss out on the big winnings others are enjoying. And the following chart gives a pretty good representation of that. Unlike 2017, Google search activity around the term “bitcoin” – a proxy for the curiosity of the general population – has hardly budged from the levels of the past few years, even as the price has surged.

bitcoinsearchvolumeandprice_coindeskresearch_20nov19

Searches for “bitcoin” and the bitcoin price.

Instead of the retail investor commentary, this time the news around this up-cycle is dominated by big-name, deep-pocketed investors discovering bitcoin. It involves people like MicroStrategy’s Michael Saylor, hedge fund veteran Stanley Druckenmiller, Citibank analyst Tom Fitzpatrick and, earlier today, BlackRock CIO for Fixed Income, Rick Rieder, who hinted on CNBC that the world’s largest asset manager, with more than $7 trillion under management, now sees bitcoin as a better hedge than gold. This is a Wall Street rally, in other words, not a Main Street rally. 

“Once bitten twice shy” may be the reason retail investors are sitting on the sidelines this time. Too many people lost their shirts by piling into the trade at the peak of the 2017 bubble. Another may be that without the initial coin offering (ICO) boom that fueled an accompanying surge in hundreds of ERC-20 tokens alongside bitcoin, the buzz around the crypto rally generally isn’t as loud. 

But I think it’s also worth recognizing the logic of the rally is quite different. This one comes amid a backdrop of concern about the outlook for inflation, fiscal debt and political stability. Those concerns are being addressed by professional investors who are taking a long-term look at bitcoin’s potential as a hedge against all that (as per the column above.) This is less of a get-rich-quick rally, and more of an insurance play. 

That’s not to say those bigwigs aren’t also looking to make a killing. It’s also not to say that at some point this “professional” rally doesn’t excite another round of FOMO among the masses. While some investors are starting to protect themselves against a correction, the fact that Joe Six-Pack has yet to jump in could suggest there’s still upside in this for bitcoin.

Global town hall

DIFFERENT KIND OF SAME. “Innovation” is a magic buzzword that conveys progress and daring. That quality makes it ideal for obfuscation. Case in point: a piece on the website of the Official Monetary and Financial Institutions Forum (OMFIF) this week with the title “The second wave of central bank policy innovation.” 

If you’re looking for descriptions of radical new digital currency projects in places like the Bahamas, Thailand and China, you won’t find them in this report. What’s meant by “innovation” here is a variety of new means by which central banks are really just extending an existing playbook into new areas, specifically by buying a wider array of assets to pump money into their financial systems. It’s a more extreme, riskier version of the same new policy “tool” that arose after interest rates had been pushed to near zero after the 2008 crisis: quantitative easing.

The problem with endless “QE” is central banks are running out of government bonds to buy; fiscal debt issuance calendars can’t keep up. So, to keep the money expansion going, they are reaching into riskier asset classes, including municipal and corporate bonds. The U.S. Federal Reserve has set the example with its Secondary Market Corporate Credit Facility, with which it buys corporate debt, and with a separate program for buying municipal bonds. Now, we learn from OMFIF that after the Bank of England “introduced a term funding scheme for small- and medium-sized enterprises” in March, the same model has been adopted by central banks in Australia, Taiwan, New Zealand and elsewhere. 

With these schemes, central banks, which are supposed to be politically independent, become creditors to entities whose interests can be politicized. If these new debtors face default in the post-COVID debt reckoning, they will be tempted to call on the support of politicians they’ve backed to pressure the central bank to forgive or restructure those debts. This is what will ultimately undermine fiat currencies. Those bonds, now sitting garishly on central banks’ balance sheets as private or political assets, are supposed to more than offset the principal liability: the monetary base. Politicizing those assets will raise concerns about their future value, which will weaken confidence in the currency. 

So, whereas the OMFIF piece says these efforts show that “Central banks have shown a continued willingness to reinvent their monetary policy toolkits,” you could equally say they’ve shown a continued willingness to double down a 10-year old bet that’s reached the end of its usefulness. 

https://www.shutterstock.com/image-photo/bank-england-flag-historical-building-london-224846611

The Bank of England
(Shutterstock)

ELITE FACTORIES. Biologists offer a unique perspective on complex systems such as economies. In studying how ecosystems and species populations can reach breaking points caused by dynamics of the supply and consumption of resources, they find patterns that human societies tend to mimic over time. In that context, the latest observations by Peter Turchin, a pine beetle expert turned cultural theorist, are somewhat alarming. 

As laid out by Graeme Wood in The Atlantic, Turchin believes the hierarchies in Western societies like the U.S. are fueling tensions due to an “overproduction of elites.” Societies that have geared their education and professional systems toward rewarding a privileged but relatively large minority are struggling to find constructive uses for them, while the majority who lie outside of that elite bubble have no upward mobility. 

This, Turchin suggests, is the root cause of the angst playing out in events such as the still unresolved 2020 election. It’s leading to a breakdown in trust and the failure of institutions. 

What does this have to do with cryptocurrencies and blockchains? Well, in theory at least, those systems are supposed to reward people for their participation in open-source, collaborative development and, in their purest form, require no identification to participate. Crypto-based bug bounties, for example, can reward whichever developer finds vulnerabilities in software code without consideration of their identity or educational credentials. 

To think a blockchain development community is utopian is, however, naive. There are all sorts of ways in which the privilege of circumstance and upbringing rewards certain people and not others. It is no accident that the vast majority of crypto engineers are white males. It’s a product of a societally formed superstructure – the very same hierarchical system that Turchin said is powering toward its own oblivion. The trick is to figure how to take the best of these open development models while proactively seeding them with newcomers from outside the existing elite production facilities at top-ranking universities.

THE TIP OF THE ICEBERG. The debt crisis fueled by the COVID-19 shutdowns remains in suspended animation. It will get worse once stop-gap measures like rent suspension and mortgage forbearance run out next year as stretched creditors start to demand what is theirs. 

In fact, as shown by this Wall Street Journal examination of the U.S. government’s aggressive Payroll Protection Program loans to small businesses, the fallout may already be starting. The reporters found that “about 300 companies that received as much as half a billion dollars in pandemic-related government loans have filed for bankruptcy.” 

These numbers will surely rise. And as any student of debt crisis knows, bankruptcies beget bankruptcies. Each debtor’s default leaves their creditors with less funds to pay their debts. A self-perpetuating cycle takes hold. 

I think this looming problem is the core driver of why big-name investors are gravitating toward bitcoin. Governments the world over will be confronted with delayed bailout demands far bigger than those they’ve already faced. Can they afford to raise taxes to pay for those bailouts? Hardly. So, many will call on their central banks to do even more than they’re already doing to try to keep their economies afloat. (See the column and the item above for why that will be problematic.) The social covenant of money is at stake. Bitcoin offers an alternative. 

Well, that’s a gloomy GTH this week! (My editor, Ben Schiller, suggests rebranding the section to “Apocalypse Watch.”) Sadly, soaring bitcoin prices tend to correlate with bad news for everyone but crypto investors.

Relevant reads

What the History of Airlines Tells Us About Blockchain Commerce. In 2014, when he was at IBM, Paul Brody wrote a groundbreaking piece on the role blockchain technology could play in regulating the internet of things. He opined then on how this would unleash an entirely new economy in which pretty much every asset and product would be in play within a fluid digital marketplace that greatly improved price discovery and resource allocation. Now, as blockchain lead at EY, Brody is a regular opinion writer for CoinDesk. In this piece he returns to his IoT thesis and offers a history lesson on how these shifts could massively disrupt different industries – in this case focusing on digitization in the airline industry. 

The Dark Future Where Payments Are Politicized and Bitcoin Wins. I really don’t mean to take issue with JP Koning regularly. He is truly an excellent writer whose clear, BS-free thinking on money adds great perspective to our understanding of how it is evolving. But this is the second week running I feel compelled to counter one of his CoinDesk columns. As I lay out in this week’s column, I think it’s overly alarmist to assume that the only way bitcoin “wins” is for society to go into dystopian meltdown. It’s not an all-or-nothing bet. This is, as always, a good read, though.

Lightning Network’s New Liquidity Marketplace Attracts a ‘Surprising’ Mix of Individuals, Enterprises. The Lightning network has long been promised as a “layer 2” solution to increase the throughput and lower the cost of bitcoin transactions by removing them from the space-constrained main blockchain. The problem is that nodes need to always have pre-seeded funds available inside the payment channels they set up with counterparties. Now, it looks like there’s a decentralized system for resolving those moments when the bitcoin isn’t there. Colin Harper reports. 

CoinDesk Daily News. Get your daily fix of crypto news from this brand new, fast moving feature on the CoinDesk videos tab, featuring our new TV anchor, Christine Lee.

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Disclosure

The Complete Case for $100K Bitcoin

What a year – a global pandemic, a wavering stock market, rising numbers of unemployed people and continued uncertainty in global markets. Yet, we saw the bitcoin price recover from $5,300 in March to almost $18,000 at time of writing. That’s almost a 240% return within nine months.

For regular investors, the burning question is whether bitcoin is becoming overpriced. Is it too late to buy bitcoin?

Hong Fang is the CEO at OKCoin, a U.S. licensed, fiat-focused cryptocurrency exchange headquartered in San Francisco. Hong spent eight years at Goldman Sachs, leaving as VP of Investment Banking. She is a graduate of Peking University in Beijing, China, and has an MBA from the University of Chicago’s Booth School of Business.

If we put aside short-term volatility and take a long-term perspective, there is a reasonable path for the price of bitcoin to reach over $500,000 in the next decade. To go even further, I think BTC is likely to hit $100,000 in the next 12 months. Significant upside has yet to play out for bitcoin.

Bitcoin is a ‘store of value’

When we talk about the valuation of an asset, the first step is to understand the fundamental economics. Equities, bonds and real estate, for example, often derive their value from generating cash flows; therefore, valuation of these assets involves projecting future cash flows. Commodities, on the other hand, are more utility based and therefore their prices are anchored by industrial supply and demand. Before taking any action on bitcoin, I suggest asking yourself, “What is bitcoin for?” Use this as a baseline to form your own view of the value of bitcoin and its fair price range in a given time horizon.

Here’s my take as a HODLer:

  • Bitcoin is sound money and the first native internet money in human society.
  • It is scarce (21 million fixed supply), durable (digital), accessible (blockchain is 24/7), divisible (1 bitcoin = 100 million satoshis), verifiable (open-source Bitcoin Core) and most importantly, censorship resistant (encrypted).  With these superior monetary qualities in one asset, bitcoin is a great store of value. Once it reaches a critical mass of adoption as a store of value, bitcoin has huge potential to grow into a global reserve currency (and universal unit of account, too) over time.
  • The history of money shows us that natural forms of money generally go through three phases of evolution: first as collectible (speculation on scarcity), second as investment (store of value), third as money (unit of account) and payment (medium of exchange). As bitcoin goes through different phases, its valuation scheme varies, too. In my view, bitcoin is currently in the early stage of phase II. Below is a short summary of the two phases bitcoin has been through and respective value implications.

Bitcoin as collectible

Between its inception in 2009 and 2018, bitcoin was in its “collectible” phase. Only a small cluster of cypherpunks believed in bitcoin as “future sound money.” It was hard to come up with a valuation scheme for bitcoin that matched its fundamentals. It was also too early to tell whether bitcoin could succeed in building consensus around its “store of value” superiority. 

Bitcoin is built as a basic utility and doesn’t generate cash flow, so there is no way to forecast its price based on cash flows. Its circulating supply was easy to calculate, but it was really hard to estimate demand given the fickle nature of speculative trading. When speculative demand surged and drained out of the system, particularly around the initial coin offering (ICO) boom in 2017, we saw bitcoin’s price explode from $900 in early 2017 to $19,000 by the end of 2017, and then down to $3,700 by the end of 2018.

Bitcoin’s opponents usually attack bitcoin’s price volatility as a bug, but I believe that bitcoin’s price volatility is a unique and smart self-marketing feature. It was key to its survival in the early days. Bitcoin operates as a decentralized global network. There is no coordinated marketing team out there promoting bitcoin’s utility to the world. It is the dramatic price volatility that has continued to attract attention from non-followers, some of whom were later converted into believers, thus driving the continued momentum of bitcoin adoption. 

Bitcoin as investment

Bitcoin went through an identity crisis as “sound money” before it graduated into the second stage as an investment vehicle. Starting with the scalability debate in 2017, when the network became congested with historical high volume and transaction costs surged, its community had serious controversies (some called it “civil war”) involving the future path of bitcoin. 

See also: Bitcoin 101

As a result, on Aug. 1, 2017, the bitcoin blockchain was hard forked to create the Bitcoin Cash (BCH) chain to allow larger blocks as BTC stuck to a block size limit with SegWit adoption to enable a second-layer solution. On November 15, 2018, the BCH network forked again into Bitcoin Cash and Bitcoin Satoshi’s Vision (BSV).

Fortunately, bitcoin (BTC in this case) survived its growing pains (and the industry-wide bear market) and thrived thereafter. It is also through such public disputes (and price performance after hard forks) that BTC support and dominance has been further solidified, with an increasing number of addresses holding BTC and decreasing volatility

Then came 2020.

Banner year

This year has been an extraordinary year in many aspects, but it is truly a milestone year for bitcoin. The coronavirus pandemic has brought emotional and economic stress to many people on a global basis. On top of that, 12 years after the 2008 financial crisis and the publication of the Bitcoin white paper, we are reminded how easily our economy could be flooded with new money printed out of thin air; $3 trillion in new money was created in just three months in the United States, about 14% of U.S. GDP in 2019. The U.S. was not alone.

In 2020, it has been extremely hard for responsible savers to find reliable, real yields to preserve their hard-earned wealth. American middle-class families have had to either accept zero to negative interest rates at banks and debasement risk or bet in the all-time-high equity market when the real economy struggles, not knowing when the music will stop. In other countries, people must fight an uphill battle everyday to simply preserve the earning power of their salaries.

These macro themes are too strong for anyone to ignore. In contrast, the Bitcoin network had its successful third halving on May 11, 2020, highlighting the beauty of having monetary discipline pre-written into code and executed by the global network smoothly ever since. As a result, more investors in traditional finance (Wall Street institutions included) have started to realize that bitcoin has a unique hedging capability against long-term inflation risk, with a risk-reward profile better than its closest monetary cousin, gold.

Different from its 2017 ride, bitcoin’s current run-up is characterized by more vocal institutional endorsement: Square and MicroStrategy allocate treasury cash into bitcoin; the Office of the Comptroller of the Currency (OCC) allow U.S. banks to offer crypto asset custody; PayPal enabling crypto buying and selling; Fidelity making a case for 5% asset allocation and doubling down on crypto engineer recruiting; well-established traditional asset managers including Paul Tudor Jones and Stanley Druckenmilller announcing public support for bitcoin. The mainstream momentum is building up.

For the first time since its historic inception, bitcoin officially entered mainstream media as “digital gold,” a legit and credible (and liquid) alternative asset to consider for both individuals and institutions. The earlier comparison to “Dutch tulip mania” starts to fade. As more people educate themselves about what bitcoin is and start to embrace it not as a speculative trading asset but as a long-term asset allocation option, we can now look at its fundamentals and anchor price ranges with a simple supply-and-demand math.

Below are three scenarios used to triangulate bitcoin’s potential one-year trajectory.

Scenario 1: 1-2% US household wealth allocation?

  • According to the Federal Reserve, U.S. household wealth reached $112 trillion by June 2020 (top 10% owns two-thirds of the wealth).
  • 1%-2% of $112 trillion = $1.1 trillion to $2.2 trillion potential demand (Fidelity’s most recent report actually recommends 5% target allocation).
  • Current total circulating BTC is about 18.5 million. To keep it simple, let’s assume 21 million max supply are all up for sale.
  • Divide the potential demand by max supply, we get a price range of $56,000-$112,000. This scenario does not account for the rest of the world ($400 trillion global family wealth, according to Credit Suisse Wealth Report 2020). If we assume 1%-2% allocation of global family wealth, we will be looking at a $228,000-$456,000 price range. Would this happen in the next 12 months? Likely not. Can this happen within the next decade? I think that’s very possible. 

Scenario 2: 2%-3% of global high-net-worth individual allocation?

  • According to Capgemini World Wealth Report 2020, global HNWI wealth stood at $74 trillion by end of 2019 (~13% alternative, 14.6% real estate, 17% fixed income, 25% cash and cash equivalent, 30% equity).
  • 2%-3% of $74 trillion = $1.48 trillion-$2.22 trillion potential demand.
  • Divide the potential demand by max supply, we get a price range of $70,000-$105,000.
  • This scenario does look at global data, but only accounts for high-net-worth individual (HNWI) allocation, assuming that this segment has more assets to invest and investment decisions are more driven by institutional asset managers and advisers. I am also assuming a higher range of allocation here because HNWI are generally better positioned to take on more risks in search of higher risk-adjusted return.

Scenario 3: Catching up with gold?

  • There has been a long-standing argument that bitcoin would catch up to gold in market cap once it is widely accepted as a “digital and superior version of gold.”
  • Current gold market cap is $9 trillion. This is about 2% of total global wealth and 12% of global HNWI wealth.
  • 100% gold market cap means $428,000 price point for bitcoin. Can we get there in 12 months? Probably too aggressive an assumption. Can bitcoin rise to 20%-25% of gold in 12 months (aka 2.4%-3% global HNWI wealth allocation)? Possible. That would give us a price range of $80,000-$110,000.

There are additional factors that could add more upside to bitcoin. Given that we are still in the early stage of mainstream adoption, I don’t want to over-emphasize them, but I want to lay them out just to keep the perspective.

  • Potential allocation from corporate treasury management. We are already seeing early signs of that with Square and MicroStrategy. Square recently allocated about 1.8% of its cash balance to buy $50 million in bitcoin. Sizing up corporate demand for bitcoin is tricky, though. Each company has its own cash flow and growth profile, which will affect its risk appetite in asset allocation.
  • Potential allocation from foreign exchange reserves of all sovereign states. According to the International Monetary Fund, the global foreign exchange (forex) reserve was $12 trillion by June 2020, with the top three reserve currencies in U.S. dollars $7 trillion (58.3%), euros $2 trillion (16.7%), and yen $650 billion (5.4%). Is it possible to see sovereign countries allocate some of their forex reserves into bitcoin? I believe that trend will emerge over time when bitcoin’s superiority in “store of value” further plays out in the next five to 10 years. Assuming 25% allocation ($3 trillion, a little more than euro allocation), that is another $140,000 upside. Bitcoin catching up on the U.S. dollar as a dominant global currency reserve could take a long time to materialize, if at all but it is not impossible to see bitcoin among the top 3 list. 
  • Not 100% of bitcoin’s max supply would be available for trade. There is about 18.5 million in circulation. About 10% of that has been dormant for over 10 years. It’s tricky to estimate how much of the total bitcoin in circulation will actually be up for sale at different price points.
  • None of the above account for the dollar’s inflation rate in the years to come, which is about 2%-3% annually as a baseline. Neither do these scenarios account for the network effect of bitcoin, the possibility of bitcoin becoming more ubiquitous and reliable as a unit of account.

What could go wrong?

A one-sided investment case is never a good one. It is prudent to play devil’s advocate and assess downside risks. What are the major risks that may derail a bitcoin bull run?

Protocol risk

The biggest risk always comes from inside. Bitcoin has inherent value only because it has the unique characteristics of “sound money” (scarce, durable, accessible, divisible, verifiable and censorship resistant). If any of those qualities are compromised, the foundation to its investment case will be eroded or gone.

Such protocol risks were high in its first few years, but after two major controversial hard forks and three successful halvings, it seems that protocol-level risks are somewhat contained. The Bitcoin ecosystem has been consistent in independent developer support. According to Electric Capital’s developer report, the Bitcoin developer ecosystem has maintained 100+ independent developers every month since 2014. Additionally, we’ve also seen an increase in commits to the Bitcoin Core codebase in 2020, reaching a peak in May (around the time when the third halving happened).

It’s also encouraging to see major development milestones emerging on the Bitcoin Core network, including the merge of Signet, Schnorr/Taproot and increased focus on fuzz testing, to name a few. These protocol-level developments continue to enhance the privacy and scalability of the network, boosting bitcoin’s technical stability as a currency.

To ensure a healthy and safe future for bitcoin, it is critical to ensure the Bitcoin Core developer community remains independent and decentralized and continues to make steady improvements in critical areas like security and privacy. This is also why we have been passionate about providing no-strings sponsorship to Bitcoin Core developers and projects at OKCoin. Investing in bitcoin development helps reduce the protocol risk.

Concentration risk

This, to me, is the second0biggest risk to bitcoin. Bitcoin’s ethos is to empower individuals through decentralization, but the risk of concentration always exists.

Within the network, the risk lies in the concentration of mining power. It is not an industry secret that 65% of the world’s hash power is in China. If mining power is coalesced, a mining pool or group of miners can manipulate network transactions, creating fake coins through double-spending, in turn impacting the market price. However, there is also the argument that such concentration risk is inevitable but to some extent harmless, too, given how the network incentive has been designed for bitcoin. In other words, the incentives in the form of new bitcoins and transaction fees should work to keep the majority of the nodes honest because it is economically costly to cheat (not because it is hard or impossible to cheat). The assumption is that the mining participants are all rational and make economic decisions.

Externally, similar risk lies in ownership concentration. Investors, or “whales,” holding significant amounts of bitcoin can influence and even manipulate the market by triggering a change in price based on their buy/sell timing. Given that an individual (or an entity) can own more than one bitcoin address, it’s hard to paint an accurate picture of bitcoin ownership. So this risk does exist. This is also why I feel very passionate about promoting financial literacy and crypto knowledge. I believe that we can build a healthier and more sustainable future if more individuals come to understand what bitcoin is about and start to embrace it. The first institutional wave is exciting to see, but if bitcoin ownership tilts too much toward the institutional end, we would be defeated in our mission of building a more inclusive and individually empowering network.

Political risk

Another major risk comes from sovereign governments. Given that bitcoin is positioned as future money, it is possible that sovereign governments ban it for fear of threatening fiat currencies. Again, such risks are highest in earlier years before bitcoin builds meaningful adoption momentum. Actually, such bans have already happened in several countries (India in 2018, for example, which was revoked in 2020). Central bank digital currency (CBDC) experiments around the world could also have an impact on how bitcoin’s future plays out.

This year has seen the first wave of institutional endorsement for bitcoin, and therefore 2020 will be recognized as a milestone year in alleviating this political risk. When publicly listed companies, asset managers and well-known individuals start to own bitcoin and speak in favor of bitcoin, such a ban is going to become very unpopular and hence harder to implement in countries where popular votes do matter. I hope the momentum will continue to build, making a risk of total bitcoin ban increasingly remote as time passes.

In a world of uncertainty, bitcoin gives HODLers like me confidence. It has a huge network effect that can ultimately empower every individual who believes in it and uses it.

A successful and complete ban on bitcoin will also need to take coordinated efforts of all sovereign governments, which is very unlikely. As long as there are countries that let bitcoin legally flow, bitcoin will have a chance to win – a decentralized global network cannot be shut down by any single party.

That being said, bitcoin price volatility could be amplified from time to time by domestic and geopolitical changes. In my view, political risks remain the second-largest risk to bitcoin until it becomes too big to be tampered with. We are obviously far away from that point.

There can also be a wider payment ban on bitcoin while it is being recognized as legal financial assets. Such a risk is not totally out of the picture yet. The good thing is, we are not banking on bitcoin becoming the unit of account and medium of payment in our $100,000-$500,000 scenario. When bitcoin does progress to phase III, we will not be talking about bitcoin price anymore, but instead talk about everything else’s price in bitcoin.

Adoption risk

This is a timing risk. It is quite possible that it may take much longer than expected for bitcoin to go mainstream.

The only way to manage this risk is to make sure your bitcoin portfolio is properly sized.

If you invest in bitcoin (or anything else) and worry about where its price would be in the next 12 months, your portfolio of bitcoin is probably too big for you. Size it based on your own risk tolerance and conviction level in bitcoin. Don’t do more than what you can afford (or believe in).

I also believe the unique quality of bitcoin will speak for itself over time. Bitcoin’s price chart between 2017 and 2018 very much looked like a bubble. However, if we look at bitcoin’s full trading history, there is a clear upward trend together with growing asset-holding addresses, growing active addresses and growing network computing power. The increasing mean hashrate of the Bitcoin network represents the security level that one would want to see in a network where people’s wealth is stored.

I may be on the bullish side for bitcoin’s 12-month price trajectory but I truly believe that with bitcoin, time will be our best friend.

Looking ahead

Bitcoin is unlike any other asset we have encountered before. This is a truly sound and global wealth network that will continue to grow as the world recognizes the significance of its properties. To put things in perspective, here is a recent tweet from Michael Saylor, CEO of MicroStrategy, that summarizes the relevance of bitcoin as a utility and store of value.

In a world of uncertainty, bitcoin gives HODLers like me confidence. It has a huge network effect that can ultimately empower every individual who believes in it and uses it. I look forward to the continued evolution of the bitcoin ecosystem and feel excited about being part of it.

Disclosure

Open Finance Is Better Than Broken Finance

As much as the global economy continues to grow, we are leaving billions of people behind who don’t have bank accounts, a reality that is exacerbated by the economic impacts of the coronavirus. Without a bank account, a person can’t get a loan, invest or earn interest on savings. Decentralized finance, or DeFi, confronts this problem head-on by democratizing access to financial services. 

Anyone with an internet connection can deposit digital assets into DeFi protocols and start earning interest as passive income. They can put up their digital assets as collateral to acquire a loan. They can earn passive income by yield farming or by adding their digital assets to liquidity pools and collecting fees on trades. 

Making these types of wealth generation opportunities available to everyone, including people in developing regions, is what will eventually close financial inclusion gaps, help people out of poverty and transform global monetary systems for the better.

Gregory Keough is the founder of the DMM Foundation, the organization behind the DeFi Money Market (DMM).

While not a panacea – DeFi is still an immature industry with capital and human risks – it presents a ramp into a financial system where people can put their money to work. 

Over time, we’ve seen economic uncertainty spur interest in cryptocurrencies. Adoption of bitcoin increased in Venezuela amid hyperinflation, for example. Additionally, the Bitcoin white paper was released in response to the fallout from the 2008 financial crisis. We are in the midst of another period of economic uncertainty today, and are seeing surging bitcoin prices and skyrocketing participation in DeFi

As the United Nations Secretary-General (UNSG) António Guterres expressed in a recent speech, “We are experiencing the sharpest decline in per capita income since 1870.” With 70 million to 100 million people at risk of being pushed into extreme poverty, the World Economic Forum (WEF) is rightly focusing on financial inclusion initiatives. Patrick Njorge, governor of the Central Bank of Kenya, conveyed in a WEF article that digital financial services have been invaluable to helping keep people out of poverty throughout the [COVID-19] pandemic by “enabling people to pay for goods and services, receive compensation for their work, access social-assistance payments and secure financial support, such as bank loans, for their distressed businesses.” 

See also: Banking the Unbanked: How the Crypto Community Can Make a Big Impact

As advantageous as such digital financial services have been, however, they rely on a broken financial system and fail to address the core issues that are keeping billions of people from participating in the global economy.

How DeFi takes finance to the next level

DeFi’s ability to improve access to financial services, regardless of whether or not peopple hold a bank account, creates an entirely new framework for finance that is ultimately better for people.

First, DeFi systems allow anyone to get a loan. Lending and borrowing is key to business growth and entrepreneurship, and without loans many people cannot gain the financing they need to jump-start businesses or advance their livelihoods in terms of career, education and family growth. 

In the midst of the coronavirus recession, it’s that much more essential for entrepreneurs to gain access to capital, as small and medium businesses will be the primary job creators worldwide. When people have jobs, they purchase goods and services – actions that propel the economy.

See also: Frances Coppola – Why Bitcoin Thrives (and Why It Won’t Replace the Dollar)

Secondly, DeFi confronts the issue of currency debasement that has plagued traditional monetary systems since the abandonment of the gold standard. Given the lack of asset backing or a value peg, fiat currency inevitably experiences inflation. This means the dollar, euro or yuan a person earns today will be worth less tomorrow. 

Such a system is not conducive to business or personal financial growth. DeFi operates outside any government or central bank and so does not experience the same debasement as fiat instruments. DeFi protocols that allow for the generation of positive, stable yield are bringing earned interest back into the global monetary financial system.

As usability improves and more people become aware of DeFi services, participation gaps will diminish.

Furthermore, DeFi offers more privacy, resistance to financial censorship as well as much-needed transparency and accountability into financial systems. Given all code is public and available for anyone to review, DeFi ameliorates concerns of corruption and theft that flourish when transparency is lacking. 

Though thefts do occur on DeFi protocols, these hacks are generally due to negligence on the part of the protocol creators in conducting security audits. If there is a vulnerability in the code, bad actors will exploit it, hence a need for thorough smart contract auditing prior to launch.

What’s next for DeFi?

Given how revolutionary DeFi is, it’s natural to wonder why everyone isn’t already using it. For one, DeFi protocols have a way to go before ease of use is on par with online trading platforms like Robinhood or payment apps like Venmo. Admittedly, getting a loan using your digital assets as collateral is not yet as simple as making a purchase from Amazon.com. 

The ease-of-use hurdle is contributing to a lack of diversity in the DeFi user base that protocols should seek to address. According to a CoinGecko survey, DeFi users are dominated by males between the ages of 20-40 years old. As usability improves and more people become aware of DeFi services, these participation gaps will diminish.

See also: DeFi Dad – Five Years In, DeFi Now Defines Ethereum

Additionally, we need to continue to press for expanded internet access across the globe. Without internet access, people are barred from participating in the growing digital economy and all the financial services DeFi provides. According to a United Nations report on digital finance, “750 million people lack broadband connectivity.” As access to smartphones continues to expand, we will witness a global transition to DeFi to close financial inclusion gaps and ensure everyone can participate in the global, digital economy. 

Disclosure

What the History of Airlines Tells Us About Blockchain Commerce

We may be nearly 30 years into the internet era but nearly every asset, product and service in the global economy remains an offline asset. From cars to farm tractors to apartments to storage spaces, the truth is the vast majority of the world’s productive economic assets are offline. We don’t know if they’re busy or not, if they need maintenance or if they’re available to be rented. We can’t even find our car keys.

That’s going to end soon. In the coming years, a combination of blockchain, wireless networks and internet of things (IoT) is going to start connecting, digitizing and tracking the world’s stock of productive assets. Every piece of capacity can be represented as a digital token on a blockchain, accessible through smart contracts, and managed and available based on IoT-enabled connectivity. The impact is going to be enormous; some industries are going to be turned upside down overnight, while others might not change much at all. How will we be able to know and predict what will be impacted and how? I suggest a brief study of history.

Paul Brody is EY’s global innovation leader for blockchain. The views in this article are those of the author and do not necessarily reflect the views of the global EY organization or its member firms.

While the possibility of true digitization has been around for about 30 years, we still have a long way to go. One case study worth considering is the airline industry, which was one of the very first to be fully digitized and has had, to put it mildly, a very rough ride along the way.

In the fall of 2005, I remember landing at San Francisco International Airport on a flight from Dallas. Over the PA, the flight attendant thanked us, as usual, for choosing her airline. She concluded her message with a line that made the whole plane laugh: “We know you had a choice of bankrupt airlines for your flight today and we thank you for choosing us.” At the time, nearly every major U.S. airline was under the protection of Chapter 11 bankruptcy. For some of them, it was their second visit in less than a decade.

While the immediate cause of this particular wave of bankruptcies was a combination of the dot-com collapse and the Sept. 11, 2001, terrorist attacks, the financial situation of the major airlines had been dire for a long time. Since airlines were deregulated in 1979 there has been a steady stream of bankruptcies and mergers as the industry consolidates. This isn’t a story about deregulation, however; it’s a story about digitization.

The airline industry offers a unique and interesting real-world experiment in what happens when you digitize an industry. What makes this industry particularly interesting is that it’s possible to look at the impact of digitization as having effectively taken place from one moment to the next. This is because although digitization of the airline industry took more than a decade, regulations that governed where airlines could fly and how much they could charge meant that no real impact on pricing or economics could be seen while the industry was regulated.

Every piece of capacity can be represented as a digital token on a blockchain, accessible through smart contracts, and managed and available based on IoT-enabled connectivity.

Starting in the 1960s with American Airlines, airlines began a process of converting their reservations systems to fully digital, online systems. By the 1970s, every seat on every flight in the U.S. was part of a continuously available digital market. Travel agents (and eventually consumers) could search the entire national inventory of flights and seats, compare prices and issue tickets entirely online. Though it wasn’t until the 1990s that electronic tickets were implemented, the reservation and purchasing process was nearly completely digital end to end by the mid-1970s.

During this period of digitization, the industry economics remained largely unchanged, thanks to the regulatory environment. Prior to 1979, the Civil Aeronautics Board (CAB) regulated airlines, determining where they could fly and how much they could charge. The CAB also guaranteed a reasonable rate of return, provided there was sufficient passenger demand and limited competition between carriers. The result was an orderly national growth of air travel and a proliferation of different airlines, many of them profitable.

From the end of 1978, the Airline Deregulation Act rapidly phased out most price and route restrictions, and suddenly we had a free and open marketplace in which all the capacity was visible. The result was a bloodbath. Between 1981 and 2000, more than 30 major U.S. airlines declared bankruptcy and most of them never returned. Famous names from the earliest days of aviation disappeared, including Pan Am and TWA. Many of the others merged with the stronger survivors – “strong” being a relative term because nearly all of the industry’s “winners” spent a stint in bankruptcy as well.

See also: Paul Brody – Enterprises Need Third Parties for Oracles to Work

The economics of air travel are challenging for a couple of reasons. First and foremost, the marginal cost of flying an additional passenger on a plane is nearly zero. Selling that ticket for as little as a few dollars is better than leaving the seat empty. And because seats cannot be filled after take-off, there is always a “final sale” going on. This often leads to airlines selling seats that are at the margin, profitable, but are on average far below costs. 

Perhaps most painfully for airlines, and despite decades of work on everything from service quality to scheduling analytics it turns out most consumers buy their plane tickets based on only one major criteria: price. And though at times it may seem like the entire world is addicted to frequent flyer miles, they turn out not to be a strong enough lure to sustain substantially better pricing over a long period of time.

The result: Prices trended towards marginal cost of flying one more passenger (which is nearly zero) and far below the actual average cost whenever the industry has excess capacity. The industry has historically been good at creating excess capacity by both ordering more planes and getting much more efficient at flying those planes. Nor is parking the plane an option, not when they cost up to $100 million each and are purchased with borrowed money.   

Finally, and this is where digitization is so powerful, the structural elements of the ecosystem (high fixed costs, low marginal costs) are amplified by the digital marketplace. Every seat on every flight is instantly visible, making comparison-shopping and capacity-planning very easy. That leaves no quiet, profitable corners of the market hidden from view.

And now as digital rolls forward, there might be many more similar industry experiences in multiple industries. IoT is going to instrument a lot of industrial capacity, much of which is presently both idle and invisible. Just like the airline industry, once a huge amount of idle capacity becomes visible and bookable online, the likely effect is a plunge in pricing. How many idle MRI machines or pieces of mobile, heavy construction equipment are out there? 

Which products and industries are most at risk? Not every product is easily subdivided or shared, but those with capacity that can be shared are at higher risk than others. Industries that have low asset utilization are also at risk. Even before COVID-19, most offices sat idle much of the time. Movie theaters are empty during the week. Classrooms are quiet three months of the year. What if all these facilities and assets could be managed, booked and utilized online?

We’ve learned the hard way in the last few months that we probably pay for much more office space than we really need. What’s next?

Many people are rightly skeptical about how transformational this technology might be – does anyone really want to use a theater during the day? How about a classroom on the weekend? But again, there are some interesting lessons from the airline industry. In the U.S., the CAB promised airlines they would receive a 12% return on invested capital for routes that operated with at least 55% capacity utilization. Airlines often assumed that mid-week flights would run nearly empty and holiday destinations would have weak performance in the off-season. 

In the decades after deregulation, airlines discovered they could fill mid-week flights and off-peak destinations to the brim if the price was right. In 2018, the average U.S. airline had a load factor of 83%. That means, as many have experienced, full planes, seven days a week, 365 days a year. With the proper incentives, we should not be surprised if, a couple of decades from now, new movie theaters or classrooms are easily reconfigured into offices or meeting spaces, and MRI services are open 24 hours a day.  

Can enterprises prepare themselves for this future of digital disruption? They can start by getting a much deeper understanding of their assets, which ones are essential, how much they are really being utilized and how necessary they are for operations. We’ve learned the hard way in the last few months that we probably pay for much more office space than we really need. What’s next?

Disclosure

The Dark Future Where Payments Are Politicized and Bitcoin Wins

Satoshi Nakamoto intended Bitcoin to be used for online payments. But it never caught on as a mainstream payments option.

The main hurdle to widespread adoption of bitcoin-as-cash is its wild, and potentially lucrative, price changes. This roller coaster problem isn’t going to disappear. Which means the only way for bitcoin payments to ever go mainstream is if the nation’s reliable payment pipelines, the ones that have knitted it together for decades, stop doing their job. Only then will second- and third-best payments rails like bitcoin be called into play.  

J.P. Koning, a CoinDesk columnist, worked as an equity researcher at a Canadian brokerage firm and was a financial writer at a large Canadian bank. He runs the popular Moneyness blog.

Here’s a short story about how America’s payments infrastructure slowly implodes and bitcoin payments go mainstream.

We all know that America is ideologically divided. This turmoil has already enveloped both the traditional media and social media, with many conservative voices now migrating to Parler while liberals stick to Twitter.

Banks and payments processors have also become venues for conflict. For instance, activists have successfully pressured card processors to cut off white supremacist book seller Counter-Currents, the Proud Boys’ merchandise store and social network Gab, which describes itself as pro-free speech but has high concentrations of toxicity.

Imagine a world in which these divisions were to deepen. Say that some payment processors begin to cut off all customers who are deemed too Republican. In 2023, the Wall Street Journal is de-platformed by its acquirer, the bank that hooks it into the Visa and Mastercard networks. Companies with Trump-supporting executives like Home Depot and Goya Foods are cut off by their banks, too.

See also: JP Koning – The Standard About to Revolutionize Payments

And conversely, Republican activists start to pressure financial institutions to unplug Democrat-aligned businesses. In 2024, several large banks agree to stop connecting abortion clinics to the card networks.

What emerges by 2026 is a divided ecosystem of payments processors. One half specializes in connecting Republican businesses and nonprofits to core payments infrastructure, the other half specializes in connecting Democrat ones. Any bank or processor that tries to stay neutral is shunned – she who connects my enemy to Visa is my enemy.

Even at this level of divisiveness, Republicans and Democrats can still do business together. As long as Mastercard and Visa themselves remain neutral by letting both Republican and Democrat-aligned payment processors hook into their networks, then dollars can flow across the ideological chasm.

But in 2029, Democrat activists pressure Visa to end its neutrality and disconnect all Republican payment processors. Suddenly, Republican businesses can no longer accept Visa cards. The next year Mastercard goes Republican. All Democrat-leaning businesses are exiled from the Mastercard network.

America is now divided into two card fiefdoms. Consumers will need one of each card if they want to shop at both Republican and Democrat stores. Democrat shoppers shamefully hide their Mastercards and Republicans their Visas, lest their friends and family see that they are consorting with the enemy.

By 2031, cracks finally appear at the core of America’s payments plumbing. The neutrality of the Federal Reserve, made up of 12 district Reserve banks, comes to an end. The CEO and Directors of the Federal Reserve Bank of Kansas City, all staunch Republicans, unilaterally decide to stop providing Democrat-leaning banks in their district with access to Fedwire. The Kansas City district includes the states of Kansas, Wyoming, Nebraska, Colorado and Oklahoma.

No one wants to live in a country where bitcoin has become vital for payments.

Fedwire, the Federal Reserve’s real-time settlement system, is America’s most important payments utility. When anyone makes a payment from their bank to another bank, it’ll eventually be settled by a movement of funds along Fedwire. By cutting off Democrat-leaning banks and their customers from this key utility, the Kansas City Fed effectively removes their access to the rest of the U.S. banking system.

The Atlanta Fed, also Republican, follows the Kansas City Fed a month later. In retaliation, the Federal Reserve Banks of San Francisco and Boston disconnect Republican banks from Fedwire, in one swoop unbanking all Republican-leaning businesses located in their districts.

In 2033, the San Francisco Fed halts all incoming payments from both the Reserve Banks of Kansas City and Atlanta. Suddenly, there is no such thing as a universal U.S. dollar. Money held in accounts in Georgia and Florida and Oklahoma can’t move into accounts in California or Washington, and vice versa. The payment tissue that once connected all American has torn.

The collapse of America’s payment infrastructure would be just one theater in a much larger factionalization of American society along ideological lines. Other key bits of American infrastructure would also begin to fall apart: the courts, law enforcement, the education system. There would be large physical dislocations as Republican families migrate to Republican enclaves and Democrats to Democrat enclaves.

But commercial life would still go on. Within their own enclaves, Democrats would still do business with Democrats, and Republicans with Republicans. They would probably rely on local credit-based systems to engage in trade. Credit, which relies on trust, is the most efficient way to carry out transactions.

See also: JP Koning – How Bitcoin Is Like Ham Radio

What about trade between Democrats in one enclave and Republicans in another enclave? Each side will produce goods that the other side needs. With neither side trusting the other, IOUs would be an unacceptable currency. 

It’s possible that silver and gold would become popular again, as they were in the 1600s and 1700s. Or perhaps bitcoin would become America’s favorite medium for conducting inter-factional trade. The nice thing about bitcoin, like gold, is that it doesn’t rely on a trusted counterparty. Suspicious traders needn’t worry about the IOU-issuer welching.

But if America’s electrical and telecommunications infrastructure has crumbled, would it even be possible for people to use bitcoin? 

It’s a stretch, but we can imagine distributed solar power solving the electricity problem. As for accessing the bitcoin network, tinkerers could try to connect old fashioned ham radios to Blockstream’s bitcoin satellite. If the remnants of AT&T and Verizon can only provide patchy internet service, so-called decentralized mesh networks might offer an alternative way to access the web.

This dystopian future probably isn’t going to happen. For now, bitcoin has found a role as a popular way for Americans to speculate, sort of like gold. Let’s hope it stays that way. No one wants to live in a country where bitcoin has become vital for payments.

Disclosure