Despite tremendous progress in economic globalization, the global financial system is still very fragmented, with only a few players having an invitation to sit at the table with the big boys. It is evident that blockchain has clear potential to consolidate and, perhaps, even standardize financial markets all over the world. Various private enterprises and regulators have already started the journey of integrating blockchain into their business models.
Recent aggressive hikes in prices of cryptocurrencies are both inspiring and concerning. Retail investors are very excited, while bystanders are waiting for the green light from the large institutional players. Enthusiasts are anticipating the new, decentralized, self-governing future, while fundamentalists are looking for facts behind the hyped-up and obscenely high valuations in this sphere.
While many media sources coin the cryptocurrency space as the next financial bubble, they fail to realize that this very “bubble” can help solve the pressing problem in the global financial system.
So, What Is That Pressing Problem?
The pressing problem the world is about to face is the slowing of economic growth. While the majority of the world’s problems we read in the press are very real and quite shocking, the lack of economic growth is one issue that could accelerate the other problems the world is facing.
Many world organizations acknowledge the problem of decreasing economic growth. The United Nations report begins with a poignant title; “The Global Economy Remains Trapped in a Prolonged Episode of Slow Growth.” It goes on, further emphasizing that:
“the factors underlying the protracted economic slowdown have a tendency to reinforce one another, through the close linkages between demand, investment, trade, and productivity.”
Research conducted by the World Bank admits that “in recent years, long-term finance has attracted heightened interest from policy makers, researchers, and other financial sector stakeholders.” A lack of longer-term funding “further heightened existing financial sector vulnerabilities and widened potential long-term financial gaps for infrastructure in particular.” A study by the Organization for Economic Co-operation and Development (OECD) adds that “long-term investment plays a key role in promoting growth and creating jobs.” It further pinpoints that “while long-term investment is essential to growth, its financing faces serious challenges which call for an increasing role by institutional investors,” indicating that private enterprises will need to take a more active part in solving problems related to a scarce supply of long-term financing.
So what if the world’s growth slows down? How is it going to impact everyday life?
The Institute of International Finance, in its report Structural Challenges to Emerging Market Growth, provides a very concise and vivid explanation of the consequences:
“Failure to maintain strong growth threatens to frustrate rising expectations – in particular of an expanding middle class – which could contribute to heightened social tension, as seen recently in Turkey and Brazil.”
Social tensions tend to rapidly escalate into all sorts of conflicts, compounding most issues.
G30, the consultancy group of international economic and monetary affairs, conducted a very careful study to identify four basic principles to govern the provision of long-term finance. The team at G30 includes top world leaders from private and public sectors, and academics such as Paul A. Volcker, Jean-Claude Trichet, Ben Bernanke, Mario Draghi, Timothy Geithner, and Paul Krugman. Here are the four principles they outline below:
- “The financial system should channel savings from households and corporations into an adequate supply of financing with long maturities to meet the growing investment needs of the real economy.”
- “Long-term finance should be supplied by entities with committed long-term horizons.”
- “A broad spectrum of financial instruments should be available to support long-term investment.”
- “An efficient global financial system should promote economic growth through stable cross-border flows of long-term finance, supported by appropriate global regulation.”
Our analysis at BlockchainDriven points out that blockchain technology and its aggressive popularization through unusual hikes in prices of cryptocurrencies can help the global financial system solve its main problem of scarce long-term financing and ensure consequent global growth due to its correspondence with each of the four principles provided by G30.
1. Increasing Market Cap of Crypto-Based Assets Indicates Willing Investors
Below are just a few headlines from some of the most credible and respectable media sources pertaining to cryptocurrencies:
▪ International Business Times: Cryptocurrency bubble? ‘To an extent’ (May 12, 2017)
▪ Financial Times: Bitcoin’s surge fuels fears of asset bubble (May 14, 2017)
▪ The Economist: What if the bitcoin bubble bursts? (June 3, 2017)
▪ Fortune: Speculators are driving a cryptocoin bubble (June 3, 2017)
▪ Business Insider: Mark Cuban: Bitcoin is a ‘bubble’ (June 6, 2017)
The term bubble appeared in every single title provided above. Whether crypto-based assets are a bubble or not – that’s a different conversation, which deserves an entirely different article. What’s truly amazing about the crypto space is the strong resilience and high level of risk-averseness of its investors. Imagine any other space getting so much negative publicity from truly credible sources and, yet, having constant growth. It sounds impossible.
While Google, Amazon, and Facebook are clearly on a level higher than Bitcoin and Ethereum, we can see that each of the two major cryptocurrencies already outpaced market capitalization of Airbnb and together they have a higher valuation than Uber.
Comparisons of payment networks bring out, even more, insights about the future of the crypto space. While Visa and Mastercard constitute 70 percent of the entire payments space, Bitcoin and Ethereum are slowly capturing their fair share of the pie with 15.4 percent of the total market share. It is also quite remarkable that Bitcoin and Ethereum combined have already outpaced PayPal, which has a market cap of $64 billion.
Often, businesses spend millions of dollars in consulting fees to get a sense of the market demand. Cryptocurrencies indicate the existence of such a demand at absolutely no charge. Its growing market cap points out that retail investors around the world have a sufficient amount of savings ready to be invested into attractive opportunities and projects. The first principle emphasized by G30 could be realized given strong leadership from both public and private enterprises to channel those savings to emerging economies in order to sustain the global growth.
2. Widespread Popularization of Blockchain Attracts Committed Long-Term Investors
The G30 report makes a very strong point about creating sufficient regional ecosystems to invite investors with committed long-term horizons. Mechanisms to “bestow an artificial liquidity on long-term instruments” has already been attempted and failed. The maturity mismatch between long-term investments and the “shaky foundation of short-term financing” increases risks for borrowers, investors, and the entire financial system. However, this risk can be minimized when “investors with appropriate time horizons, risk appetite, and liquidity needs are matched with the right investment opportunities.”
Global institutions and central banks have been urged to create a more interconnected global financial system for quite some time now. Financial and industrial globalizations have been increasing substantially, creating new opportunities for both emerging frontiers and developed economies. Technological advancements may have made the world flatter, but the global financial system remained fragmented due to a transition towards a more multipolar world order.
Blockchain technology finally allows cooperation between participants who do not trust each other. Its widespread popularization, partially due to price hikes in cryptocurrencies and increasing market capitalization of crypto-based assets, instigates financial institutions to integrate blockchain in their business models. Messages from global regulators often include terms such as blockchain, distributed ledger technologies, and digital currencies. For example, the International Monetary Fund urged central banks to “assess costs and benefits of increasing access to their settlement systems or offering digital national currencies.”
Strong considerations for promoting new best-practice guidelines for evolving financial landscape is very much needed by long-term investors, including global asset managers and sovereign wealth funds. These enterprises have a sufficient level of assets under management (AUM) to help sustain economic growth worldwide. For example, the top U.S. asset managers, including Blackrock, Vanguard, State Street, Fidelity, and J.P. Morgan, manage a total of $34.5 trillion according to the data provided by Willis Towers Watson. $34.5 trillion managed by U.S. financial institutions constitutes to almost half of the global GDP. The reason behind such an extensive proportion of holdings is mainly due to the diverse and accessible capital markets of the United States.
While private enterprises figure out ways to interact and collaborate via blockchain, public enterprises represented by sovereign wealth funds can start launching similar initiatives. The cumulative AUM of the largest sovereign wealth funds exceeded $7 trillion based on the research conducted by the Sovereign Wealth Fund Institute. What’s even more staggering is that 75 percent of total AUM managed by sovereign wealth funds belongs to emerging frontiers, with China, UAE, Saudi Arabia, and Kuwait leading the way.
G30 supports the creation of “new dedicated long-term financing institutions” and “new savings pools that can act as sources of long-term finance.” Given a sufficient supply of capital from both asset managers and sovereign wealth funds, blockchain technology can facilitate flows of long-term finance to bring about sustainable economic growth.
3. Short-Term Gains in Crypto-Based Assets Will Cause the Development of Diverse Global Capital Markets
The Institute for International Finance puts this very simply. The most important emerging economies can be divided into three groups:
▪ Export-led growth: China,
▪ Export of commodities: Russia, Brazil, and Indonesia,
▪ Strong credit creation: Brazil, Poland, and Turkey.
In other words, all three models of growth focus on attracting capital and exchanging them for goods, commodities, or future payments. However, the report mentions these traditional drivers of growth:
“are being exhausted and need to be replaced – or more accurately, complemented – with new growth drivers.”
Research conducted by the United Nations, the World Economic Forum, the World Bank, the Institute for International Finance, and G30 points out that continued economic growth could be triggered by development of the open capital markets in emerging economies. A strong bullish market in cryptocurrencies is forcing such development to take place as soon as possible.
A low interest rate environment in developed countries has led investors to look for higher-yielding assets in developing countries. However, only very few countries offer a sufficient real interest rate level. In addition, low risk premiums for investing in emerging markets might not be sufficient to compensate for exposure to currency, political, economic, market, and liquidity risks. Aside from BRICS (Brazil, Russia, India, China, and South Africa) and a couple of other emerging economies, including Saudi Arabia, Indonesia and Mexico, the nominal rates of return offered by central banks worldwide adjusted for inflation are actually negative.
To compensate for low interest rates, global capital markets posted substantial gains across the board. South Korea spiked almost 31 percent in the last year, with China and the United States surging in the 20 percent range. Some markets were bouncing off historical post-crisis lows, but many mature economies have been and still are trading at dangerously high price-to-earnings multiples, signaling a possible correction. I’ve previously written on the advantages that countries can gain from creating their own cryptocurrencies, and I believe this inevitable process will be a strong indicator that crypto-technology is ready to impact the global financial space.
Despite the fact that in 2016 we witnessed extremely high capital gains worldwide, global capital markets still have a number of barriers preventing many investors from diversifying their portfolios with international exposure. Capital requirements, regulatory compliance and security concerns are just a few issues faced by investors.
On the other hand, the cryptocurrency market’s fewer barriers to entry coupled with aggressive expansion triggered by growing interest from its shareholders is very appealing. While commodities dropped between -25 percent (crude oil) and -4.1 percent (gold), bitcoin and Ethereum’s ether rallied 287 and 2,936 percent in the last year respectively.
Increasing valuations of crypto-based assets driven by above-average yields not seen in traditional capital markets presents a huge threat (and a huge opportunity) for emerging economies seeking long-term financing. Developing countries must offer more attractive investment opportunities for potential investors to stay competitive within the crypto space. Thus, facilitation of diverse regional capital markets with low barriers to entry is not an option anymore; rather it is the only right prescription that will ensure continuing growth. Investment opportunities for both retail and institutional investors to get exposure to Egyptian 10-Year Treasury or Turkish Mortgage-Backed Security, for instance, are likely to evolve sooner than later.
4. Rapid Expansion of Crypto-Based Assets Instigates Collaboration Toward Global Regulations
A lack of sound regulatory framework around cross-border capital flows via digital currencies presents a huge threat to both regional and global financial institutions. Banks and asset managers could lose potential clients, making the entire global system even more fragmented. Decentralization is the sole purpose behind public blockchains. However, an absence of adequate regulatory framework and strong leadership might lead to unforeseen market failures. The decentralization of the financial system is inevitable, but the process of decentralization must be conducted in accordance with interests of all direct and indirect stakeholders to ensure a smooth transition.
Rallies in cryptocurrencies will surely attract attention from regulators for a couple of reasons. Illicit financial flows, the credit and default risk associated with ICOs, and tax avoidance are just a few of many risks national states are potentially facing due to such a rapid expansion of crypto-based assets. Global regulators are aware that it is more feasible to join the trend, since fighting against it is so challenging. Moreover, the instigation of cross-border capital flows to spur global economic growth is one of the major topics of policy makers’ agendas. G30 points out that:
“policy makers should also gradually move toward liberalization of capital accounts in emerging markets while maintaining financial stability, using macro-prudential policy tools.”
According to the World Economic Forum, several advancements regarding blockchain and Distributed Ledger Technology (DLT) have already taken place. WEF’s research indicated that 80 percent of banks could initiate DLT projects in 2017, with more than 90 central banks engaged in DLT discussions worldwide. The IMF introduced a new concept of a central bank digital currency, or CBDC, which could “resolve the coordination problem over new virtual currencies, and thus spur technological innovation.” Overlooked by many, the OECD organized a Multilateral Convention to implement tax treaty-related measures to prevent base erosion and profit shifting with seventy ministers and high-level representatives participating in the signing ceremony. Essentially, OECD made another step against “tax avoidance strategies that inappropriately use tax treaties to artificially shift profits to low- or no-tax locations.”
Regulators are starting to realize the enormous potential of blockchain, and the increasing utilization of cryptocurrencies by public and private enterprises and investors will prompt a faster resolution regarding relevant regulatory framework around the crypto space.
The G30 outlined four key principles to spur economic global growth. Our expert analysis at BlockchainDriven points out that all four principles are perfectly aligned with the development of blockchain technology and its widespread integration into both public and private sectors. A high volatility environment and above-average yields posted by many crypto-based assets will help bring more awareness to the crypto assets from financial institutions and global regulators.