What can crypto tell us about innovation in financial markets?

When one of the 21st Century’s most successful bankers comments on markets, people take notice. Jamie Dimon, the JPMorgan Chase Chairman and CEO, recently said he thinks there’s a good chance that ‘Satashi’ (Satoshi Nakamoto) will suddenly reappear and erase all Bitcoin.

Sounds pretty risky, so let’s not worsen our already chaotic lives with any crypto research ‘to-do’ lists.

However, we appear to be living in a period of exponential growth in technological capabilities. Perhaps then, it is worth spending some time looking into the potential for new ideas to improve (not erase) previously accepted ways of working.

Although Bitcoin (BTC) was not the first cryptocurrency (cryptographic-based ‘eCash’ was launched in 1990), it is the largest as of January 2024 with a market cap of c.$775bn, and can therefore be a useful starting point for delving deeper into crypto. Doing so is probably worth your time when you consider BTC’s market cap is 10x larger than the AIM All Share (AIM and in fact the Aquis Stock Exchange too, being further examples of financial innovations originally dismissed by more established market participants).

I consider Bitcoin below, as a readacross to crypto, but take no view on BTC as an investment idea.

Some widely repeated claims on crypto and Bitcoin, along with the potential counter arguments are below:

• ‘Crypto has zero intrinsic value’. Intrinsic value in traditional finance is understood in quite narrow terms i.e. cash flow. However, cryptocurrency ‘value’ is considered to be: scarcity (limited supply mitigates devaluation), immutability (cannot be forfeited), durability (cannot be destroyed) and decentralisation (cannot be controlled).

• ‘Crypto isn’t backed by anything tangible.’ The network of computers that collectively agree on for example, Bitcoin transaction data, is the most powerful computing network currently in existence. Is the internet ‘tangible’?

• ‘Bitcoin wastes huge amounts of electricity’. The electricity usage is a security feature, making network hack attempts unfeasible. Profit seeking miners are also incentivised to seek out cheap, sustainable energy sources (70% of miners use renewable energy). It is estimated that the traditional financial system uses more than twice the amount of electricity of the Bitcoin network.

• ‘Bitcoin is incredibly slow at processing transactions’. BTC is admittedly poor if speed is of the essence. If however, speed and immutability is required, the BTC blockchain provides individuals with the ability to use a secure, decentralised network without the need for excessive data resources.

• ‘Crypto markets are too volatile’. Without centralised control over supply and demand, volatility is currently a function of crypto, but volatility will decrease if the networks continue to grow. Volatility must also be considered against returns and time horizon. For example, Bitcoin’s Sharpe ratio (i.e. risk-adjusted returns) is in line with that of the S&P 500, but BTC is up more than 5x since the start of 2020, versus the S&P 500’s return of 1.5x. Length of investment is therefore a crucial factor in crypto markets.

• ‘Bitcoin is mainly used for criminal activity’. Anyone with a computer can transact using crypto, just as anyone with cash can conduct economic activities, nefarious or otherwise. Blockchain data platform Chainalysis estimates that 0.24% of crypto transactions in 2022 were considered illicit.

Whether such counter arguments hold merit or not, the point is that they should at least be considered.

While it might be a low-risk strategy to agree with somebody that has the financial eminence of Jamie Dimon, it could prove fruitful to consider whether equally distinguished individuals or institutions also agree.

For instance, on 10th January 2024 the SEC approved 11 Bitcoin Spot ETFs that will hold BTC directly (the Proshares ETF approved in October 2021 could only use futures contracts). Some well-known institutions are among the 11, namely Blackrock, Invesco, Fidelity, Franklin Templeton, and WisdomTree.

I often hear younger retail investors say that they see crypto markets as ‘the great leveller’, more of an ‘open door’ that allows them to access growth potential before larger institutions have asserted their dominance. These individuals are ambitious and want to build wealth but feel as though traditional financial markets make it difficult, thus forcing them to consider alternative approaches.

These views often strike me as analogous to Aquis Stock Exchange’s approach to younger growth companies. Where the original Bitcoin whitepaper offers a new, alternative approach, removing perceived inadequacies of traditional finance, the Aquis Stock Exchange suggests a new approach to facilitating growth for smaller companies, specifically designed to remove hurdles that are inadequate for the needs of smaller companies and investors. Like AIM before it, AQSE tailors a product specifically to initially smaller growth companies, just as Bitcoin aimed itself at market players troubled by the role third parties played in the 2007-2008 financial crisis, by removing the need for third parties.

Old/new doesn’t have to mean either/or. Even Jamie Dimon had to start somewhere. What seem like riskier, early-stage, novel ideas today, may well evolve into accepted norms within a short space of time, so taking the time to explore innovative solutions may prove worthwhile.