Wealth

Cryptocurrencies are a lot more than just currencies

Their true value is the power of an idea, says Jennifer Zhu Scott

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the official view or position of UBS.

 

Bitcoin has dropped by 70% since hitting record highs last December. But volatility in disruptive financial innovation is nothing new. 

Here, Hong Kong-based expert, Jennifer Zhu Scott, asks how we can leave the current cycles of boom and bust and shift the focus to a more sustainable model. 

Ms Zhu Scott is the founding principal of Radian Partners, a private investment firm for family offices and UHNWIs focusing on artificial Intelligence, blockchain, and renewable energy and a member of the Council of The Future of Blockchain at the World Economic Forum.


In the 10th Century, China’s Song Dynasty issued the world’s first paper money, ‘Jiaozi’.

Jiaozi had no intrinsic value itself but it was issued with certain conversion rates to gold, silver, and silk. The Song citizens had to make a trust leap from real gold and silver to a paper money – or ‘fiat currency’. In the following 11 centuries till today, countless fiat currencies were issued by each society’s governing body around the world.

Some of them succeeded and dominate the world’s economy (for now). Hundreds of others failed and caused the nation’s economy to collapse and the holders’ wealth to evaporate. Even the US dollar, the world’s most popular reserve currency today has lost 97% of its value since the establishment of the Federal Reserve in 1913 and the US national debt is rapidly approaching USD22 trillion.

Despite the repeated failures, issuing money and controlling monetary policies have been unchallenged, centralized rights belonging exclusively to the governmental authorities of each sovereign nation.

They were unchallenged for very practical reasons. For strangers to exchange value with each other, the centralized institutions have been acting as a necessary trust body bridging the trust gaps between the two sides and standardising and guaranteeing the value of its currency.

Jiaozi, one of the first banknotes, used in the Sichuan (China) under the Song dynasty (960−1279)

Meanwhile, we are in the third decade of development of the internet. Technologies are enabling peer-to-peer trust between strangers from renting a house, a car, finding a date, to trading goods. In the ashes of 2008 Global Financial Crisis, Satoshi Nakamoto pushed such trust even further by creating the Bitcoin protocol.

Such protocol enabled a completely decentralised peer-to-peer monetary system and inspired many other decentralised protocols to empower a large number of individuals to collaborate and exchange values based on codes instead of a trusted centralised body or institution.

The world witnessed the largest gain of any assets in human history last year – with the value of bitcoin growing by 20 times within a year to USD20,000.

Across the globe, more than 1700 cryptocurrencies were issued. Many of them gained unjustified and outsize returns.

This crypto mania attracted still more ‘coin issuers’ to go to an ICO (Initial Coin Offering) with many projects at the pre-product stage raising much more than the limited amounts of venture capital that were expected.

Most of the regulators around the world reacted with force, with the Chinese regulator banning ICO’s in September last year. By March, systematic measures were in place to block the IP addresses of the offshore crypto exchanges and wallets to disable Chinese residents and institutions from trading. In March 2018, the SEC subpoenaed 80+ ICOs and warned that all tokens would be assumed to be subject to compliance with the Securities Law.

Today, crypto exchanges and even some investors in the US are under tremendous pressure. As such, the skeptics think the crypto boom was nothing but a bubble, and the evangelicals believe the capabilities of crypto could eventually displace central banks and solve all of the world’s most challenging problems.

Many people in between of the two extremes feel confused.

This is only natural. Very few individuals in the world can honestly claim they fully mastered the full set of knowledge including the history of Bitcoin, the underlying mathematics, the cryptography, the coding of the blockchain technology, the mining aspects, the pros and cons of different protocols, the countless ICOs, the economic and technical designs of each token, the potential applications to different industries, the ever-evolving regulations in different jurisdictions, and the related social and philosophical debates etc.

There is confusion because Bitcoin and other cryptocurrencies are called ‘currency’ but cannot truly serve as a mainstream currency.

Blockchain technology is the infrastructure that cryptocurrencies like bitcoin are founded on.

This is mainly due to two key factors: the scalability measured by the number of transactions per minute, and the fact that no sovereign nation would ever allow a functioning currency to float in society in any meaningful way without its central bank’s oversight. These technical scalabilities can be solved over time. For the central banks’ functions to be displaced even partially is not likely to happen. Despite the title, many ‘cryptocurrencies’ behave more similarly to commodities than currency. Bitcoin itself, though intended as a payment system, is more likely to disrupt gold and serve as digital store-of-value than disrupting currency.

Meanwhile, Bitcoin itself is closer to a crypto asset than cryptocurrency.

During my debate with Nobel Laureate Prof. Robert Shiller at Davos this year, I said that I didn’t care about the price of Bitcoin.

But how do you discover the value of something if at the same time the unit pricing does not matter? The reason is, I believe, that the true value of Bitcoin is that it is a powerful idea. A powerful idea that will ignite many groundbreaking solutions that have potential to transform our economy.

Bitcoin has demonstrated how easy it is, using the underlying technology blockchain, to establish a peer-to-peer system to exchange value and create micro-incentives to empower a large group of people to collaborate based on the coding rules rather than relying on centralised institutions.

Such capabilities are laying a foundation for a true digital economy that, instead of using a hierarchical organisation to manage a large group of participants as we humans have always done before, we can have a flat structure using coding protocols to regulate and implement the rules. Companies and industries can find alignments with a large group of stakeholders or customers and use blockchain to tokenise micro incentives as a tool to scale collaborations to achieve efficiency or scalability.

Well designed micro-incentives, or tokens, have the potential to reorganise how some industries transfer the values between stakeholders, shareholders, or customers. The true value for Bitcoin and the crypto market is, no matter how immature or overhyped, it is a demonstration of how the future economy and monetary system might be transformed and organised. That process will create many significant winners and losers. Therefore, no matter how little you can afford to lose, by participating, investing and learning, we can treat this as an educational process.

Already it is hard to overstate how many ‘coins’ created in the past two years will fail and disappear, just like those failing companies went IPO in the 90’s only based on a website. In fact, by the end of Jan 2018, the Bitcoin price had dropped by USD6000 and the crypto market has been looking bearish ever since.

The correction might still be temporary because of the intense incentive and excessive liquidity. That said, the crypto market bubble will likely burst at some point. While that is happening, a new attempt of trust leap is already well under the way. Unlike many vocal crypto skeptics, to me, when the bubble bursts, it will not be the end, but simply an exciting beginning.


Jennifer Zhu Scott is a partner in Radian, a progressive investment community.

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