Blockchain analyst Tim Swanson remembers a client representing a major bank who, during the heady days of the 2017 cryptocurrency bull run, kept asking how to get in on the action.
Swanson, who was working for the banking blockchain consortium R3 at the time, wondered why a bank would be so intent on cryptocurrencies when trading the new digital asset came with a variety of risks.
“Why would they trade this? There are so many other things in the world to trade with,” Swanson remembers asking his boss. “He said, ‘Tim, you don’t understand—traders like to trade stuff. They just want to make money. They’ll trade anything.’”
Four years later, those traders are getting their wish.
With Bitcoin on the balance sheets of major public companies and investor sentiment shifting in its favour, the mainstream financial system’s integration with the radical project is growing. That means Wall Street and Bay Street are exposed to the risks of Bitcoin and other cryptocurrencies failing, but also to the risk that they’ll succeed at undermining the ability of governments and central banks to affect the economy. With the price of Bitcoin up 70 per cent since the beginning of the year, it’s easy to understand why Wall Street and Bay Street are interested. But Bitcoin wasn’t designed to make money for bankers, who are nevertheless fuelling the sector and providing support for its goals.
Recent weeks have seen cryptocurrency integrated into the mainstream financial system in a variety of ways that make it easier than ever for retail and institutional investors to buy in. Canada launched the world’s first physically settled Bitcoin ETFs; U.S. bank BNY Mellon announced it would allow its clients to hold and transfer cryptocurrencies; and public companies including Tesla, Square and MicroStrategy announced they had added a collective billions in Bitcoin to their balance sheets.
With the price of Bitcoin up nearly 70 per cent since the beginning of the year, even after a dip this week—and with Tesla reportedly earning more on its Bitcoin bet since disclosing it than it did selling electric cars last year, according to a research note from Wedbush Securities—it’s easy to understand why Wall Street and Bay Street are interested. But Bitcoin wasn’t designed to make money for bankers; it was designed to render central banks obsolete and shift financial control away from banks and the government to individuals.
For better or for worse, the fate of this experiment and the fate of the mainstream financial system are becoming tied together. Wall Street and Bay Street are increasingly exposed to the risks of Bitcoin and other cryptocurrencies failing—but also to the risk that they’ll succeed.
“Large-scale short- and long-term Bitcoin investment certainly affects the credit risk of the investing firm, since Bitcoin is quite volatile,” said Linda Schilling, a professor at the École Polytechnique Center for Research in Economics and Statistics in France who studies cryptocurrency economics, in an email. “Due to the strong interconnectedness of some financial firms, large-scale Bitcoin investment can further increase the systemic risk in the financial system.”
There are still plenty of people in the traditional finance world who think cryptocurrencies—Bitcoin, in particular—are overvalued and not worth the hype. On the same day two weeks ago, Bay Street stalwart David Rosenberg and Bank of Canada deputy governor Timothy Lane called the price run-up “a massive price bubble” and a “speculative mania,” respectively.
But sentiment seems to be shifting compared to 2017, when JPMorgan Chase chief executive Jamie Dimon called Bitcoin a “fraud” and said he’d fire any employee “stupid” enough to trade it. In the last week and a half alone, BlackRock, Morgan Stanley, DoubleLine Capital and Deutsche Bank all made the news for indicating interest in cryptocurrencies.
That means serious money is on the line if the 2021 Bitcoin bull run is followed by a crash as dramatic as the one in 2018, when it lost 84 per cent of its value over 12 months. Last March’s Bitcoin price correction was still enough to wipe out some cryptocurrency hedge funds, with institutional and retail investors much more broadly exposed this time around.
Bitcoin is also a relatively illiquid asset class, with research firm Chainalysis estimating that just 19 per cent of Bitcoin in circulation is used for trading, leaving it vulnerable to big price movements when people sell large amounts. And one of the tradeoffs Bitcoin makes in shifting control from financial institutions to individuals is that holders are responsible for securing the digital private keys they need to access it—a responsibility that most outsource to exchanges, sometimes with disastrous results when they fold, get hacked or act unscrupulously.
Stefan Coolican, chief financial officer of Ether Capital, a Canadian public company that invests in projects involving Bitcoin competitor Ethereum and consulted on the Purpose Bitcoin ETF, said cryptocurrencies’ wild price swings are a symptom of the fact the technology is still in its early days, similar to the dot-com boom and bust of the early 2000s. He pointed out the traditional financial system is hardly risk-free, either, citing the financial crisis of 2008 as a prime example.
“Bitcoin is, in many ways, a response to bailouts of the banking system and the lack of transparency around the traditional financial system,” Coolican said. “Sure, there is volatility and risk in crypto, but that’s to be expected in the infrastructure phase we’re in. And it’s not like the traditional financial system is a beacon of stability—it can be, but it isn’t always.”
Many Bitcoin supporters argue the increased interest in the asset from institutional investors and public companies is fuelled by rational concerns about how governments and central banks are responding to the pandemic, piling on debt and engaging in quantitative easing that could cause inflation to spiral out of control. Jordan Anderson, chief operating officer of the Canadian cryptocurrency-trading platform Bitbuy, said many of his clients find Bitcoin’s algorithmically limited supply appealing.
“It’s really that narrative around Bitcoin being digital gold, and it being a long-term store of value to hedge themselves against traditional currencies being subject to inflation,” Anderson said.
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Thorsten Koeppel, a professor who studies blockchain economics at Queen’s University, said he thinks most people are investing in Bitcoin right now because they’re looking for something to do with the money they’re saving during the pandemic, not because they’re placing a bet against the traditional financial system. While central banks with unstable monetary supplies in countries like Zimbabwe and Venezuela may face an existential threat from the rise of cryptocurrencies, he said the capitalist system in countries like Canada is more likely to do what it does best: absorb any threat to it and find a way to make money from it.
“The traditional financial system is not going to go away,” Koeppel said. “We don’t need a separate cryptocurrency to use some of the ideas that decentralized finance or distributed ledger technology offers.”
Whether public companies and financial institutions are signalling they share Bitcoiners’ concerns about U.S. monetary policy or just piling into the new hot thing, their investments are fuelling the sector and providing support for its goals. Swanson said they should be prepared to answer some questions about that.
“I’m surprised that more companies like Tesla aren’t saying exactly what the fundamental analysis is,” he said. “What’s the utility that they’re providing to their shareholders, or to society?”