Bitcoins, BS and Banking

I do not believe in Bitcoins because the whole idea behind them smacks of alchemy. For centuries, going back to classical Greece, people believed they could turn lead into gold. A great many, otherwise intelligent people spent a lot of time in this pursuit from the Middle Ages into the 20th Century.

In the latter half of the 19th Century people believed that the new Industrial Age would come up with a mechanical contraption to solve every problem. There were people peddling mechanical contraptions which claimed that you could put a lead bar in one end and a gold bar would come out the other. The process or internal workings of the machine were not disclosed and they became known generically as “black boxes”.

Today, thanks to new technology, you can buy a machine, plug it in and every so often it will send a few lines of computer code to an electronic wallet. You can then exchange that code for a lot of cold hard cash.  That is exactly what a Bitcoin is, just computer code that can be replicated by a machine. They may have value today; but sooner or later those lines of computer code are more likely than not, to become worthless.

For these lines of code to retain value people must be willing to buy them after they are manufactured. As the price increases, more and more people will likely start manufacturing them especially if the next generation of machines are more efficient or cost less.  Sooner or later there will be more code in the market than the market wants and the price will drop. That of course is just basic economics.

Basic economics is something that is often absent from any discussion about crypto-currency. It seems that many people who support crypto-currency, who are passionate about it and who are absolutely certain that it will prevail and disrupt the world are people who have technical backgrounds.  Some of those who are most adamant in the defense of crypto-currency have backgrounds in totally unrelated fields. They gained their insight into finance by having a credit card or reading economic theory in magazine or blog articles.

Most economists, including a Nobel Prize winner or two and most people who have worked in finance or banking dismiss crypto-currency as a fad.  On more than one occasion, a negative pronouncement by someone with stature in economics or finance has led to the crypto-enthusiasts mocking economics, economists and anyone who has worked in finance.  More than one has suggested that I and others are just too old to understand the new Blockchain technology that forms the underlying platform for crypto-currency.

Blockchain is essentially a decentralized ledger. It is a method of bookkeeping where each participant to a transaction creates a record of the transaction which is matched and verified with the other participants to the transaction.

When I wanted to learn about Blockchain I spoke with people who are working in Blockchain at large companies and universities in the US and around the world.  What they told me is that we may see Blockchain coming into various industries in the next few years. Initially they expect that it will be used in supply chain and logistics applications.

What I do not hear from these same people is a lot of enthusiasm for Blockchain in the financial sector.  FINRA assembled a panel of Blockchain experts in 2016 that looked at various functions in the financial markets that might be made more efficient by Blockchain. The overall conclusion was that Blockchain development still had a way to go.

There will certainly be decentralized ledgers within various financial companies and for some financial tasks. The entire world of finance is based upon checks and balances, supervision of employees, and repeated audits. Some of that has been automated since the 1970s.

The financial markets need to keep the bad actors out. Decentralization does not do that. If anything it is the opposite.  Blockchain verifies the transactions but not the people behind them.

A decentralized system prides itself on anonymity and anonymity invites bad actors.  If you read what the regulators of the banking and financial markets around the world have published, they continually share two main concerns about crypto-currency; money-laundering and tax avoidance.

Crypto-defenders will argue that far more money is laundered through banks. Banks spend a lot of money trying to curtail money laundering. The crypto-industry spends virtually nothing. The fact that there are other ways to launder money is no excuse for the creation of a new system that makes money laundering easier.

In the past few months banks, bankers, stockbrokers and serious investors have all given the thumbs down to crypto-currency. Recently the large credit card companies announced that their credit cards can no longer be used to purchase crypto-currencies. The largest stock brokerage firms will not purchase crypto-currency as an investment for their customers. Most professional investment advisors realize that they cannot purchase crypto-currency for their clients and satisfy their obligations as fiduciaries.

Part of the reason is that the crypto-currency industry itself cannot decide if crypto-currency is a security, commodity, currency or a whole new asset class. There is so much divergent opinion within the crypto-community that anyone who reads a few dozen articles on the subject is likely to be confused rather than enlightened.

Much of that divergent opinion is caused by the fact that these are legal definitions being interpreted by non-lawyers. I will not apologize for thinking an opinion written by a non-lawyer with a technical background living in Europe, Asia or Australia about how something should be defined under US law should carry little weight.

That does not stop the crypto-community from hanging on the word of every hack with a keyboard who holds himself out as a crypto-expert.  For an industry barely 2 years old, there are enough people holding themselves out as “crypto-experts” to fill Yankee Stadium at least once, perhaps more.

If all was well in crypto-land I would never have heard about Tether. Tether is a crypto-currency that is exchangeable into US currency at a fixed rate.  It claims to have a cash reserve of $2 billion to back up each and every Tether coin that has been issued.  People have questioned whether the owners of Tether really have secured $2 billion and the owners have repeatedly refused to respond with simple proof that the $2 billion is there. In any legitimate industry this question would never have to be asked more than once.

Theft and fraud are rampant in the crypto-currency world.  Electronic wallets are routinely hacked. Estimates run as high as 10% of the money sent to ICOs may have been hacked from the ICO’s wallet and hundreds of millions of dollars have been stolen from the various secondary market exchanges where the crypto-currency is traded.

Fund raising using crypto-currency (ICOs) has reached a fever pitch and has attracted a significant amount of scoundrels. Very few ICOs fund projects that are worthwhile ventures and most cannot be considered worthwhile investments by any stretch of the imagination. Telling the whole truth about the venture being financed is becoming the exception rather than the rule. Following existing laws regarding investment offerings is an anathema to the crypto-industry.

On more than one occasion an ICO has listed someone as an advisor who has never heard of the company or never agreed to be an advisor. I know this to be true because a few months back someone alerted me that my picture had been included in an ICO offering even though I had not given permission for the company to include it. This actually happens way too often.

There was actually one ICO that was so brazen that the people behind it raised a few million dollars and then took down their website leaving only the picture of a phallic symbol. The people who invested in this ICO got the shaft in more ways than one.

What I find most ridiculous about crypto-currency advocates is their overwhelming dislike for banks and their absolute but incorrect belief that crypto-currency and Blockchain will replace banks and send them to the rubbish heap of history.

Some of these people are European based Socialists who have always hated banks, which is their prerogative. But they have unsuccessfully been trying to supplant banks since the French Revolution. Blockchain is not going to help them.

Other people hate banks because they assert, incorrectly, that banks were the cause of the stock market crash in 2008.  I do not know of a single instance of a bank putting a gun to someone’s head and making them take out a loan that they could not afford to repay. The real estate bubble that preceded the crash might better be laid at the feet of the thousands of real estate brokers who encouraged people to buy homes with the foolish notion that real estate always goes up in value.

The most vocal group of bank haters seems to be millennials who have very little experience dealing with banks, but who constantly tell me that they do not trust them. They tell me that banks charge too much and that the world needs better platforms to make payments.

A payment platform like PayPal works quite well and is a big step up from the way banking worked 20 years ago. All it actually does is move money from my bank to a vendor’s bank quickly. Blockchain may make these payments systems better and faster.

I think these advocates will be disappointed to find that banks will ultimately take the best Blockchain has to offer and utilize it in such a way as to fire significant numbers of employees and make more money. Blockchain may actually strengthen the banking industry rather than displace it.

The problem with the idea that crypto-currencies will replace banks is that banks do a lot more than just facilitate payments. The primary function of banks is to aggregate and intermediate capital.  Banks take deposits from a lot of people and use the funds to make loans to small businesses and to make mortgage loans to homeowners.  The consumer side of these transactions can be done with a peer-to-peer approach and an app. You can apply for a small loan or a mortgage from your smart phone, but you are still borrowing from a pool of money held at a bank.

Banks also make large loans. On any given day General Motors or Dow Chemical may float a bond issue to borrow a few hundred million dollars. On the same day the State of New York may float a bond issue to fund a highway or bridge project or new university dormitory. There may be a hundred or more of these large loans and bond financings taking place around the world every day.

It is not likely that these large complicated financings will ever be done with an app on a smart phone.  These bonds are sold to syndicates of commercial banks. This requires that capital be pooled and that large entities have control over those pools of capital. Bank depositors do not decide how the bank invests the money they deposit.

This is the antithesis of the decentralized world envisioned by crypto-enthusiasts. In their world, the crypto-currency is held in electronic wallets over which only the owner has control.  No banks or centralized entity has access to those crypto-funds. There are no banks or similar entities to pool those funds and make the large loans upon which the global economy depends.

Crypto-enthusiasts have no answer to how these large loans might be made in a decentralized financial world. They do not care that banks evolved to where they are because of the need for large loans to fund large companies and large projects.

The US capital market is not a stodgy outdated system screaming for reform. It is a large, dynamic system that handles trillions of dollars of transactions every day. Virtually every transaction settles with every party happy.

It is way past time for the Blockchain industry to leave crypto-currency and the bank-haters behind and to focus on the applications for Blockchain in existing financial institutions and other industries.





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