The past week saw Goldman Sachs and JPMorgan, two traditional finance investment banks, discuss cryptos, their identities as an asset class, and CBDC’s potential threat to the U.S. dollar. Dr. Marc J.J. Fleury, CEO of fintech firm Two Prime, discusses the following topics this week, with full commentary below.
Q1 2020 hedge fund letters, conferences and more
- GS: Crypto is not a real asset —In a recent investor call, Goldman Sachs spoke about how bitcoin and other coins were unsuitable for investment, with BTC’s run likened to that of the Tulip mania back in the 1600s. When it seems so obvious that crypto is here to stay, what do they still not understand?
- JPM: CBDCs may undermine the hegemony of the USD — In a report last week, JPMorgan asserted that “there is no country with more to lose from the disruptive potential of digital currency than the United States.” How realistic is it for a digital currency like bitcoin to become the world’s new reserve currency? What conditions should be met for this to occur? How will the global monetary system look if the scenario is impossible?
On Goldman Sachs Dismissing Crypto As A Real Asset:
First they ignore you, then they laugh at you, then they fight you and then you win — goes the mantra of revolutions and how incumbents typically react to them. Crypto instruments are completely aethereal instruments, disembodied and trusted internet records which no one (not even governments) can hack and which hold few to no real economy assets. This apparent weakness — the lack of endogenous cash flows — is in fact what makes them such attractive stores of value, particularly at a time when real economic assets are crumbling.
There are many forms of crypto — some of which are volatile, offering great upside potential (BTC, ETH); some are fully stable, offering downside protection (USDT); whereas others are balanced hybrids, offering both downside protection and upside potential (FF1 by Two Prime). As a store of value, cryptos have shined during the COVID-19 pandemic. With the ongoing monetary expansion, high net worth individuals and savers will be ill advised to ignore this numerus clausus asset class.
On JPMorgan Believing That CBDCs Can Undermine The Hegemony Of The U.S. Dollar:
It is unlikely for bitcoin to become the world's new reserve currency.
Central banks are seriously evaluating digital currencies and direct distribution. The Bank of China is coming out with its “digital Yuan’' and attendant wallet distribution (think of the new Silk Road). Meanwhile Washington has been evaluating options during the COVID crisis to deploy Fed funds directly to the users, bypassing traditional banking channels or the President holding relief checks to put his signature on them.
It would just be more efficient to use some form of digital currency, as the BoC has figured out. Notably, these are stablecoins pegged to their respective fiat currencies. These stablecoins are also highly centralized. The people will have to pry the printing presses and monetary issuance out of the dead cold hands of the central banks. However, it is unclear that CBDCs would be desirable or a better model.
CBDC and bitcoin
Furthermore, if we look at the other digital currencies, Bitcoin in particular is not suited at all. There is close to zero chances for Bitcoin to reach reserve currency status, a great asset class it is, but a currency it is not, much less a reserve one. There are various structural reasons for that. Firstly, Bitcoin is way too volatile, and secondly, its issuance is algorithmic and inflexible, which is a strength for a numerus clausus asset class. From a modern monetary policy standpoint, though, the Bitcoin’s limited supply is catastrophical. The ability for monetary policy to be flexible is too important at times like these.
BTC is also held in way too high of a concentration by Chinese miners. Can anyone really envision a world where the United States trusts shoddy mining rigs in Sichuan, China, thereby giving up the privilege of the dollar? Lastly, BTC is too concentrated in wealth distribution. If BTC were to become a reserve currency, this would mint shadow quadrillionaires. Again, possibly not a viable societal construct.
While it is clear that CBDCs are on the way and there will probably be de facto implementations within a decade, meaning we will have digital central bank currencies, there is no realistic scenario where BTC hijacks that role nor is it suited for that role.
A hybrid coin would be the most ideal form of a CBDC.
CBDC options
Since there is no way the central would willingly relinquish the control of the monetary presses, this would have to be done in dramatic opposition — perhaps revolutionary opposition — to said central banks. An internet reserve currency would, almost by definition, be anti nation-state. This may take place in Africa, which seems to show rapid signs of adoption at the moment in reaction to their corrupt institutions and the ruling class abusing the minting privileges.
Another option would be South America, where rampant inflation and government debasement drives crypto adoption. We may even look at Asia, particularly China, where many people seem to want to avoid confiscation from “Big Brother” and hide their savings. In the West, financial speculation and libertarian sentiments seem to drive the adoption of crypto.
Fed policy
There are various attributes that a real reserve currency needs to have. It needs to be flexible in issuance. We know that the gold system was catastrophical during the great depression for it was inflexible and possibly ushered the depression by creating fake scarcity. The digital reserve currency would also need to have governance like nothing we know today and it would need to be flexible regionally. We should not underestimate the stabilizing power of QE. Many fledgling economies need the flexibility of foreign exchange to float their currencies, and the ability to revalue and devalue them.
Witness again QE2 as a competitive US-China devaluation at the heart of the 2008 crisis. A digital reserve currency would also need a lot more security in the infrastructure. At a time when crypto is still dealing with scammers and theft on a daily basis it feels way too immature to fulfill the role of reserve. And finally, we would need a lot more ease of use for mass adoption. The system, as it currently stands — with private keys and how easy it is to lose the keys — just doesn’t make sense.
That all being said, a real internet reserve currency may in fact see the light of day. Today, all manners of “3-letter agencies” use cryptocurrencies to move funds internationally. Millions of users do remittance with crypto everyday. From a volatility standpoint, we would need a form of hybrid stablecoin, like nothing we see today — something that is stable and has downside protection (otherwise it doesn’t function as a reserve) as well as upside protection (otherwise the current Treasuries will look more attractive.) Finally — and this cannot be stressed enough — the digital reserve currency will need to be able to grow with the economy it represents while being outside of the debasement reach of the central banks.
We will likely see a bipolar world banking system had CBDCs not come into existence.
The US Dollar continues to enjoy reserve currency status even in the face of massive Fed balance expansion or perhaps, ironically, because of it. What was counter-intuitive in 2008 to the rest of the world — but was clear to the scholars running the Fed — was that the unprecedented expansion of the balance was accompanied both by muted inflation and a blistering rally in the dollar. In short, the Dollar was a safe haven. In times of turmoil, the U.S. still shoulders a lot of responsibility and enjoys good will. The country’s recent disgraces are irrelevant to this financial reality. The green back may be tired, but it is still mighty.
The more we print dollars, the more it rallies. The expansion of USD flowing into the market we are seeing at the moment is also unprecedented, even compared to 2008. We are talking “10s of trillions” not just “trillions”. We have yet to see how this new wall of liquidity will play out, but in the short term, the money seems to be flowing from the equity markets into alternate stores of value such as BTC and other digital currencies. Not only are cryptocurrencies rallying in a way to seem to confound everyone, but they do so violating the fundamentals of discounted cash flow analysis. They are turning into stores of value with diminishing economic backing; they simply find market equity value via market supply and demand.
The tsunami of liquidity that is hitting the various markets will result in an equities rally, which will further entrench the USD. At a minimum, we will see a bipolar world banking system, with USD and Chinese Yuan denominations. The EUR/JPY may also be particularly important. The new variable as we emerge from the recession is obviously the assertiveness of the Bank of China and it’s innovative approach to core banking (using open source software) and monetary issuance and distribution (using cryptocurrencies). Smaller currencies, under the control of corrupt regimes (in particular looking at some parts of Africa and South America), will be wiped off the face of the earth very soon by a plethora of cryptocurrencies allowing for safer and transnational banking without fear of corruption.
About Dr. Marc J.J. Fleury, Chief Executive Officer of Two Prime
Dr. Marc Fleury is the Chief Executive Officer and Co-founder of Two Prime, a fintech company that focuses on the financial application of crypto to the real economy. Building upon his financial expertise, spanning from his role advising private equity firms to his academic pursuits in modern monetary theory and banking theory, he provides the strategic direction for core vision investment strategy and partnerships for the firm.
About Two Prime
Founded by Dr. Marc Fleury and Alexander S. Blum, Two Prime is a fintech firm that focuses on the financial application of crypto in the real economy and is rethinking the approach to crypto application.
