by Shanna McEachern, Manager, Field Marketing, Americas, IPC
Though forming an asset class of their own, Bitcoin – and cryptocurrencies, more generally, still stole a few minutes in the spotlight at the recent TradeTech FX conference in Miami, Florida.
At the time of last year’s TradeTech FX event in mid-February 2017, the combined cryptocurrency market capitalization floated around $19Bn[i]. One year later that market capitalization has exploded to a volatile $450Bn (which was, notably, down from the $828Bn peak only weeks prior). What’s more, some savvy, respectable investors are predicting cryptocurrencies will soar above $2Tr by the end of 2018[ii].
With numbers like that can the argument still be made that cryptocurrencies are just a fad or is this the natural next step in the evolution of capital markets?
Superimposing the innovation of Bitcoin with, yes, the evolution of species in the theory of Darwinism, I’ll suggest that cryptocurrencies followed a rather natural introduction to the financial marketplace. I’ll then compare Bitcoin to woodpeckers as vital species within two (very different) ecosystems and comment on the importance of the hype in advancing innovation. Lastly, using take-aways from TradeTech FX, I’ll attempt to address the question of whether these new digitally-fabricated currencies have any place in an institutional investment portfolio.
Darwinism, the theory of natural selection developed by Charles Darwin in the 1800’s, states that evolution occurs through the survival of small, inheritable mutations that render a species better able to survive and flourish. The concepts describing evolution bear an appreciable applicability to human innovation in many ways. We can use these concepts to explain the becoming of cryptocurrencies.
“World-changing ideas generally evolve over time as slow hunches rather than as sudden breakthroughs” [iii]
Similar to evolution, innovation tends to occur within the realm of possibility and over long periods of time, as opposed to being entirely foreign ideas conceptualized in ‘eureka!’ moments so frequently cited. Though many scientists and innovators stake claim to sudden break-throughs in their research, the reality is that nearly all such progress is the consequence of significant time, effort, or research leading up to the event. Darwin himself purports experiencing a ‘eureka!’ moment in conceptualizing his theory of natural selection (suggesting he was presented the idea in but a single moment), but a more detailed study of his documents demonstrates that Darwin had written much of the theory long before drawing it all together as one. Similarly, though Bitcoin (and the other cryptocurrencies) appear to much of the public as a sudden, out-of-nowhere creation emerging in mid- to late-2017, we need only to hear from the multi-millionaires that Bitcoin has been around for almost a decade (since 2009). Bitcoin was not birthed from nothing; rather, years of development went into the production of the technology behind it – namely, blockchain and the distributed ledger technology (DLT).
Bitcoin introduced a platform for innovation – for the evolution of the financial marketplace
In ecology, scientists distinguish a special group of species dubbed ‘ecosystem engineers.’ These species play a disproportionate role within their environment as they actually create habitats for the benefit and survival of others – such as a woodpecker creating holes later inhabited by a different species of bird, or a beaver damming a river to diversify the resultant river habitat. In the financial ecosystem Bitcoin may reasonably be deemed an ecosystem engineer – fundamentally altering the environment and boasting a platform (blockchain and DLT) upon which other innovations may flourish. Spawned from the blockchain concept, we saw the formation of Ethereum in 2013, which introduced a new (some may say, enhanced) platform that allowed for the development of apps across its network. Suddenly, the concept of Bitcoin was extended far beyond just cryptocurrency, and so technological evolution progresses.
The hype is helpful, whether you like it or not
In the natural world, random encounters at the molecular level can lead to genetic mutations and the introduction of new traits. At the organismal level random encounters between species may eventually lead to symbiotic partnerships or adaptation as organisms learn to live together. In the world of humankind random encounters are similarly fruitful as they lead to the sharing of knowledge and ideas through the network effect (a concept not foreign to IPC – read more in this blog[iv]). This concept is supported in the study of big cities, where creativity and innovation has been shown to thrive disproportionately when compared to more rural towns. Physical run-ins, the internet, and thriving social media platforms are bringing more people and more ideas together and spawning partnerships in innovation like never before. The more people talking about Bitcoin, the easier it becomes for innovators to find each other and bounce ideas around. You might be tired of hearing about Bitcoin on the morning news, but that hype is only accelerating progress in blockchain, DLT and cryptocurrencies for future applications that extend far, far beyond an investment vehicle.
OK – So the evolution of Bitcoin is not so farfetched, but does that mean institutions should be investing?
When posed the question of Bitcoin’s institutional investment viability at TradeTech FX 2018, a stage of panelists divided the room with opinion. From where I was sitting in the audience, it seemed half the room were a strong For, and half passionately Against. What are the benefits, and where are the risks?
On one hand, proponents for institutional investment in cryptocurrencies suggested that, bar the bubble of January 2018, it feels hard to testify that ‘Bitcoin is going to zero’ when it has consistently bounced back from every momentary stumble thus far. According to 99bitcoins.com, Bitcoin has been forecasted to fail at least 236 times thus far. That 0 for 236. And let’s not forget – the housing bubble certainly didn’t eradicate or invalidate real estate investment.
Further, proponents emphasized the enormous opportunity for returns in cryptocurrencies whilst the volatility runs high – which is, they noted, expected behavior for such a new an asset class. For them, cryptocurrencies only diversified better the portfolio of the risk-friendly.
On the other side of the argument, not all financial institutions adhere to the same risk allowances, and the combination of both internal policy and regulatory governance may render some shops simply unable to accept the risk. For those who can, the decision still has to be made on whether they want to, and how that investment decision will bode with their clientele.
“Look, if one of our funds dropped 50% next week, my clients would call me screaming” – MD, IPC Client
The decision to then acknowledge cryptocurrencies as a viable asset class and incorporate them into an institutional investment portfolio rests entirely with the institution themselves, and from what I heard at Tradetech FX, one size does not fit all. When IPC chats cryptocurrency to our client base we hear a wide range of opinion – and as you can imagine the response from the CIO of a prop trading firm is oft not the same as that of a Portfolio Manager from a large sell-side.
In summary, though the introduction of Bitcoin (and other cryptocurrencies) to the financial marketplace may seem less unusual when compared to Darwinian evolution in the natural world, and whilst Bitcoin has brought tremendous value by way of a platform for new innovation, we cannot yet conclude where it stands within the realm of institutional investment. Whilst various financial firms negotiate their position on cryptocurrencies, IPC stands ready to support any such investment decision by way of connecting firms to all of the counterparties they need to trade. We are excited to be amidst the conversations with bustling new cryptocurrency trading desks and exchanges – amongst others – in further diversifying our financial markets community. As always, please reach out to learn how we can help you achieve your business goals – crypto-related or not!
© 2018 IPC Systems, Inc. All Rights Reserved. The contents of this publication are intended for general information purposes only and should not be construed as legal or regulatory advice.