Is it worthwhile to take the risk of
investing in cryptocurrency?
A discussion with hedge fund manager
Amit Rajpal about the case for investing heavily in digital assets — and why
Bitcoin is more long-term than investors believe.
This is the first in a series of
conversations with Bloomberg Opinion columnists about how to address the
world's most serious policy issues.
Trivedi, Anjani: You've been a
long-time traditional bank investor who's tracked the evolution of global
financial services organisations and the financial system. As the hedge firm
Marshall Wace's chief executive officer for Asia, you're now focusing on
cryptocurrencies, blockchain, and fintech. When did the switch take place, and
what prompted it?
Marshall Wace Asia Ltd's chief
executive officer, Amit Rajpal: I got to the conclusion about a year ago that
we're transitioning from a process of redefining financial services by altering
the architecture that underpins our financial system to one of truly
reinventing financial services by changing the architecture that underpins our
financial system.
There have been a lot of fantastic
fintech companies, but they've mostly operated on the outskirts of the
traditional system. Fintechs are now becoming mainstream, in my opinion. Unless
the mainstream adapts, it will be compelled to downsize and function solely
within the confines where traditional enterprises can compete under the current
technology architecture.
AT: When you suggest that traditional
banks will be increasingly restricted, can you offer an example of where this
is happening in the financial system?
AR: The financial system accounts for
between 5% and 10% of GDP in the majority of affluent countries. That is the
revenue source from which it creates intermediate savings flows, which is the
financial system's primary function. Payments are undergoing the most
transformation, with a total addressable market of $2 trillion, according to
McKinsey. Much of today's payment infrastructure was built years ago to support
business-to-consumer payments, trade finance, and supply chain activities. Many
of these payments use a standard template, have a lot of manual overlays, and
are often costly. We can get a fundamental shift where we move from manual to
automated and from significant economic rents to a much more effective manner
of intermediating savings with the evolution of blockchain technology at scale
and the correct compliance solutions underlying it.
The majority of central banks are
already aware of this. They're only trying to figure out the best way to make
this new technology mainstream without having bad implications.
AT: Do you think this is a turning
point in the way investors view the financial system? During the financial
crisis, the industry's regulation triggered a huge upheaval. Is this a similar
situation?
AR: We're still in the early stages.
From the perspective of an investor, there are several limitations. To begin
with, there is a great deal of noise and confusion. Cryptocurrency is a system.
It's a raucous and tumultuous environment. The emergence of non-fungible
tokens, or NFTs, as well as blockchain's ability to redefine processes and
flows, are all factors to consider. Because there are so many moving
components, it's difficult to predict how things will turn out, which has
diminished investor interest.
It's never a straight line process
with anything new. It's always turbulent, which is what makes this a good
investment opportunity for us. The general investor population is unaware that
financial services are transitioning from the fixed-line era to the smartphone
era. Investors' perceptions of the change are clearly out of step with the
opportunity.
AT: Isn't there a distinction between
how individual investors and institutional investors view these assets as an
investment opportunity?
AR: There is a fundamental difference
in the opportunity set. I divide it into three categories: Consumer-facing
business models, such as Coinbase Global Inc. or Monex Group Inc. in Japan,
which provide access to digital assets. Then there's the infrastructure that
goes into making the ecosystem popular, such as payment apps, scaling, and
compliance and regulation solutions.
The evolution of DeFi, or
decentralised finance, is the third. The potential set for these protocols will
grow as more assets are digitised.
These are items that aren't
immediately available in stores. These are either private market listings or
public market early-stage listings.
AT: What are the dangers for
small-scale investors?
AR: A large number of trading venues
are unregulated. Obviously, we've seen huge hacks in which exchanges were
cleaned out and investors who backed those exchanges lost their money.
Trading futures on cryptocurrency also
involves a lot of leverage. It's a combustible combination to trade a highly
volatile asset type on margin. Volatility, on the other hand, is nothing new.
People that participate in this activity are well aware of the dangers they are
taking. The regulatory framework is strengthening with time, and more exchanges
are becoming compliant. In a manner that they weren't three to five years ago,
trading venues are also becoming more mainstream.
AT: Is the financial system at risk in
a larger sense?
AR: I'm still of the opinion that it's
a minor issue. The value of crypto assets has just surpassed $1 trillion. To
put it in perspective, several large U.S. technology businesses have a market
valuation that is double, if not triple, that of Apple. The value of crypto
assets is less than 50 basis points when compared to the value of all financial
assets outstanding in capital markets. While crypto receives a lot of attention
because of its volatility and the fact that it's new and attempting to disrupt
traditional asset classes, the truth is that it's still too small to pose any
systemic risk.
AT: You identified the lack of
regulation as a risk. Regulating and innovating rarely go hand in hand. Is that
the case in this instance?
AR: I'd concentrate on how the United
States is approaching it. Six regulators are currently devoted only to the
adoption or mainstreaming of blockchain technology into the financial system. The
Office of the Comptroller of the Currency (OCC) is first, followed by the
Federal Reserve, the New York Department of Financial Services, the Securities
and Exchange Commission (SEC), and the Financial Crimes Enforcement Network
(FCEN) (FinCEN). They're all handling it in different ways in order to
stimulate innovation while limiting negative actors.
Just this year, the OCC has
accomplished a great deal. This year, they've given out three digital bank
licences. These are banks, however they only trade with digital assets rather
than fiat cash. This is a significant event. The United States also allowed
public blockchain to be integrated into the traditional payment system, which
had previously been prohibited. This opens the door to new ideas.
Other regulators are concentrating
their efforts on restricting rogue actors. The travel rule, which applies to
transactions above a certain threshold, will now apply to all digital asset
transactions, according to FinCEN. They have stated that know-your-client and
anti-money laundering procedures must be followed in order to achieve
equivalency with the mainstream system. This is the correct strategy.
Having the correct regulations in
place could prove to be a competitive advantage in this industry.
So far, the United States has taken
the correct approach.
Other countries, especially China,
must be more open to stimulate innovation while minimising bad-use situations
so that the system can grow more efficient.
AT: Marshall Wace, your hedge firm,
has built up a crossover strategy focusing on digital-asset investments. What
do you think the most promising opportunities are?
AR: The goal of this strategy is to
catch the redefining of financial services. The application of blockchain in
reinventing financial services, as well as payments within the financial
infrastructure layer, are two of our top goals.
We're putting a lot of effort on
India. I see the potential for a massive financial digital leap. This is
because India begins from a relatively manual position: digital payments
account for only a small part of overall payments. It also starts from a low
point of inclusion, so new technology adoption can make a significant
difference.
Scale will grow at a breakneck pace.
We believe that being ahead of the curve, rather than waiting for the IPO, is a
significant benefit. And the investing community is still catching up in terms
of understanding the changes that are coming.
AT: Can you give some examples of how
blockchain is transforming financial services in the real world?
AR: Linklogis Inc., a publicly traded
firm in Hong Kong, is one example. It employed blockchain to verify supply
chains all the way down to the sixth or seventh level, starting with huge
anchor clients. This information is constantly updated. It's also tokenized by
means of digital payment obligations.
Others are more generic in nature.
There are many states in India, for example, that maintain shoddy manual
records on real estate and property ownership. There is always a battle for the
championship. Many companies are turning to blockchain to update records in
real time and avoid the litigation issues that come with title, which is a
common characteristic of real estate ownership in emerging nations. For
decades, these have been major annoyances with no resolution other than people
going to court or settling out of court.
AT: Developing and scaling up
underlying blockchains consumes a lot of energy. Do you see this changing when
the space shifts from proof-of-work, where everyone can answer difficult
equations, to proof-of-stake, where you have to have a stake in the game?
AR: Bitcoin's original blockchain was
built on a proof-of-work model. And Bitcoin aspires to stay true to its word. I
believe the balance will continue to shift in favour of proof-of-stake, which
is far more energy-efficient, over time.
Proof-of-work is bad for the
environment because it makes you a victim of your own success. If the value of
the crypto asset – let's call it Bitcoin – continues to rise, more people will
be motivated to solve the problem. As a result, the equation becomes more
difficult, necessitating more processing power, which has an environmental
impact.
The fact that Bitcoin mining can go to
the source of electricity, as opposed to gold mining, which requires going to
the source of gold, is a mitigating factor. Bitcoin mining still uses less
energy than gold mining. Fourty percent of Bitcoin mining is already done with
renewable energy sources. And if China is excluded from the equation, the
figure rises dramatically.
If governments decide to impose a
carbon price on Bitcoin mining, this trend might be accelerated. That is a very
possible scenario. Bitcoin mining can become significantly renewable with the
correct set of incentives and checks and balances. This is a problem that can
be solved. And it's just Bitcoin. People should be aware that the remainder of
the blockchain is beneficial to the ecosystem. It uses so little energy in
comparison to what it replaces that as more objects shift to proof-of-stake,
our net energy usage will decrease. Bitcoin mining will lower its carbon impact
with the correct amount of concentration and attention, making it more
sustainable and, ultimately, more investable.
AT: How long do you think it will take
for other investors, the laggards, to catch up and start looking at this asset
class in a more positive light?
AR: It'll most likely happen in the
next three to five years. The financial system, for example, performs a variety
of important and useful societal functions that we all require on a daily
basis. Payment applications, for example, are essentially a message system in which
you must continually calling each other, filling out paper and documentation,
and going to your bank branch to move money someplace. You seem to go through a
lot of paper. Anything that requires the use of paper is considered manual. It
necessitates a physical presence.
The carbon footprint of the banking
sector is roughly seven to eight times that of Bitcoin mining.
The entire debate will be flipped if
we replace banal operations currently performed by the banking system with a
proof-of-stake mechanism, which consumes far less energy than traditional
tasks. In contrast to popular belief, blockchain will become a net contributor
to reducing our environmental or carbon footprint. This is a set of wheels in
motion. They take time to complete.
Anjani Trivedi is a Bloomberg Opinion
columnist who focuses on Asian manufacturing firms. She was once employed at
the Wall Street Journal.
