On Finance, Sports and 'Cut the Consensus'

Off the Blocks | Vol 104, March 3, 2020

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A Glimpse Into Financial Reordering

(This is a second post in understanding The Changing Face of Finance. Part one here.)

Until recently, money simply meant cash. Central banks across the world had a fantastic grip on its creation (and destruction). In a financially interconnected world, bank deposits lubricated a variety of financial transactions and payments and gave rise to trillions of dollars in derivative assets. The financial relationships were sacrosanct and there was no real need to cross lines, even if it meant inconvenience, friction in forex conversions, delays in money transfers, and large transaction costs. The price everyone paid for ‘stability’.

Technology and particularly electronic money has changed everything. Modernization of payments is underway in a big way and the implications of digital money are global. Some might question whether e-money is actually money in the sense of the older traditional order, but at this point the debate is all but moot. Alipay, M-pesa, WeChat Pay, Paxos, USDT and a plethora of other digital money equivalents are increasingly gaining a larger share in our wallets. The convenience of using these as forms of payments and the network effects associated with them have made them a strong force. These alternatives, not issued by central banks, will impact the financial markets in three big ways: they will be complementary to fiat for transactional purposes, they will be competitive with fiat as a store of value and finally, they will transform banks into private investment funds.

According to the IMF the value of e-money transactions in China, WeChat Pay and Alipay, surpass those of Visa and Mastercard worldwide. The IMF also published a neat graphic to illustrate and aid in the understanding of the evolving nature of money.

Building on this, last month, JPMorgan published its internal research on the state of the crypto and blockchain markets. In a comprehensive analysis, the bank pulled in perspectives from a broad range of its global team to create a narrative around mainstream applications of blockchain technology, its rise as a means of an alternative payment system and the outlook on stablecoins and especially the technical hurdles they need to overcome.

For digital money to thrive, the underlying infrastructure needs to be robust to handle the demands of both consumers and financial institutions. As a result, we have seen a flurry of activity around settlements, clearing and collateral management, particularly led by stock exchanges. The notorious coin offerings have shown that under proper a regulated framework, exchanges can serve as a robust platform for launching new digital assets and double up as trading venues. A real-time settlement of trades will generally imply a lower reliance on capital requirements and subsequently lower reconciliation costs.

This has also created an opportunity for stablecoins to try and corner a big chunk of the market. There are some major macro-risks asssociated with this, particularly, (a) the risk of disintermediation of banking intermediaries and (b) without government backing digital money could significantly reduce the efficacy of monetary policy. Despite this, there is even talk amongst some central authorities to consider asset-backed stablecoins as a global asset reserve.

Stablecoins and various forms of tokenized payments can be broadly split into asset-backed, sponsored, and algorithmic tokens. The asset-backed can be backed by a mix of on- and off-chain collateral. The market trends indicate that the industry has somewhat coalesced around asset-backed stablecoins.

Arguably, fiat-backed tokens work well from the perspective of reducing volatility. According to Coinmetrics, even for nascent fiat-backed tokens, pegging them to fiat is effective in reducing the volatility - with daily volatility of 0.5% for pegged assets vs 4-6% for BTC, ETH, and XRP. While this is still unacceptably large for some large practical applications say forex trading, proponents argue that more short term liquidity and a wider base will help alleviate these concerns. A large scale payment system with little or no short term settlement liquidity will be inherently unstable. The unavailability of short term credit extensions for settlement liquidity is a critical difference between fiat and crypto-assets. Going forward, it is therefore expected that innovation in creating liquidity mechanisms will be a boost to wider and more mainstream adoption of blockchain and crypto-assets.

Ironically, entrepreneurs and some digital native payment advocates will do better if they hed to some of the lessons that come from the old fashioned world of finance: short-term credit is essential, and reserve assets should be thought of as collateral rather than a source of returns.

Now some significant news from the world this week:

  1. Sports | Blockchain a Home-Run in the Sports World — Use Cases Climbing in 2020: The new decade has kicked off with blockchain technology finally being utilized in real case scenarios in the world of sports. Many blockchain proponents are enthusiastic about the wide variety of potential use cases, but real-life working examples are often hard to come by. From the football-mad continent of Europe to the world of the NFL and Major League Baseball, blockchain-based applications are being used to improve ticketing, merchandising and interactions between audiences and sports teams and organizations. [… Read More on CoinTelegraph]

  2. Legal | U.S. Blockchain Regulations Fragmented and Undeveloped: The U.S. is by far the largest blockchain market in the world, with U.S. companies investing twice as much as their European counterparts and about three times as much as Chinese companies in 2019. Still, regulators have mostly neglected the legal challenges and opportunities brought about by the new technology. In light of the federal government’s no-show, some states have introduced progressive regulations on their own. California and New York, which are both home to a large number of crypto businesses, are leading the pack. Wyoming and Arizona have also become two of the most progressive states. On 20th February, Assemblywoman Yvonne Lopez proposed the Digital Asset and Blockchain Technology Act to the New Jersey state legislature – intending to establish new requirements for digital currency businesses and step up consumer protection. [… Read More on The Blockchain Land]

  3. Finance | Design Choices For Central Bank Digital Currencies Need To Follow Customer Needs - BIS Report: A new report from the Bank for International Settlements (BIS) calls for potential issuers of central bank digital currencies (CBDCs) to keep consumer needs in mind when making technological choices. The BIS is an international financial institution owned by 62 central banks. In the latest report that focused on the topic of CBDCs, the group visited the much-debated question of whether central banks should issue digital currencies at all. The report approached the topic by outlining six core consumer needs – privacy, ease of use, cash-like safety, universal access, across-border payments, and cash-like peer-to-peer usability. The authors then analyzed the design choices that would address these needs and make such CBDCs useful. [… Read More on The Block]

  4. Identity | S Korea’s NH Bank Releases Blockchain Employee ID System: South Korea’s Nonghyup Bank (NH Bank) introduced its ‘Mobile Employee ID’ underpinned by blockchain technology. this was the first commercial application of the distributed identity technology developed by the ‘Initial DID Association’. The Association is a decentralized identity consortium hosted by the Ministry of Science and ICT and the Korea Internet & Security Agency (KISA). LG, SK Telecom and Samsung Electronics founded the consortium and were later joined by several other telcos and commercial banks, including NH Bank. The consortium aims to introduce self-sovereign identity allowing users to control their own data, including personal information and qualifications. [… Read More on Ledger Insights]

  5. Human Resources |Giant Randstad Explores Blockchain to Quickly Match Talent With Recruiters: Randstad, the world's largest human resources firm, has begun testing a combination of the Cypherium blockchain and Google Cloud to better match talent to corporate needs. The Netherlands-based firm said in a blog post the blockchain can offer ways to automate bureaucratic tasks associated with workforce recruitment by handling the "nuts and bolts" of day-to-day recruitment activities, making the entire process more efficient. A recent study conducted by Randstad found that distributed ledger technology (DLT) provided a means to securely preserve customers' personal data while enabling the verification of academic and professional qualifications, as well as birth dates, addresses, and IDs, of prospective talent. [… Read More on Coindesk]

The Final Word | Cut the Consensus: You Can’t Run a Business Like a Blockchain

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Over the past few years, we have learned a lot from the “governance of blockchains,” primarily about consensus and decentralization as the two primary characteristics. Our applied knowledge stalls thereafter. We know much less about the field of “governance by blockchains,” as this is still at the experimental stage.

Consensus is a dreadful management practice for decision making.

- William Mougayar, author of The Business Blockchain

The desire to apply consensus methods and decentralization architectures to how we run organizations is an interesting concept. It stems from well-intentioned objectives wanting to mimic the governance of blockchains as a guiding strategy. In the simplest form, people who have a stake into projects are seen like nodes, and they are given voting power. The more decentralized the better. Voilà. If it works for a blockchain, it should work for organizations, no? Except that people are not computer nodes and consensus is a dreadful management practice for decision-making.

[… Read More on Coindesk]

About Proteum
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