The Digital Assets Revolution
I’m a firm believer that history never repeats itself, and never will. However, it teaches us how and why success or failure occurs and over time create heuristics. Our mind will combine lessons learnt with theory and guide us through the uncertainty of tomorrow. However, history is unable to show us how to model the consequences and outcomes of a revolutionary new technology.
As it stands today, the Industry of Money is built on out-dated, pre-internet technology, on top of a fiat system which has, primarily due to a misalignment of interest, resulted in what I would argue is the manipulation of capitalism. Arguably, the most important ‘price’ in the market is the cost-of-capital, which is effectively determined by global interest rates. However, interest rates are clearly not driven by supply-demand factors, but rather by central bankers’ attempt to smooth cycles.
Whilst we do not believe the fundamental structure of capitalism is broken, manipulating the cost-of-capital, whether intentionally or unintentionally, has very significant consequences. Specifically, the price market participants pay to access capital is too low to meet the required return of the owners of capital. A study by the World Economic Forum in 2017 found that global pensions systems will face a shortfall of $400 trillion USD by 2050. Since President Nixon abolished the gold standard in 1971, Debt held by the US Treasury has grown over seventy-fold (7000%!), whilst US GDP has grown by 1800%.
Inflation is a risky way, but perhaps the only way, to fix this problem. Inflation could drive asset values higher whilst not impacting the liability side of the equation. It might also spur investment and subsequently lead to higher growth. This is a key reason why Central Banks are happy to continue on the path of loose monetary policy, in the hope that inflation and growth will reverse the public debt bubble they created. Whist the objective is inflation, the outcome could result in stagflation or worse still, a depression…perhaps even greater than the Great Depression (coming up with a new name will be the least of our problems!).
For this very reason inflation is a major concern and investors are justifiably looking for ways to protect capital. When the debt bubble bursts, it will get ugly, and is one of the key reasons why we believe the 60-40 era is dead, and portfolios based on the theoretical bond-vs-equity mix will face significant headwinds.
For over four centuries gold has proven to be a store-of-value, and it might prove to be so for the next four. However, despite being a proven store-of-value with attractive physical characteristics, in the digital age – as a means of exchange – gold is more cumbersome.
The now famous white paper published in 2008, titled Bitcoin: A Peer-to-Peer Electronic Cash System, was an attempt to solve this problem. Since 2008 Bitcoin has not only survived several cycles, but the open-source technology it is built on – the Blockchain – offered an opportunity to revolutionise the Industry of Money.
Bitcoin has many characteristics one would want to see in “digital gold”, and accordingly the digital gold narrative has gained a lot of support. However, up until now, Bitcoin has behaved more like a speculative, risk-on asset, rather than a robust store-of-value or stagflation hedge. Whilst the seeds have been planted for a Cryptocurrency to fulfil the role of “digital gold”, or indeed a global reserve currency, it is too early to assume Bitcoin, or any Cryptocurrency in existence today, will fulfil either of those.
However, what truly grabbed our attention is the idea of Smart Contracts. The Blockchain serves as a digital ledger, where transactions are recorded and then distributed to the public, after which it cannot be altered. This solved the double-spending problem of previous digital currencies, but also the opportunity for any transaction…any agreement!!…to be recorded and timestamped.
Ethereum, developed in 2014, is a blockchain network offering exactly this functionality: the ability for developers to create decentralised applications based on smart contracts. DeFi, short for Decentralised Finance, is effectively applications built on a smart contract blockchain network, which allows its users to enter into financial transactions without the need for intermediaries. The resulting opportunities from this type of application is very significant. Perhaps one of the most exciting innovations using smart contracts on blockchain technology is DAO’s, or decentralised autonomous organisations. DAO’s are internet-native entities with fully democratised ownership structures, governed and manged by its token holders.
Whilst doing research on the technicalities and opportunities in DeFi, I stumbled into the “Metaverse”. We’ve all heard of Web 3 and non-fungible tokens, but after doing some more research I suddenly found myself in the Matrix! Virtual concerts, LAND sales on Decentraland and 3D Avatar sales are growing in all aspects…the Metaverse is truly buzzing!
However, the true value of the blockchain is perhaps much more in its real-world application rather than the speculative value of ‘fungible tokens’, aka Cryptocurrencies. The proceeds of a beautiful song going to the songwriter or singer, rather than a major record company; or buying real estate in New York, Tokyo…or the Metaverse…without the extortionate bill for legal fees! Maybe it is selling your business or your data…with primarily you benefitting from your creations!
So, to conclude, whilst Bitcoin may or may not prove to be the store-of-value many hopes it will be, it is in no way the solution to our insolvent public finances. However, born out of the technology which accompanied its creation, a Digital Asset Revolution has arisen, and with this comes a host of exciting new possibilities!
“The world as we have created it is a process of our thinking. It cannot be changed without changing our thinking.”
Chart 1 – US Debt creation has significantly outpaced GDP growth over the last 50 years:
Chart 2 – How inflation erodes the purchasing power of $10,000 over time:
Chart 3 – Despite significant debt creation and periods of inflation over the last 50 years, Gold has retained its purchasing power:
Chart 4 – Whilst the price of Ether, the native cryptocurrency of the Ethereum platform, has been nothing but volatile, its value, use and market awareness have arguably grown significantly more: