Bitcoin is going off the rails, but so what?

Number goes up, number goes down. Cryptocurrencies as a whole have been tumbling, and the original cryptocurrency, Bitcoin, is no different. It looks as if there was a bubble and it is bursting. The economist John Kay is unconvinced that this bubble will lead to anything. He wrote that “the underlying narrative of cryptocurrencies is, by the standards of historic bubbles, unusually weak; more akin to tulips than to ultimately transformational innovations such as railways or electricity” going on to observe that the “power of the current narrative is that it brings together so many features which make for an attractive and infectious story” which I think is congruent with some observers’ view of Bitcoin as a protest movement rather than a financial revolution.

I have a suspicion that John may be wrong though. I think Bitcoin will have an impact and that it will lead to the creation of new markets. His mention of the railways reminded me of Nouriel Roubini and Preston Byrne’s observation that that the cryptocurrency mania of today “is not unlike the railway mania at the dawn of the industrial revolution in the mid-19th century”. I’d put the dawn of the industrial revolution a little earlier than that, but The Black Swan and The Black Marmot are on to something here and to see why you need to know a little about that railway mania that they refer to.

Opening Liverpool and Manchester Railway.jpg
By A.B. Clayton, Public Domain.

I wrote about it some years ago for Financial World magazine (back December 2011 in fact) and made the point that Victorian Britain’s railway boom was truly colossal. The first railway service in the world started running between Liverpool and Manchester in 1830 and less than two decades later (by 1849), the London & North Western railway had become the Apple of its day, the biggest company in the world.

(See Christian Wolmar’s fabulous Fire and Steam for a beautifully written history of the railways.)

This boom led to a colossal crash in 1866. The crash was caused (here’s a surprise) by the banking sector, but in that case it was because they had been lending money to railways companies who couldn’t pay it back rather than American homeowners who couldn’t pay it back. Still, then as in our very own crash of 2007, the government had to respond. It did so by suspending the Bank Act of 1844 to allow banks to pay out in paper money rather than gold, which kept them going, but they were not too big to fail and the famous Overend & Gurney bank went under. When it suspended payments after a run on 10th May 1866 (as frequently noted, the last run on a British bank until the Northern Rock debacle), it not only ruined its own shareholders but caused the collapse of about 200 other companies (including other banks).

(The directors of Overend and Gurney were, incidentally, charged with fraud but got off as the judge said that they were merely idiots, not criminals.)

The railway companies were enormous and many ordinary people had invested in them. When their Directors went to see the Prime Minister in 1867 to ask for the nationalisation of the railway companies to stop them from collapsing (with dread consequences for the whole of the British economy and in particular the widows and orphans who had invested in them) because they couldn’t pay back their loans or attract new capital, they didn’t get the Gordon Brown surrounded by advisers who happened to be bankers tea and sympathy followed by the suspension of competition law. Benjamin Disraeli told them to get stuffed: he didn’t see why the public should bail out badly run businesses, no matter how big they might be.

The Mallard, holder of the world speed record for steam locomotives, 126mph.

Needless to say, the economy didn’t collapse. As you may have noticed, we still have trains and tracks. A new railway industry was born from the ruins, just as new cryptomarkets will arise from the ruins of Bitcoin. The transport services kept running because the new industrial economy needed them and that economy kept on growing. The new post-industrial economy needs a new transport network, for bits rather than iron and coal, and Bitcoin’s heirs and descendants might well provide it. The impact of the railway crash was not restricted to rail transport and the industries that used it, just as the impact of the Bitcoin crash will spread far beyond online drug dealing and mad speculation.

As I noted in my book “Before Babylon, Beyond Bitcoin”, Andrew Odlyzko’s superb paper “The collapse of railway mania, the development of capital markets, and Robert Lucas Nash, a forgotten pioneer of financial analysis” argues convincingly that the introduction of basic corporate accounting standards following the collapse of the railway companies was a significant benefit to Britain and aided the development of Victorian capitalism. You can’t make an omlette, as the saying goes, without letting the bad eggs go to the wall. Hence, as I summarised more recently, the vital lesson of that crash is that letting the railways collapse not only led to a stronger railway industry but it also helped other industries as well, because it meant that new standards for accounting and reporting were put into place.

This is hardly a novel observation. History has repeatedly gone through this cyclic co-evolution of technology, business and regulation to end with something pervasive and fundamental to the way that society operates, which is why I think Nouriel and Preston are right to use the comparison. Benoît Cœuré, chair of the Committee on Payments and Market Infrastructures (BIS), and Jacqueline Loh, chair of the Markets Committee (BIS) made a very good point about this in the FT writing that “while bitcoin and its cousins are something of a mirage, they might be an early sign of change, just as Palm Pilots paved the way for today’s smartphones”.

This, I think, is the narrative that I find most plausible. But what are cryptocurrencies “paving the way” for? I think it is for cyryptomarkets that trade in cryptoassets: cryptocurrencies with an institutional link to real-world assets. These are markets made up from money-like digital bearer instruments or, for want of a better word, “tokens”. As I have written before, it is not the underlying cryptocurrencies that will be the money of the future but the “tokens” that they support. Assuming that the fallout from the Bitcoin bubble is better regulation of the platforms, then cryptomarkets based on tokens will aid the evolution of post-modern capitalism as much as the invention of auditing helped Victorian entrepreneurs a century and half ago.

The Man Who Tokenised The World

David Bowie was a genius. That is a word that gets bandied around all too lightly these days, but in his case it is entirely justified. And not because of his music, as brilliant as it is. No. Bowie was a genius because he understood the future. When looking at how the internet was developing, he famously predicted the end game: streaming. Indeed, he said at the time that music would become “like water” piped into our homes.

(And his music was indeed brilliant: Aladdin Sane was the first album I ever bought with my own hard-earned cash, Ziggy Stardust was part of the soundtrack to my college years and “Heroes” is one of my all time favourite songs.)

Not only did Bowie predict the future, he monetised it. In what I am convinced that future economic historians will surely highlight as one of the weak signals for change to a post-industrial economy, he created the Bowie Bond. This was a 10 year, 7.9% self-liquidating bond backed by the revenues from all of his music prior to 1993. The value of this over a decade was estimated at $100 million and stamped as AAA by credit rating agencies. Then, in 1997, these bonds were sold to Wall Street. Whether Bowie knew that this valuation was nonsense or not I couldn’t say, but he made $55 million from the bond sale. A few years later, the bonds were trading as junk. Bowie, as it turned out, was smarter than the bond market.

Ten years ago I wrote about the Bowie Bonds when I was thinking a lot about private currencies and digital money. It had occurred to me that those $1,000 Bowie Bonds were a shade away from being a form of Bowie Bucks and that if they had been issued as some kind of digital bearer instrument (DBI, or what many people now call “tokens”) then would have been a form of repetitional currency. I said that while it might seem strange to imagine trading in Bowie Dollars that are simply units of Bowie bonds, why not? As I noted at the time, it would be no different to trading with Edward de Bono’s “IBM Dollar” (in that it’s a claim on some future asset) or a similar instruments.

At the time, of course, I did not know that the shared ledger revolution was around the corner, so I imagined that Bowie Bucks would be implemented either in decentralised hardware (a la Mondex) or centralised software (a la Digicash). Now we have another and more appealing alternative to deliver the currencies of the future: tokens trading on shared ledgers. If Bowie were here today, I’m sure he would be discussing a token sale rather than a bond sale. But on what platform? Do the permissionless public ledgers work as a platform? Or do we need institutions to create permissioned ledgers with service-level agreements? How exactly will the money of the future work?

Digital and Crypto Layers 

I’ll be talking about this world of cryptomarkets, cryptoassets and cryptocurrencies at the 3rd Nordic Blockchain Summit at Copenhagen Business School on Friday, so I look forward to seeing you all there. I’m genuinely keen to learn more in this space interested your spectrum of view on tokenisation and such like. Don’t be shy with the question.

Oh no, not “legal tender” again

Oh well. Just had another pointless argument about cryptocurrency and legal tender with someone in another context. The argument was pointless for a couple of reasons…

First of all, the argument was stupid because the person I was arguing with didn’t know what “legal tender” means anyway and, as I’ve already pointed out, it doesn’t mean what a lot of people think it means. Let’s just have a quick legal tender recap, using the United States as the case study. Section 31 U.S.C. 5103 “Legal tender” states that “United States coins and currency [including Federal reserve notes and circulating notes of Federal reserve banks and national banks] are legal tender for all debts, public charges, taxes, and dues”. Here is chapter and verse from The Man commenting on what that means: “This statute means that all United States money as identified above is a valid and legal offer of payment for debts when tendered to a creditor. There is, however, no Federal statute mandating that a private business, a person, or an organization must accept currency or coins as payment for goods or services. Private businesses are free to develop their own policies on whether to accept cash unless there is a state law which says otherwise”.

TL:DR; The Man says no-one can force you to take dollar, dollar bills. 

Secondly, the argument was stupid because the person I was arguing with hadn’t bothered to fact-check the story that they were arguing with me about in the first place. It was to do with this story, supposedly noting Bitcoin’s status in Japan saying that “in Japan bitcoin core (BTC) is ruled legal tender and is already used to buy everything from airline tickets to sushi”. This is, as you may suspect, is completely false because in Japan the Virtual Currency Act defines Bitcoin (and other virtual currencies) as a form of payment method and not as any kind of legally-recognized currency or legal tender.

TL:DR; Bitcoin is not legal tender in Japan, nor anywhere else for that matter.

Nor, I strongly suspect, will it ever be. So let’s put that to bed and ask the more interesting question as to whether a central bank digital currency (e$, for short) would be legal tender. Here, I think the answer is unequivocal: yes, and in unlimited amounts, because there is no credit risk attached. A transfer of e$ is full and final settlement in central bank money and in time Section 31 U.S.C. 5013 will undoubtedly be extended to say so.

Basically, nothing is happening in UK banking

The British newspapers all reported on the latest figures for current account switching. Here’s an example: “Branch closures, IT meltdowns and vanishing cash machines have forced nearly a million disgruntled savers to ditch their bank and move to a rival in the past 12 months”. Wow. Nearly a million. That sounds like a lot.

But I wonder how many disgruntled customers did that last year? Not so wow. Nearly a million. So, basically, nothing has changed.

In fact the number of people switching accounts, while slightly up on last year, is 9% down on 2016. And the number of people switching is still a fifth down on 2012, the year before the banks were forced to introduce the Current Account Switching Service (CASS, a system which cost hundreds of millions of pounds) to reduce the average time to change bank accounts from around 10 days to a week.

Yes, that right. There are still fewer people switching accounts now than there were before the convenient and user-friendly account switching service was introduced.

Frankly, you can understand why no-one bothers switching. Every bank delivers basically the same service as every other bank, so the number of people switching accounts remains at around 3% of the customer base. And in a sector that is so heavily regulated, the cost of innovation is so high that only the most mass market of new products or services can get into production – it is very difficult to go down a more agile, design-led path.

The headline should have been “Despite everything that banks can throw at them, British bank customers resolutely refuse to move accounts”. This more accurate description of the retail banking landscape appeared, as far as I could tell, only in the Pink ‘Un. In a lovely piece titled “What would it take for you to switch your bank account”, Clear Barrett highlights the specific example of TSB and notes that despite the catastrophic failure of their system and weeks of chaos, only a tiny fraction of the customer base blew them off and switched! They had a net loss of only 6,000 customers (26,000 customers left but – astonishingly – 20,000 joined).

What about the “challengers” you say? Well, first of all, “challengers” is a bad name for what are essentially niche banks. Second of all, what about them? According to the FT, when data analytics company Ogury carried out a study of just over 1.5m mobile users in the UK in the second quarter of this year, it discovered that all of the top ten most-used ‘banking’ apps were from the traditional high-street banks.

So, no-one changes their current accounts (or their savings accounts, which the FCA says gives the big banks a cheap way to fund lending and stifles the “challengers”). But in the future, this inertia will be overcome.

How? Well, as the FT noted, and as I have repeated ad nauseam, “UK bank executives probably aren’t losing too much sleep over fintechs just yet. More likely to have them reaching for the Zopiclone are the US tech giants moving into the payments sector who — somewhat perversely — could end up being the biggest beneficiaries of PSD2″.

What does this mean for account switching? I think it could be very significant indeed. Open banking means that banking services will be delivered by these tech giants acting as “third party providers” (TPPs). The TPPs will manage the relationship with the customer and interact with the banks through application programming interfaces (APIs). The banks will be the heavily regulated, low margin, high volume machines sitting behind those APIs, and the will be selected because of service level agreements and cost/capacity calculations, not because of adverts of spacemen floating down beaches while singing.

The account switching will be done by bots rather than by those customers, disgruntled or not. When I decide to open my Amazon savings account, I’ll never bother to read the small print and find out that the account is actually provided by Barclays. And when Barclays try to charge Amazon a penny more, Amazon will move the account to Goldman Sachs. I haven’t switched my main bank account for 41 years, but I can imagine algorithms changing it for me every 41 days to get the best possible deal on financial services at all times.