Financial Institutions are Feeling Conflicted.


October 2021. Kevmate.


Look what I've got. Its money.

When the world of crypto was invented, with the invention of Bitcoins, the narrative was that of a rebellion against the way the fiat money system worked. Satoshi Nakamoto was dismayed that when governments didn’t have enough money they just printed some more. He or she created Bitcoin with the aim of giving the world an alternative. This was probably the narrative the early adopters followed, and indeed this view has prevailed, at least to a large extent.

But this simple fact, that it removes the ability of anyone to print more or otherwise make new rules, gives it this amazing property that everyone secretly wants. It acts as a store of value that can be trusted. In particular people who have lots of money want that.



Money is power.

And people who have lots of money, as well as other people who just have normal amounts, have lots of influence in most democratic countries. They exert influence over the politicians and the banks and the other financial institutions whose job it is to keep them happy.



Bad things might happen.

But Bitcoins and cryptocurrencies are dangerous to governments and banks because they remove their power over our money. All sorts of bad things could happen if they suddenly found they couldn’t control our money. Obviously they wouldn’t be able to devalue it by printing more, which would upset them, but we might think that was fine. They really shouldn’t do that anyway. However they might face other problems, like for example they might find it harder to collect taxes. If 99% plus of our transactions go through banks everyone knows they can’t cheat, but as that percentage drops it becomes more costly to trace things, and it is easy to imagine a fall in the amount of tax collected. Even a small fall could be very bad for the government and subsequently for things like schools, police, hospitals etc.

So, bad for the government then, but in fact also bad for the banks and other financial institutions. Really, an existential threat. When you look at Bitcoin you see that it can do what money does, at least eventually, with layer 2 solutions etc, but when you look at Cardano you see that it can replace all the financial services. With native assets, scalability, and smart contracts, there is very little of the financial world that couldn’t be replaced with something better. Of course they can adapt and try to keep up, but that’s expensive and slow and risky.

So, existential risks for both governments and banks. You would think that these risks would mean that they are doing everything in their power to wipe all memory of it from the face of the earth.



Companies have to make a profit, to be healthy.

Which brings me to the point of this article; financial institutions are feeling conflicted.

You see, all private companies have a single driver. Maximise profit. This simple maxim is so commonly cited that we tend to take it for granted. However, in most cases, it means that the goals of the company do not align with the goals of the customers. To maximise profit the company has to put the least possible amount of effort in while at the same time charging the most possible money for the service. The only saving grace is that it wants to attract and retain customers, so they have to be happy. In most cases the company can select a product or service it wants to sell and persuade customers that they want it using marketing. Whether they succeed completely or only partially varies, but the point is that their goals are not truly aligned.

But… Bitcoin and cryptocurrency is a bit different.



That looks like a big lump of easy money. That's unusual...

Cryptocurrencies are designed so that when people want them the price goes up, so people who have them make a profit. This makes them a bit moreish. They are the best performing asset class of all time, and they are just getting started. Financial institutions want to buy them because they want to make money, so they make money in a way that makes money for their customers. Not by charging high fees etc, their goals are aligned. And they can make LOTS of money.

Hedge funds, Pension funds, Investment banks, even Governments (maybe one day), can see that they can generate profit with cryptocurrency, even if they aren’t quite sure exactly how to do it yet.

It's an existential threat, but they just can’t ignore the lure.



Come and get it, you know you want to.

I’m sure I have offended people by putting a picture of an Angler fish here. For a start, it looks seriously evil. People will not be happy to have Bitcoins and crypto portrayed as a grotesque devouring enemy.

And… Of course it isn’t evil, it just looks scary. The poor guy is just making a living. It’s not his fault that he looks scary to land lubbers. I bet he is attractive to some of the local girls. If he is male. Otherwise, maybe he is attractive to the local blokes.

Sorry, I digress.

The point is that Angler fish have a luminescent lure that dangles in front of their mouths that other fish just kinda can’t resist. It’s just instinct. That promise of profit is irresistible, so they wander over for a little taste, and boom… they are off down the one way tunnel.



Oooo - shiney thing...

Clearly, financial institutions, and perhaps a wider range of institutions, people, companies, and even governments, are being drawn to the light by the promise of profit. Profit and new cheaper better ways to get the job done. In the end, they also have to serve the people, if they want to keep their customers or if they are a democracy, and they also hear encouraging voices telling them it's ok. Their customers want them to look a bit closer, even if it seems scary.



But, surely it's more complicated than that?

The fact is, there are innate features about both banks and governments which make it difficult for them to avoid the bitcoin trap. Lets take governments first:

First, they don’t move quickly. They are the big structures involving lots of people who are all vying for position and trying to decide what to do to get ahead in the game. A lot of discussion has to go on before they decide they need to do something, then a lot more time before they can decide what to do.

Second, they aren’t long term thinkers. Typically in a democracy the people making the decisions changes every five years, so they plan for the short term. If a problem seems a long way off they put off taking action. If they have a plan it often gets shelved by a regime change.

Third, they have to try to keep as many people happy as possible. They can upset a few people sometimes, but if a decision will upset a lot of people they tend to avoid it.

Fourth, they are in competition with other governments. They know that cryptocurrency is a global phenomenon and if they create restrictive unpopular rules it will just move to another country. The technology is borderless so they still get the downside but miss the upside.

Fifth, there is an opportunity to tax this new money tree. There are too many people who have made a lot of money in it to risk losing that opportunity.

Governments which are not democratic might not have all these features, but there are enough democratic ones to make it fly. In fact, sometimes even authoritarian governments choose to use Bitcoins as a trick to avoid sanctions. By doing so they take freedom for themselves, but in the process spread the message that freedom is available to all.



Banks are pretty fat, but they are also greedy

Then there are the financial institutions and the banks:

First, they are very much in competition with each other to take advantage of this marvellous new asset type before their competitors do. The ones that seem to be holding back soon notice that they are being asked difficult questions by their customers. As I mentioned above, it is the best performing asset class ever, by some metrics. It’s profitable.

Second, there is a long list of very high nett worth individuals who have embraced the cryptocurrency space quickly and to good effect, and they are making quite a lot of noise about it. These people are highly influential, over other investors as well as the banks themselves.

Third, when managing a large lump of money there is a golden rule that you need to diversify across different asset classes. In particular you want non-correlated assets, so that if some of your assets fall in value unexpectedly others are in the pot which might be going up. This is called a hedge. Cryptocurrency has been, generally, quite good as a hedge.

Fourth, there has been a perception in recent months that stocks might be getting into bubble territory. A lot of money has been moving into what are often called Growth Stocks. These are stocks where the profit of the company doesn’t warrant the value, but there is an expectation of future growth. Increasingly this can look dangerous, so having a portion in a hedge asset makes sense.

Fifth, there is an increasing number of companies that are adding bitcoin to their balance sheet. These are large organisations that are showing the way. They are proving that it can be done and that the market and the shareholders are comfortable with it. They are not likely to convert back to cash anytime soon.

Finally, there is an increasing fear that inflation is going to become an important enemy. Funds have to take increasing risks to stay ahead of inflation and Bitcoin is clearly being seen as a solution. If the risks of holding Bitcoin were lower this would become an important effect.



Welcome to the new world

As time goes on, the incentives to dabble in the dangerous crypto waters grow. As do the difficulties involved in fighting it. The speed of the current slowly accelerates, and the incentives get stronger. Some sensible controls will be put in place, hopefully, so that the brave new world still works, and we still have to pay our taxes.

And, in the end, they will embrace it, and after a bit of panic and flapping around, we will all get dragged in. I will see you on the other side.

There are plenty of people who agree with me on this, but one I will mention here is Alex Gladstein who has likened Bitcoin to a Trojan Horse. It’s the same idea, it is welcomed in through the front doors but ends up destroying the city. Except, it’s our city that we are destroying, so I hope he is exaggerating the results.



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