Blockchain and capital markets: foreign exchange trading

FX market

For something so little talked about, the foreign exchange (FX) market is a big deal.

The world’s largest and most liquid financial market, over $5tn a day changes hands in FX cash and derivative transactions. That’s more than the entire annual GDP of some countries.

The bulk of transactions are for FX derivatives, and few appreciate how integral these are to the functioning of the world economy. In terms of value, FX swaps are the most traded instrument in the world, exchanging an average of $2.4tn per day. When a central bank, commercial bank, corporation or fund manager needs a foreign currency for a purchase, an investment or a hedge, they generally resort to FX swaps – basically, they lend their domestic currency to foreign institutions, and simultaneously borrow from them the currency they need. This works out to be much cheaper and faster than directly borrowing the money in another country. In principle, the collateral for each side is the payment (or series of payments) they commit to making to the other.

As with most derivative markets, the system is clunky and relatively expensive, operating on dispersed, decentralized exchanges with duplicate processes, a lack of standardisation, an emphasis on direct relationships and increasing capital requirements. Although the infrastructure has radically improved over the past few years with the introduction of new trading venues, greater liquidity, algorithmic execution and improved data aggregation, the industry still regards settlement risk as one of its greatest threats.

New technologies and processes are making a difference, and are becoming even more essential in light changing regulation and increasing costs. Clearing houses are becoming even more important, for example, and traditionally opaque over-the-counter markets are being given a welcome (but expensive) wash of sunlight as post-crisis financial regulation demands greater transparency and less risk.

Given the decreasing profitability of swap market making (due to greater capital requirements and a recent slump in volume due to macroeconomic conditions), many prime brokers are either pulling out of the sector or closing out smaller clients, leading to lower liquidity and increased risk. This encourages even more prime brokers to pull out. Non-bank dealers and infrastructure innovations are picking up some of the slack.

Several capital markets businesses – both startups and incumbents – are looking at how blockchain technology can help reduce operating costs.

One of the most prominent is Cobalt, a startup working on a blockchain platform for FX post-trade settlement which it claims can reduce risk and cut costs by 80% (according to the FT, banks currently spend about $500m a year on technology for currency trading). In May, it announced that two of the world’s largest FX traders – Citadel Securities and XTX Markets – will use its service. They join 22 other banks and traders, including Deutsche Bank, UBS, BNP Paribas and Bank of America Merrill Lynch, in testing the platform ahead of a launch expected later this year.

While Cobalt is currently building on a blockchain platform designed by UK-based startup SETL, it aims to be ledger agnostic. The startup cites Tradepoint (a foreign exchange trading technology provider), First Derivatives (a database technology developer, which will apparently feed the data) and Kx (focused on high-speed data processing) as tech partners, and counts CitiGroup (which has the lion’s share of the global FX market) and DCG among its investors.

From startup to industry incumbent… NEX Group (formerly ICAP) has been working on a distributed ledger for FX trades – called Nex Infinity – built with technology from New York-based startup Axoni. The company recently began allowing clients to test the platform.

This makeover is a key part of the company’s strategy as it moves away from its history as one of the market’s leading interdealer brokers and into trading infrastructure. Its subsidiary Traiana will most likely end up playing an important role in the rollout of NEX Infinity, as it is one of the market’s leading post-trade and risk specialists. (As an aside, the founder and CEO of Cobalt – Andy Coyne – used to be CEO of Traiana.)

And, moving up the ladder, CLS Group – the world’s largest FX settlement service (handling over 50% of global FX transactions) – is working on CLS Netting, a blockchain-based settlement system for trades in currencies outside the standard service. The platform won’t be used in the core settlement system, but rather to improve liquidity in other currencies with more challenging legal frameworks that are currently settled on a bilateral basis, such as the renminbi and the rouble.

CLS is a founding member of blockchain consortium Hyperledger, and the platform is being built on Hyperledger Fabric. Several banks – including Bank of America, Goldman Sachs, Citi, JPMorgan Chase, Morgan Stanley, HSBC, Bank of China (Hong Kong), Bank of Tokyo-Mitsubishi UFJ, FirstRand and Intesa Sanpaolo – have expressed an interest in participating. Not bad for a fledgling project. Development is expected to near completion in early 2018.

The FX market is not an easy one to disrupt, even though the opportunity is obvious. First, scale matters – small startups, unless they have influential backers, are at a disadvantage in a sector in which most participants know each other, and trust is an important factor. What’s more, the incumbents increasingly seem to be aware of the potential of blockchain technology, as well as the need to innovate.

Second, the spectre of tightening regulation and the impact of macroeconomic trends add risk to the outlook for any foreign exchange project, for both startups and incumbents. FX volumes have been declining for a couple of years, although the slump has been concentrated in the spot market – derivatives are growing nicely, for now.

The next 12 months should see some key announcements in the nexus between blockchain technology and FX trading, as projects mature and more proofs-of-concept emerge. As regulations change, economic trends realign and even newer technologies develop, the market will continue to evolve towards a more efficient, transparent and trustworthy financial service. We are witnessing what will be looked back on as a fundamental shift in capital markets.

ICOs, common sense and the long reach of the law

I’m scratching my head here.

Most respondents to CoinDesk’s poll question “Who should be most fearful after the SEC’s DAO token sale ruling?” answered “Nobody, very unactionable”.

CoinDesk poll on SEC impact

This goes a long way to explaining the continued momentum of initial coin offerings (ICOs). A quick look at any of the ICO tracking sites shows no shortage of upcoming sales, many of which look to the naked eye very much like securities.

Are the respondents on to something? Or are they buying into the tragic “it’ll never happen to me” fallacy?

The thing is, they’re probably right. The SEC doesn’t have the resources to “go after” every digital token that acts like a security but didn’t register.

But, its moves can be swift and sharp. Today CoinDesk reported that the SEC has ordered the temporary suspension of trading in OTC-listed CIAO Group over questions about ICO-related claims.

Whether this is a one-off or the beginning of a slew of actions is unclear (the fact that CIAO is a listed company is no doubt a significant influence). However, the chance of a sanction or even an investigation should be enough to give pause. It’s a career-breaker. Even if the SEC ends up giving the green light after poking around, the stigma of having been singled out will be difficult to wash off.

What’s more, almost all digital token issuers are young startups with shallow pockets. An SEC fine would financially cripple the founders for years. Even just doing a simple risk analysis of [potential cost * probability] vs [potential benefit * probability] shows that, in many cases, ploughing ahead on the assumption that you’re immune is just not worth it.

The likely outcome is that the SEC, having issued a warning shot and seeing that the industry didn’t really take it seriously, swiftly moves to take action. We can probably expect further precedents to be set over the next few months as the regulator decides to make examples of some of the more egregious cases.

Meanwhile, lawyers will continue to speculate on what the rather vague wording of the SEC statement means, cryptoasset entrepreneurs will continue to build new economic models and investors will continue to dream of rapid riches with no consequences. All part of the evolution, right?

Is bitcoin money?

by Ondrej Supitar via StockSnap
by Ondrej Supitar via StockSnap

I’m currently reading “Money: The Unauthorised Biography” by Felix Martin, which I thoroughly recommend. Thought-provoking, illuminating and beautifully written, it debunks our preconceived notions and highlights the surprising evolution of this social technology that we use every day.

In the first chapter, Felix explains that the coins and notes that we carry around are not money. Money is the system of credit and debt that is sometimes represented by circles of metal and rectangles of paper. But usually not – most transactions are not represented by anything physical.

Rather, coins and notes are tokens that help us keep track of debts. The big innovation was to start exchanging those debts for others. Frank owes me, and here’s a token that represents that. I owe you, so here, take Frank’s token. Now he owes you. This conceptual leap is what kickstarted trade and the concept of an “economy”.

Looking back through history, that is what money has always been: a system of recording debts, and a representation of trust. That we associate money with coins is simply survivor bias – coins tend to weather the test of time better than other types of physical token.

One of my favourite anecdotes from the chapter is the siege of Malta. When the Turks cut off the fort from its supplies of gold and silver, the mint had to resort to making coins from copper – it inscribed each with the motto Non Aes, sed Fides – ”Not the metal, but trust.”

The system of recording that trust is what we call money.

Enter an entirely new way of recording that trust: bitcoin.

So, yes, bitcoin is a type of money. Perhaps not a currency – the online dictionary defines “currency” as “a system of money in general use in a particular country”. Since bitcoin is not confined to a particular country, that rules that out. (JP Koning points out that “currency” used to mean “something that could legally be used by the new owner if stolen”. So that would probably include bitcoin – but that definition has fallen into disuse, so we’ll go with the more modern one for now.)

According to the US Commodities and Futures Trading Commission (CFTC), bitcoin is a commodity. If you’re talking about bitcoin the coin, then yes, it could be. Commodities (gold, silver, cacao beans) have often been used in the past to represent money. BUT bitcoin is more than just a commodity, just as the euro is more than just copper coins. (Interestingly, paper – which also represents money – is not considered a commodity.)

And anyway, the CFTC ruling is mainly aimed at the regulation of derivatives, not so much at the use of bitcoin as money.

The topic is tangled, though. If bitcoin is a commodity (like silver), what makes it usable as money (like silver)? An official stamp of some sort – after all, monetary systems have always been controlled (or at least overseen) by a central authority. For the first time, we have a money that escapes the traditional parameters.

Also, commodities have always existed independently of the monetary system they move on (for instance, copper is not just used for money, knots on a string can mean something other than debt). Until now, anyway.

The confusion highlights the need for a new attitude. Maybe it’s time we updated not only our vocabulary but also our understanding of the monetary system. It’s not going to be easy.

Blockchain and capital markets: equity swaps

by Jan Vasek, via StockSnap
by Jan Vasek, via StockSnap

The world of capital markets is littered with terms that sound simple on the surface, but thoroughly confusing once you start poking at them.

Take, for instance, “equity swaps”. Easy, you swap equities with someone else, right?

It turns out that you don’t swap equities. You swap the returns that the other party’s equities give. That way you can diversify your portfolio without having to actually sell underlying holdings. Selling large holdings incurs costs and can move the market, which you probably want to avoid. Or, maybe your fund’s bylaws prohibit you from doing so. Or, maybe you would rather avoid capital gains tax. Other possible advantages include retention of voting rights (you want to retain your holding in a company but would rather have a fixed dividend than a variable one), access to illiquid markets, or being able to legally go around holding restrictions (eg. limitations on foreign funds).

So, let’s imagine you have a holding that pays you a fixed rate, the same payment every year. But you would rather a variable one. Rather than sell your fixed rate security, you enter into a swap with another party that has a holding that pays (for example) the return on the S&P 500 stock index. They are tired of so much volatility and want something more stable (or maybe they have fixed payments coming up and need to lock in those receipts).

So the two of you enter into a swap – you get the other party’s payments from their security, they get yours.

Now, just imagine the complicated and duplicated paperwork that backs up this operation.

Digitisation helps, obviously. Traiana, founded in 2000 to provide pre-trade risk assessment and post-trade solutions, is the market leader in electronic processing of over-the-counter (OTC) swap trades. It connects derivatives exchanges, institutional investors, interdealer brokers and swap execution platforms, channelling trades to clearing houses and providing analytics.

It is owned mainly by the Nex Group (formerly ICAP Ltd.), which at one stage was the world’s largest interdealer broker for OTC trading with daily transaction volume of over $2.3tn. After a tumultuous few years (which included whopping fines from the Commodities Futures Trading Commission in the US and the UK’s Financial Conduct Authority), that division was sold at the end of 2016, and Nex now focuses on market infrastructure.

Traiana counts among its investors such blue-chip firms as Bank of America Merrill Lynch, Barclays, Citigroup, Deutsche Bank, JP Morgan, Nomura, and the Royal Bank of Scotland.

Yet in spite of the presence of a clear market leader, the sector does not have a common infrastructure, leading to costly data reconciliation.

Could equity swaps benefit from blockchain technology? That’s what New York-based startup Axoni is hoping to determine.

Last year it completed a trial involving nine market firms, including Barclays, Credit Suisse, IHS Markit and Capco (a capital markets consultancy owned by FIS), as well as shareholders Citigroup and Thomson Reuters. The project established a blockchain processing network for equity swap trades using Axoni’s proprietary distributed ledger software.

One interesting aspect is the involvement of Traiana competitor IHS Markit in the trial. One of Axoni’s investors is Euclid Opportunities, the investment arm of Traiana’s parent Nex, and the two firms also both have Citigroup and JP Morgan as investors.

Although it worked with IHS Markit in this trial, Axoni has collaborated with Traiana on other projects in the past, such as a securities post-trade prototype in early 2016 and a foreign exchange one currently under development.

Could there perhaps be industry consolidation further down the line?

While equity swaps are a small part of the global OTC derivatives market, they could be considered the “low hanging fruit” of the sector for capital markets blockchain integration. The processes are complex, and the market is distributed and fragmented. What’s more, changing regulation calls for increased transparency and reporting. Coherence and coordination will benefit all participants, adding liquidity while reducing costs.

A blockchain-based platform would have the additional advantage of scalability, perhaps also including other types of swaps and offering even further efficiencies to market participants.

While blockchain exploration is ongoing in other areas of capital markets, Axoni’s equity swaps test is an interesting snapshot of a concrete use case. Furthermore, it points to how the sector will be restructured: carefully, one application at a time.

(This is the first in a series on the potential impact of blockchain technology on capital markets. Up next: FX.)

Bits and stuff: media, labels and awe – August 6, 2017

I’m so looking forward to getting back to my old routine of researching and writing… Soon, very soon. Meanwhile, I still have a lot of figurative desk-clearing to do. But making progress.

— x —

My CoinDesk article this week, on how last week’s statement from the US Securities and Exchange Commission says more about the future of securities than the future of digital tokens (and yes, there is some convergence).

More Welcome Than Warning? The DAO Ruling Could Transform Securities

— x —

The explosion of coverage of cryptocurrencies in the mainstream media is startling. Even the Daily Mail of the UK, one of the leading “tabloid” newspapers, has frequent columns about bitcoin (I confess that I’ve seen them but not read them, so I don’t know how accurate they are).

I used to summarize the mainstream coverage for the CoinDesk Weekly newsletter, and I remember that there were weeks in which it was a struggle to find a handful to report on.

These days there are so many that I get to pick and choose which to mention!

Fad or trend? I suspect the latter…

— x —

I’ll be changing the name of this column (which, in spite of the name, is not Daily), since my friend and ex-colleague Ryan Selkis has relaunched his weekly newsletter called The Daily Bit. Given his tenure, he deserves the name much more than I do. For original thoughts entertainingly expressed, give his newsletter a look.

So far I like Bits and Stuff – what do you think?

— x —

This stunning photo was picked from the National Geographic Travel Photographer of the Year Award, featured in My Modern Met. Take a look at all of them, if you want to feel total awe at the beauty of this world we know so little about.

via My Modern Met
via My Modern Met

Daily Bits: top blockchain journalists, sublime hype and a gripe – July 25th, 2017

After an overwhelm-induced break (work obligations intensifying) punctuated by a couple of days in rainy Scotland tending to a family errand, the Daily Bits resumes.

I confess I considered shelving the format, but instead I will continue to tweak the presentation. My purpose is unclear, to be honest – do I really think I’m helping anyone, is this a learning tool, or am I just having fun? I don’t have a clear answer. So, expect less structure and more free-form (whatever that means).

— x —

The mainstream coverage of blockchain and cryptocurrencies has shot up. The pity is, most of it is still bad. There’s just more of it.

Why is it bad? Incomplete, cursory, relying on soundbites and hype. To be fair, I probably bought into the hype a bit too much when I was starting out. But as I’ve pointed out, hype serves that purpose: it ropes people in. Maybe what grates most is that I’ve been around it now for so long that it’s getting really tiresome.

Actually, what most annoys me about mainstream coverage is the unnecessary generalities. Take, for instance, this article from the BBC: “How Bitcoin is infiltrating the $60bn global art market”. There is so much to say about the potential impact of blockchain on art, but instead they interview a gallery owner who doesn’t seem to grasp the basic tenets.

“And the fact that there is no centralised body – like a bank head office, for example – makes cryptocurrencies safer, she argues, despite their reputation for being volatile, high-risk and the favourite “store of value” for criminals and hackers.”

No explanation of why the lack of a “head office” makes cryptocurrencies safer (than what?). And there is no evidence whatsoever to show that bitcoin is the “favourite ‘store of value’ for criminals and hackers”. I mean, groan.

What frustrates me is that reputable sites are spreading misinformation, either in a misguided attempt to sound like experts, or in the hopes of generating fear-induced clicks.

However, my frustration is tempered by the comfort that not everyone needs to be interested in cryptocurrencies – the markets are not yet liquid enough to withstand full mainstream attention. Also, it’s not essential to “get” blockchain’s potential – it will reach it with popular support or without.

Not all of us are going to get involved in blockchain applications. Most will end up benefiting from improved processes without understanding why. The “misinformation” won’t derail work underway, or deter those pushing the limits of what we can imagine. In other words, the poor journalism can’t really do much harm, other than perhaps the occasional boring social encounter with someone who knows more than you do because he/she read it in the news.

It just drives me mad, that’s all.

— x —

Who are the best blockchain journalists out there?

Needless to say, my colleagues at CoinDesk “get it”, and the professional rigour is impressive. Aaron von Wirdum of Bitcoin Magazine is usually excellent, and has published some of the most easy-to-understand explainers of the scaling debate.

Beyond the specialist sector, I will read anything written by Joon Ian Wong of Quartz and Tanaya Macheel of Tearsheet. Izabella Kaminska’s well-known scepticism, published in the Financial Times, makes entertaining reading – and, worryingly, I’m agreeing with her more and more. Kadhim Shubber, also of the FT, knows a lot and writes well. For wittily lacerating yet insightful comment, Matt Levine of Bloomberg. Jordan Pearson of Motherboard does excellent reporting. Their work is all the more impressive since they don’t just cover the blockchain sector.

This is my off-the-top-of-my-head list – I’m sure there are more that deserve inclusion, and I’ll add names as I think of or come across them.

— x —

A flash of inspiration, humour and almost poetry from the Alphaville team at the FT, who finally got their act together enough to set up what we’ve all been waiting for – the Alphaville initial coin offering. Their white paper title gives a hint at the jargon that is to follow:

“Alphachain: a self-potentiating, decentralised crypto-spool for independent journalism.”

And the text includes such gems as:

“Alphachain empowers smart-contract bubble journalism, decentralising hack finance for a trustless news protocol with a deep commitment to verified insecurity.”

And:

“Tokens are fully fungible in a Turing-complete context, enabling subsequent resale or lease transactions with Zero-Day settlement invulnerability.”

Seriously, read, re-read and bow down in awe.

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This collection of old stock photos will no doubt come in handy to add some retro style to blog posts. (Via Mashable.)

stock photo old 2

 

Or they’d be great for caption contests.

 

stock photo old

 

But some of them are really scary.

 

stock photo old 3

(All images via Mashable.)

 

Blockchain and student loans: a solution to an urgent problem?

by Davide Cantelli via StockSnap
by Davide Cantelli via StockSnap

The New York Times reported this morning that tens of thousands of people who took out private loans to pay for college may be about to see their debts wiped away.

Why? Because critical paperwork has gone missing.

Judges are throwing out recovery suits brought by loan issuers because they cannot produce the relevant paperwork to prove ownership of the debts. The New York Times did some digging and found that many other collection cases also had incomplete documentation.

This could turn out to be a very big deal. The paper draws parallels between the student loan overhang and the subprime mortgage crisis a decade ago, when billions of dollars in loans were swept away by the courts because of missing or fake records.

Given that student loans have ballooned to account for approximately 7% of GDP, with more than 44 million borrowers owing $1.3tn, the hit to the economy would be sizeable if a chunk of that debt were to “disappear”. Over 10% of these loans are in default.

The default percentage could suddenly rise when word gets out that the debt cancellation only benefits those that don’t meet their obligations, ie. those against whom the lending companies bring suit. Don’t pay your student loan, get sued by the issuer and have your debt cancelled. What could go wrong? (Note: this is so definitely NOT advice, nor is it a good idea.)

That such an important sector of the economy – student lending is the second highest consumer debt category, behind mortgages and ahead of credit card and auto loans – is still dependent on paper documentation is staggering. These “lost” cases at least are shining a spotlight on the urgent need for reform.

The UK government is investigating the potential use of blockchain technology to manage student loans. The advantages include more secure documentation, less administrative overhead, greater oversight and more transparent data.

It sounds like the US could use similar help. True, the cases mentioned by the New York Times are from private lenders, which account for approximately 10% of the overall market. The troubled loans in question total about $5bn. That is still a sizeable hit, though, and the ripple effects could cause other debts to be questioned, future loans to be denied and uncertainty to deepen in a sector already trembling from the default overhang.

That the problem is due to missing documentation highlights the importance of trustworthy records. That a sector struggling to increase the repayment rate has yet to modernize, especially after seeing what faulty records did to the sub-prime mortgage sector ten years ago, is puzzling.

Hopefully the exposure of this vulnerability will trigger a re-design of the loan process. The benefits of using blockchain for the modernization are apparent, and it would provide the most future-proof solution, but other technologies could also help. The important thing is that the shift happens, because for both students and lenders, a lot is at stake.

A small nation steeped in history helps blockchain move forward

san marino

The elusive myth of 5G is getting closer to becoming a reality, and the impact this could have on blockchain development is significant.

According to a report in the FT this morning, the microstate of San Marino will become the first country in the world to test the new broadband service.

Tucked away in the northern part of Italy, San Marino has the smallest population of the Council of Europe and claims to be the oldest still-existing sovereign state in the world, as well as the oldest constitutional republic.

Telecom Italia Mobile has signed an agreement with the government of San Marino to upgrade the 4G system in preparation for state-wide 5G trials starting in 2018. 5G testing is ongoing in other regions such as South Korea, China and the US. However, they tend to be small trials lacking the pressure of real-world use cases. San Marino’s small size makes it the ideal site for first nation-wide test case (although it should be noted that AT&T plans to roll out 5G in test cities such as Austin and Indianapolis, each with approximately 30x the population of San Merino).

As its name implies, 5G is a step above 4G, which is what most developed countries have installed in the cities (with 3G still the main carrier technology in the countryside), with speeds up to 10x faster. 5G promises broader coverage, faster downloads and lower latency.

While the first two characteristics sound great from a user perspective, the latter is essential for effective deployment of the Internet of Things (IoT). Latency refers to the time elapsed between one node sending a signal and another receiving it. If we are going to have a myriad of gadgets exchanging data, we need to know that the transfer is fast, especially if payments are made or if decisions are based on the information.

Driverless cars, for example. Sensor-based shopping. Smart gadgets reacting quickly (lights turning on, doors opening, alarms alerting).

With sensors in close proximity to the central server, latency is not usually a problem. But with sensors distributed in a wide area, it would be, especially if the connection is to a blockchain.

I’ve written before on how blockchain technology can help the Internet of Things, but since that was a while ago, a brief update: a network of gadgets connected to a central server is more vulnerable than one connected to each other. It’s not only the single point of failure that is the concern – the possible manipulation of data, relatively simple when that data is centralized, is also a significant risk.

On a blockchain, however, gadgets share information with each other. “Smart contracts” can help to execute actions dependent on that information, and verification is carried out by the network itself. The security is much more hack-proof than traditional databases. And regulators can be “looped in” to the network, facilitating compliance and approval.

Blockchain IoT networks can also give rise to new business models, with “things” being owned collectively, and being economically self-sustaining. For example, a driverless car can both earn (by ferrying passengers) and spend (on tolls, parking and maintenance) its own money.

This scenario is not possible, however, without an upgrade in connectivity. 5G could offer that.

Once the new service is rolled out, San Marino perhaps could also become a testing ground for distributed IoT networks, and other latency-sensitive blockchain applications.

So, the nationwide trial is a big step forward not only for mobile networks but also for blockchain. While many experts believe that we won’t see 5G rollout until the end of this decade, we are getting closer. And San Marino, small and steeped in tradition as it may be, could end up helping pushing development of these two key technologies forward.

Biases, barriers and bitcoin

I stumbled across a fascinating video this morning, about cognitive biases and money. Watching this, I realized that many of us bitcoin holders fall into the same trap.

The video talks about how we mentally segregate our “assets” into different compartments, which affects how willing we are to spend them. This is curious, since in the end it’s just money, right? And money is fungible, right?

So, why are we willing to spend some types of money and not others?

The video gives the eye-opening example of the movie ticket, the result of a study by renowned behavioural psychologists Kahneman and Tversky. If you go to the cinema and pay for a $10 ticket with a $20 bill, in exchange you get the ticket and a $10 bill. Now, say you lose the ticket. Do you buy another one with your remaining $10 bill? Most participants in the survey said no, they’d just go home.

But say instead the cashier gives you two $10 bills, and you are to hand in one of them to gain entrance to the theatre. If you lose one of the $10 bills, would you use the other one to see the movie? Most say they would.

This is notable, since the end result and cost is the same. (I think time and hassle should also be taken into account since they are an invisible cost, significant to some – but the point holds.)

Put any kind of barrier, even just one of form, between us and our money and we spend it less readily.

We all have things that we wouldn’t part with, even if it would get us in to see Hamilton. That’s because they have more than monetary value to us. They give us pleasure, they stimulate a memory, perhaps we know we couldn’t replace it easily… But a movie ticket? Not much sentiment attached there.

Now, sidestepping over to bitcoin, I have often pondered why some pundits point to bitcoin’s lack of acceptance in stores as a sign of failure. I couldn’t see the sense in spending something that you think might go up in price. You spend it, it’s not in your wallet anymore, and you lose out on the appreciation.

Through a different lens, I see now that that is totally stupid a narrow way of looking at things. And what’s more, misses the point of bitcoin.

It’s money. And it should be used. Holding onto it because “it’s bitcoin” denies it that use, which contradicts the interest that got us into the asset in the first place.

Plus, it might go down in value, so spending it now would be a good asset management decision. Or it might go up, but you can always buy more with the money that you would have used had you not used bitcoin. By using the cryptocurrency you perhaps saved money or time, so that would also have been a sensible decision.

But we’re not sensible, as Kahneman and Tversky – and all of us who prefer to hold bitcoin rather than spend it – show.

Most bitcoin these days is held for speculation. We buy it thinking it will appreciate in price. With that, from the beginning we are not regarding it as money. Those of us who buy in because we love the concept and we want to try out using it, end up falling victim to the rising market mentality of “can’t miss out on appreciation”. We stop seeing it as money and start seeing it as a ticket to riches.

We can offer in our defense the fact that merchants don’t take bitcoin. True, but take a look at the number of merchants who did and stopped because no-one was using it, or the number of merchants that don’t even bother because no-one is using it. It’s hard to deny that we are perpetuating the problem.

For bitcoin to reach its potential, it needs to circulate, and it needs to be used for more than portfolio diversification. The longer we let the current trend of market obsession continue and the longer we let our cognitive bias rule, the more we delay bitcoin’s debut as a global currency.

It’s strange how sometimes you can be searching for an answer to one question and end up understanding a completely different one a bit better.

Flowers, data and community currency

by Roman Kraft via StockSnap
by Roman Kraft via StockSnap

A recent article in the Financial Times on the purchase of Worldpay by Vantiv contained this gem, which encapsulates the debate around going cashless:

“Mr Jansen says Worldpay can respond by selling extra services to its customers based on analysing all the data from the 41m transactions it handles on an average day. For instance, it can tell a florist at what time of day rival stores in the same area are selling most products.”

Data is useful. But do you really want your competition to know what time you sell the most merchandise? Would that not be handing them them the opportunity to undercut you by targeting special offers for just that time? Will this not trigger a “race to the bottom” as businesses vie to undercut each other?

And here is another aspect to consider: to whom does that data belong? Obviously in this case, to the payment company. After all, the florist is using the payment company’s platform.

But, the payment is between the client and the florist. The client initiates the transaction (12 roses, please), the florist executes the request (here you go, sir). The platform is just an intermediary. But who has the ultimate power over the business? The intermediary, especially if it can choose to help the business’ competition.

How could a business work around this and still use the convenience of a service like Worldpay? Perhaps Worldpay could offer an opt-out service. Businesses could pay a fee to have their data not sold to the competition. Although doesn’t that sound a bit like extortion?

This increasing power, which can be used against the very businesses the payment platform is supposedly helping, could be enough to discourage businesses from using such services.

Which brings us back to the cash vs. digital payments divide. To keep its business metrics private, florists and other small enterprises would have a good incentive to stick with cash. It’s the ideal transmission mechanism when private contracts are involved.

It is, however, clunky, costly, relatively inconvenient and has certain security vulnerabilities.

If I were the florist in the example, I’d be contemplating setting up my own payment… not sure what to call it… “walled garden”? An electronic payment method, the data of which stays with me. I’d share aggregate information with the tax authorities and my bank, but the privacy of the information would reflect the privacy of the contracts between me and my clients.

Maybe this is where the innovations in the payments space will end up. The winner could be a service that respects the sovereignty of data. “Here, use my platform, set up your own walled garden, you own your client information and business metrics, check out these functions that allow you to do targeted promotions, all I need is aggregate information for compliance, oh, and this is my hefty fee.”

Such a platform could also kickstart the proliferation of seamless loyalty programs (no extra work from the client required). For instance, for each rose you buy, you get a flowertoken, which is attached to the identity automatically created when you pay with your mobile phone. You can, if you wish, use your considerable flowertoken balance to pay for the next bunch of flowers.

Flowertokens could become a type of money.

This idea (which may already exist, I confess I’m not a payments expert but I do enjoy thinking about these things) would take us a step towards the society predicted by David Birch, in which hundreds of different currencies happily co-exist, managed via very clever apps in our smart devices.

Oh, oh, oh, and I could do a flowertoken initial coin offering. Issue tokens on a blockchain, get tons of money up front.

I’m off to register the business now.