Global standards are changing. Over the coming years the basis of our commercial connections will evolve. We will move away from a trade based on the services created in recent centuries towards a digital system based on new technologies and new powers. It’s hard to predict exactly how it will unfold but there are some clues as to the direction it will take.
One clue is cryptocurrency. Don’t get distracted by the volatility of the market: this isn’t about the price today, it’s about the tech. It’s almost certainly true that almost all of the different electronic offerings out there today are going to fail but, like the first dot com bubble or the railways bubble of the 19th century, the underlying technology that is created is what matters.
Over the past few months I have been experimenting with different coins. Bitcoin, Ethereum, AAVE, Compound – all offer different ways of interacting with digital assets. Like many I want to know how the markets work, how the trading happens and what the point of them is. I’m in no position to lose a fortune so I’ve limited my experiment to a few hundred pounds, which I’m treating as a fee for lessons. I expect to lose.
There are a few quick warnings that are essential to understand. First, some of the transaction costs are astronomical. Switching currencies or wallets can cost 20 per cent for the small sized moves. This is the charge for those who operate the network and verify the transactions and is an extraordinary tax on the market.
Second, the systems are awkward. Gone is the simple relationship between a sort code and account number, and instead there is a series of complex codes identifying a place on the blockchain with no correction if you get it wrong.
Third, not all systems are even vaguely user-friendly. Depending on the wallet, it can be near impossible to withdraw the money – there’s one wallet I can’t get £20 back from, and almost certainly never will. It’s not enough to worry about but it’s worth knowing.
Last, and perhaps most importantly, this is a world of believers and enthusiasts (if you’re feeling positive) or con artists and charlatans (if you’re not). The same has been true of technology booms and bubbles throughout the ages. This time is no different. And while there are plenty of prophets out there preaching that we’re missing an opportunity, it’s worth thinking what that chance is. It’s probably not the chance to cash in, but it may be the chance to shape the future.
Bitcoin today could be MySpace, a failed internet firm, or Facebook, one of the giants of the industry. It could be worth a fortune or nothing at all. But the concept of financial instruments based on technology, not just state-backed institutions, is here to stay.
There are a range of opinions on which of the new coins will turn out to be successful. Some claim that Bitcoin, the first to achieve financial status equivalent to a currency, is now here to stay. It is described by supporters as a gold equivalent, but it can’t be turned into jewellery (an admittedly limited use of the global gold reserve) and needs a huge amounts of power to keep it going.
That’s prompted others to argue that we’re seeing what some crypto devotees are calling “the flippening”. This is the moment when the market cap of Ethereum, or Ether, overtakes, or flips, Bitcoin. That seems likely because Ethereum can do the more complex computations required for financial products such as loans or smart contracts. It requires less power and has shorter response times so it is being used more widely as a base layer in the world of so-called decentralised finance.
Energy consumption is not a side issue. Bitcoin is reported to consume more power than Argentina, and just shy of Norway, to maintain its integrity. That compares to Ethereum which is on a path to require the energy output of a small town. That’s because Ethereum is moving to a so-called proof-of-stake system that uses less energy.
This makes me bullish on Ethereum for now, but that’s not an investment opinion, it’s a view on which style of system is most likely to be adopted. Something that is more efficient seems more likely to win. If it is not Ethereum then it seems likely it will be another system that uses the more power efficient proof-of-stake.
It’s likely there is a future in lower energy base protocols of blockchain on which others can build products to allow new forms of loan, risk sharing or interest calculation – all actions that are based on the Ethereum blockchain – but none of those guarantee that this particular base layer will endure.
Ethereum and Bitcoin could be the Betamax and VHS systems in a world that is accelerating fast, away from these early experiments. Perhaps more likely, seeing the interest placed on these new assets by Beijing and others, there is a danger that they will be locked out of major markets and other systems will gain ground and form the new protocols of trade.
Given the risks, how should the state think about these innovations? Why does it matter to us which succeeds, and shouldn’t we just wait and see? We could, perhaps, achieve second mover advantage, that ability to spot the errors of an early system, correct them and achieve dominance by bringing out a better version.
All that is possible, and worth debating, but I believe we need to think hard about how we encourage home-grown currencies and exchanges, not because we care about the cash, but because the future these systems could one day offer, could – perhaps – shape the basis of the UK’s global economy.
A new electronic currency is not the principal question at stake. There are massively more electronic pounds in circulation than paper ones already today and the Bank of England, and others around the world, are already considering central bank digital currencies. This should focus on how we build future financial instruments and new forms of contracts that can be trusted to share risk and encourage transnational cooperation.
Creating the ability to be rewarded for shared effort is what made the existing financial products based on UK law so powerful. Those principles grew out of our inheritance from the Dutch trading empire and others. From insurance to limited liability, and later to SG Warburg’s issuing of the first Eurobond for Autostrade in 1963, the City of London and the services that support it, have been central to global finance.
Today, we need to think hard about how we keep that advantage as it is being challenged by the emergence of new technology. We also need to think about the shared liability of society. Governments need to collect revenue to pay for common services. If consumers gravitate to new platforms and away from conventional currencies, will that become more complex?
That’s why we need to think about Britain becoming a safe space for crypto. It’s not about recreating the Wild West at home – any more than Warburg’s did 60 years ago – but about preserving the DNA of our legal system and service sector and updating it.
This isn’t about retail investors like me. Once my experiments in the online world are done I will be back to the vanilla offerings of the retail market. This is about ensuring the lawyers, the bankers, and the insurers who have shaped global trade for centuries are able to continue their work.
In the early days, this will be about taking risk. Regulators and innovators will have to discuss the shape of the market and the structure of offerings, ensuring that the counterparties know they’re entering a different world. That’s how some in the US Security and Exchange Commission have been thinking about this. They’re not looking to remove all risk but to recognise that relationships between consenting adults are legal so long as the deal is clear and neither side is behaving fraudulently.
Creating a legal environment for this is possible, creating a cultural space is going to be much harder. That’s where the government can show leadership. It will be a risk but given that the new norms will be provided either by authoritarian states, or decentralised autonomous organisations known as DAOs, the place for a responsive, responsible administration is clear. We need to balance the needs of individuals and the state, and innovation and legal accountability. If we don’t step up soon we may find that the technology is developing so fast that the opportunity to order this new world has slipped by.
In the next few months we need to see the three chancellors thinking through the questions posed. The Chancellor of the Exchequer, for the financial instruments, the Lord Chancellor for the legal innovation that this will require, and the adaptation required to create a decentralised system with its own legal DNA, and the Chancellor of the Duchy of Lancaster because the Cabinet Office, as the operational heart of the government, will need to think through dangers to citizens today, and balance it with the risk of others shaping the world of tomorrow, leaving us with analogue answers in a digital world.
The focus for many so far has been purely on making money from Bitcoin and Ethereum price moves. The bigger questions are about the legal protocols, the systems that will be built by industry and regulators, and the implications for all of us of the changes that have started already.