Seventeen years before there was Bitcoin, my colleague Stuart Haber and I developed the basic elements of the blockchain, as described in the Journal of Cryptology, January 1991. Namely, using cryptography, we found a way to create an immutable, shared ledger. Its integrity was based, not on some trusted third party, but on the democratisation of trust across all participants in the ledger. This is the blockchain: an immutable record, witnessed and vouchsafed by all mankind.
And so while I find little to quibble with in recent blockchain-related Cuffelinks articles by Joe Davis of Vanguard and Carlos Gill of Microequities, I can nevertheless bring an historical perspective to the subject.
A new asset class?
For superannuation managers, perhaps the most pertinent question to ask is this: Is the blockchain space a new asset class? If so, what portion of a portfolio should be allocated to it? Or is it simply an internet version of the Dutch tulip craze, an emotional bubble to be avoided at all costs?
Some would say that of course blockchain is a new asset class. After all, the combined market capitalisation of all cryptocurrencies is in excess of a quarter of a trillion dollars. Cryptocurrencies and their related derivatives are traded on several exchanges, tracked breathlessly by well-established companies, and analyzed by hundreds of analysts.
But all of those trappings of credibility also accompanied the collateralised debt obligations of subprime mortgages, broken into tranches rated as high as AAA by our unerring guardians of the galaxy, Fitch, S&P and Moody’s. And we all know how well that turned out.
To answer the question, let’s begin by observing how diverse the blockchain economy has become. Five years ago, blockchain and Bitcoin were all but synonymous. However, since then there has been what Scott Rosenberg called a Cambrian-Era explosion of use cases.
The largest criticism of Bitcoin is the enormous energy consumption and instability that mining and proof of work create. But let’s not confuse the particular volatile mix of incentives Satoshi created with the full range of possibilities that the Haber-Stornetta paradigm allows for.
There is more than one blockchain
There are blockchains that completely disavow proof of work as an incentive mechanism. Or Ethereum, whose raison d’être is smart contracts, which aim to make many business transactions, currently requiring tedious paperwork and accountant and attorney fees, frictionless. Then there is the class of asset-backed stable cryptocurrencies (of which Australia’s own Havven is a leading example), whose prime directive is to eliminate the volatility so often associated with Bitcoin. There are also utility tokens, which don’t aim to be currencies at all, but simply measure prepaid deposits into a system for which work can be claimed. And Australia’s own ASX, which is transitioning from CHESS to a blockchain-based solution, simply on the merits of settling transactions more inexpensively, quickly and reliably than its predecessor – hardly the stuff of a speculative bubble.
One way to examine how meaningful blockchain might be in the future is to consider its effects in the present. The emergence of Initial Coin Offerings (ICOs) has already begun to disrupt the venture capital industry. This is a particularly poignant example as the VC industry traditionally views itself as the ones in charge of disrupting other industries. What’s good for the goose . . .
Where will blockchain take us?
Will blockchain disintermediate the banks? Commoditise attorneys and accountants? Threaten fiat currencies? Some think this last idea is particularly preposterous. Perhaps. But fiat currencies have only really undergirded the world’s financial system since the abandonment of the gold standard. Not much more than a century. This is something about which another eminent Australian, Shann Turnbull, has written quite incisively (That’s the third Australian reference to blockchain in this article. Is there a pattern here?)
So to finally answer the original question.
Yes. Blockchain is, in fact, an emerging asset class. Certainly with its own set of risks, but in the midst of all the hoopla, it is finding footholds of genuine value creation. And with value creation will come appreciation in price. Hence, those who invest responsibly can expect above average risk-adjusted returns. The trouble, as always, is how to invest wisely in the blockchain space. But that is a Cuffelinks column for another day.
W. Scott Stornetta, Ph.D. is, along with his colleague, Stuart Haber, widely credited with the foundational work for the blockchain. He will be speaking at the University of Sydney as part of the Blockchain World Tour event on 1 May 2018. This is the first article written for the Australian market by Dr Stornetta.