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Economic Insights

Here is a brief introduction to the technologies that have the potential to change the nature of global financial transactions.

It’s hard to believe that Bitcoin, the speculative upstart within the sphere of financial technology, has been around for nearly a decade. In 2009, a group, or person, by the name of Satoshi Nakamoto, released a white paper, “Bitcoin: A Peer-to-Peer Electronic Cash System.”  Bitcoin, also referred to as a cryptocurrency, operates in a digital and decentralized environment without an institutional or governmental authority to provide oversight.

Since 2009, Bitcoin has risen in popularity, as many individual investors, businesses, and sectors explore the idea of using cryptocurrencies to conduct their daily financial activities. To be sure, it remains difficult to buy a cup of coffee with a virtual currency that is regulated in different ways by governments around the world, and is regarded with varying degrees of suspicion by central banks and law-enforcement bodies. As Leah Traub, Lord Abbett partner and portfolio manager, notes, only Japan among major nations recognizes Bitcoin as legal tender. While Bitcoin remains the best-known digital currency, a number of other offerings have followed in its wake, including Ethereum, Ripple, and Litecoin.

The rise of cryptocurrencies has coincided with the rise of blockchain technology. A blockchain is a decentralized public ledger that allows the transfer of money between different entities on a network without the need for a central authority to verify the transaction (i.e., a bank, government, etc.). A ledger can be thought of as the “book” where the transactions are recorded and totaled.

Blockchain Benefits
Why is blockchain important? Because the technology offers significant potential benefits over the way virtual money is currently stored and transferred, including increased transparency, decentralization, immutability, and security. Part and parcel of that last feature is the anonymity inherent in certain blockchain transactions, which has raised concerns about the use of cryptocurrencies for money laundering and other illicit activities.

Although blockchain technology is most commonly associated with cryptocurrencies, there are a number of practical uses for various industries. For example, Massachusetts Institute of Technology’s Media Lab believes a “decentralized record management system for electronic medical records that uses blockchain technology to manage authentication, confidentiality, accountability, and data sharing” will be able to drive innovation and efficiency in the healthcare field, according to a recent briefing.1 In fact, financial institutions, including asset managers, are actively considering the use of blockchains and distributed ledgers to streamline the management of portfolios, expedite the clearing and settlement of trades, and reduce operational expenses. According to the Financial Times, earlier this year, BNP Paribas Asset Management announced that it had completed an end-to-end fund transaction test using blockchain technology.2

The apparent need for cryptocurrencies and blockchain technology, as a unified solution working hand-in-hand, arose from the possibility of double-spending in digital transactions. Double-spending is the risk that a digital currency can be spent twice, since information can be reproduced relatively easily. As a result, it is virtually impossible to make direct peer-to-peer transfers of digital assets. In order to reduce the risk of fraud and ensure transactional validity, institutions and governments must serve as intermediaries closely monitoring the process from start to finish.

A Question of Value
In the foundational white paper in 2009 cited above, the inventor(s) cited the cost of mediation and the weakness of the third-party-reliant mechanism to make his (their) case for an electronic payment system “allowing any two willing parties to transact directly with each other without the need for a trusted third party.”

It is important to note, however, the value of cryptocurrencies or related investment vehicles is determined by what the market will pay for them; there is no intrinsic value (Bitcoin serves as Exhibit A). Unlike equity securities, Bitcoin’s price is not determined by financial metrics such as revenues, earnings, or total assets. As a result of its speculative nature, Bitcoin has experienced extreme volatility since it was created.

While the technology has been around for years, experts are still working to identify the scalability of blockchains and cryptocurrencies as well as the risks and opportunities involved. There are enormous implications for economies and financial markets, which we cover in additional installments of our special report on cryptocurrencies and blockchain technology.

Reported by John George, Lord Abbett product consultant

 

1Ariel Ekblaw,* Asaph Azaria,* John D. Halamka, MD,† Andrew Lippman* (*MIT Media Lab, †Beth Israel Deaconess Medical Center), “A Case Study for Blockchain in Healthcare: ‘MedRec’ Prototype for Electronic Health Records and Medical Research Data,” white paper, August 2016.

2Attracta Mooney, “Blockchain ‘Could Save Asset Managers $2.7 Billion a Year,’” Financial Times, February 22, 2018.

 

 

FOR FURTHER READING

For readers looking to gain an even deeper understanding of this technology and its potential uses, we have compiled a list of additional reading materials from academic, governmental, and institutional sources.

U.S. Federal Reserve

Distributed Ledger Technology in Payments, Clearing, and Settlement

Bank of England

Innovations in Payment Technologies and the Emergence of Digital Currencies

Massachusetts Institute of Technology

Blockchain, Explained

Bank for International Settlements

Central Bank Cryptocurrencies

The Wharton School, the University of Pennsylvania

The Age of Cryptocurrencies: Is This the End of Money?

 

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