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Economic Insights

How might these transformative technologies shape the world in the years to come? We asked Giulio Martini, Lord Abbett director of strategic asset allocation, for his thoughts.

In the other segments of our special report on blockchain and cryptocurrencies, we provided a basic view of how these technologies work, and discussed their implications for today’s investors. We also spoke with a Lord Abbett currency expert on their potential economic and market impact.  Here, we asked Giulio Martini, Lord Abbett partner and director of strategic asset allocation, to share his views on the emergence of these transformative technologies and their potential global impact in coming years. What follows are edited excerpts from the conversation:

Much has been written about digital currencies like Bitcoin and the adoption of blockchain technology—and a lot of it is confusing. Can you provide some clarity?

Martini: What I think the average person is having a problem with is distinguishing between Bitcoin as a medium of exchange for transactions and blockchain technology as a distributed ledger to track and bundle transactions and to provide some layer of security, which doesn’t exist right now.

It’s very curious that the desire to have an alternative currency would arise now, because currencies typically do a very good job of what we want them to do when inflation is low. And inflation's been very low for a long time. So, it's not as if we're in some dire situation as during Weimar Germany, and inflation is thousands of a percent per day, causing people to lose faith in the established currency. That's far from the case.

And, in fact, I don't think what Bitcoin, Ethereum, or Ripple represent for many people is really the currency aspect of them. Right now, you can only use them in a very limited circle for a very limited amount of transactions. And also because it's very clear that many of the initial adopters of cryptocurrencies might have some extralegal uses in mind.

So, the cryptocurrency boom might be fueled, in part, by a desire to evade the law?

Martini: There is a long history of new technologies being promoted by illicit behavior. So, if these currencies are mostly traded within criminal networks, or with people who want to evade international sanctions or capital controls, that doesn't mean that the technologies won't survive and become much more commonplace.

But I do think that these technologies expose you or anyone else to a lot of risk, because there are some key differences when it comes to cyrptocurrencies. In the traditional sense, a currency is something that only limited numbers of economic actors have the right to issue [i.e., a fiat currency].

In other words, the sovereign, whether it's the king or the elected government, has the authority to issue and take actions to maintain the value and integrity of a nation’s currency. So when the sovereign's right to issue currency is infringed, that historically has been a sure sign of the end of the authority of a government.

And so, if this does indeed happen—alternative currencies displacing currencies issued by a sovereign entity—I think that would be one of the most dramatic signals that not only have people lost faith in governments but also that governments have lost faith in themselves—and in their ability to control the global economic environment. Such an outcome would be extremely chaotic.

What’s the worst-case scenario?

Martini: Well, there are all kinds of possibilities in that regard. And that's a little bit scary. Because it really suggests that if cryptocurrencies are successful—that is, if they're adopted widely—and if control over issuance of currency by governments is lost, that could end up undermining global financial systems so profoundly and so severely that the very success of a cryptocurrency leads to its own collapse. That’s because the economic system that gave rise to it, and that it functions within, can't function anymore. So there is a potential for really significant threats to come out of the adoption of these digital currencies. Which is why, sooner or later, governments will at least make an attempt to regulate them heavily.

And, in my mind, that's a legitimate function of government: to regulate currency issuance and currency circulation. Whether these efforts will be successful in this so-called cryptocurrency era is hard to say. You see, we're at a point where the willingness of governments to cooperate with each other on issues such as trade, international regulation, or money laundering has diminished. Harmonizing of tax regimes has been systematically undermined, and cooperation is probably at the lowest point that we've been at since the last world war.

Nonetheless, it sounds like global governments are going to have to work together on this.

Martini: I suspect this will be required—meaning, global regulation, not national regulation. Because the networks that cryptocurrencies operate on are global in nature. But I think it’s going to be very difficult to get any kind of comprehensive agreement.

With governments very concerned with their own national situations, first and foremost, they are limited in their ability to cope with this effectively. There's little desire for cooperation today. If the United States is following an America first-kind of policy, and saying that every other country should do the same, that's not exactly an environment in which nations can easily come to sign treaties on very complex issues, especially those with significant financial consequences. Or, for that matter, even talk about them at all. But the underlying thing that I think has been difficult for people to separate from the other issues involved is the distributed ledger technologies, which, in different forms, are part of all the various cryptocurrencies.

When mainstream financial institutions begin adopting these technologies, how might things evolve?

Martini: Do you know who Blythe Masters is? She's a former J.P. Morgan executive who went out to build one of the first distributed ledger blockchain technology companies, Digital Asset Holdings. And that technology was adopted by the Australian Securities Exchange (ASX) at the beginning of December 2017 to replace its current clearing settlement compliance architecture.1 The project will replace all its back-office systems with a blockchain, distributed ledger-type of format. So, when a well-established, regulated financial entity like the ASX adopts the technology, that should tell you something.

I've heard people who are looking at this say it could be a game changer, because they think it could reduce the cost of transaction processing by 50% or more. If this technology is out there, companies are going to use it. And that's important, because transaction processing is a gigantic cost center for an insurance company or a bank.

Every new technology seems to have some unintended consequences, and can create fortunes for those who saw an opportunity where others did not. Is this still the case?

Martini: I was talking about this recently with someone who pointed out that when it comes to applications of new technologies, the kind of things they're going to spawn are completely unknown. For example, who could tell that a service like Uber would be an outgrowth of Internet technology? Because Uber couldn't exist without GPS technology, which evolved in tandem with the Internet.

So, as blockchain technology and the various cryptocurrencies evolve, we have no way of knowing what other collateral developments will happen and what completely new types of businesses may open up. That's just inherent in the nature of commercialization of technologies.

If blockchain technology, distributed ledger technology, is really what people say it is—a secure transaction platform that preserves anonymity—they will create a lot of possibilities, with new applications out there that are extremely significant. And so, that's what investors may be playing for in “crypto” stocks and futures on Bitcoin, Ethereum, or Ripple. If something like Bitcoin is really a currency with a whole lot of other things attached, and those other things are more valuable, then that’s where the real opportunity is.

And there is in this sort of an analogy to Amazon. Nobody knew what it was—nor what Facebook was, for that matter. People initially didn’t know their long-term potential: Amazon merely sold books, Facebook was a way to search out high-school classmates. But time, and technology, and user enthusiasm showed that they could become something else entirely.

It’s that uncertainty that makes cryptocurrency and blockchain investments so volatile, and that’s understandable. It's just potentially staggering what these technologies could do—but also what we should beware of.

Thank you for taking the time to speak with us.

 

1Jamie Smyth, “ASX Chooses Blockchain for Equities Clearing,” Financial Times, December 6, 2017.

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