- J.P Morgan’s Global Research franchise published a +55 page institutional-grade overview of the potential impacts of blockchain and crypto across global markets and sectors
- We summarize the report which provides a holistic view of the narratives being fed to traditional legacy institutional investors and clients
This past week J.P Morgan’s Global Research franchise refreshed their quarterly Perspectives series, following up on their Decrypting Cryptocurrencies series published last February with a 55-plus page pragmatic overview of the developments in blockchain and crypto in 2018, examining both commercial viability and barriers to implementation. Contrary to the headlines that other publications have pushed, the report offers an in-depth collection of varying views from analysts across sector and regional expertise, some more bullish/bearish in scope than others. To save you the time, we’ve summarized the highlights of the report below, which provides a holistic view of the narratives being fed to traditional legacy institutional investors and clients.
Monitoring adoption across sectors
Blockchain in ‘Big Tech’ is evolving – According to Software Tech analyst Sterling Auty, enterprise blockchain and Blockchain-as-a-Service (BaaS) are largely being built in-house, with AWS and Microsoft Azure offering public cloud environments to help enterprises explore blockchain and dapp development. The team is monitoring developments with a potential Facebook payment solution.
Financials – European and US Bank analysts still hold the view that the lowest hanging fruit for blockchain remains within harvesting cost efficiencies across global bank processes, seeing the biggest opportunity within Trade Finance — a business line that still relies on manual and paper-based processes. Bank analysts believe progress on proofs of concept and early stage experiments actually translating to live implementations that move the needle for banks and solve scalability issues are “at least 3 -5 years away.” Challenges remain the same in other sectors, namely cross-network/platform integration, governance of systems, and regulatory buy-in.
- KYC potential: While KYC functions remain another low-hanging friction blockchain is looking to solve, with several pilots completed like R3’s Corda platform, few PoC’s have progressed further at this time (noting that Komgo is looking to release a product sometime in 2019). Furthermore, the European bank analysts currently haven’t bought into the results provided from these early pilots, with “efficiency gains limited for various technical reasons, such as the presence of few minimum common fields when considering cross-jurisdictional requirements.” The team sees the potential to improve the KYC process within banking institutions, however, sees “more progress and investment needed to find the right solution.”
- Opportunities in syndicated lending: Like all use cases, application is still nascent, but the opportunity to improve the process exists due to syndicated loan settlement cycles often lasting +20 days. First test case of the application was the world’s first syndicated loan (€150 million) which leveraged Hyperledger and Ethereum, delivered by BBVA, BNP Paribas, and MUFG. The bank analysts view individual institutions, specifically Spanish banks like BBVA and Banco Santander, making “larger strides” in the space than consortium developed platforms.
Transport – The bank’s Airfreight and Transport Analyst sees supply chain applications still in its infancy as realized efficiency gains require significant cross-institutional buy-in. Compatibility across information management systems is also a major roadblock to digitizing the entire supply chain stack. The Transport team sees the potential applications lacking commercial viability given current solutions inability to scale and overall lack of digitization currently within supply chains. The analysts see parallels between specialized blockchains to prior years of customized IT solutions which have created fragmented networks susceptible to incompatibility.
- Use cases include: Factoring receivables/payment collections, minimize transaction disputes, provenance of goods, and automating middleman processes.
- Examples: IBM’s Trade Lends partnership with Maersk, we.trade in Europe, and trade finance platform Voltron built on R3 Corda.
Utilities – The European Utilities analyst offers one of the more bullish sector opportunities for blockchain, given the utilities industry is susceptible to a technology-driven cost optimization phase, and stating “we believe blockchain has the potential to drive a seismic shift in energy markets and allied enterprises.” The Utilities team estimates that blockchain has the potential to unlock efficiency gains by as much as “€750mn annually,” and could reduce costs of commodity trading via p2p trading networks and use of smart-contracts.
Asset Management – The brokers and asset managers see recent futures products, the VanEck proposal, and market surveillance developments as necessary steps to “begin addressing regulatory concerns.” Meanwhile, the team views the ICE/Bakkt partnership as “potentially appealing to institutional investors, as it’s designed to protect investors in both regulated storage and purchase agreements… which could ultimately significantly expand [the investor universe] and expand market size and liquidity.” The team counters by acknowledging these developments will clearly take time, and believes the “prospect of a [SEC regulated] bitcoin product will be postponed.”
Challenges and Roadblocks to Adoption
Beyond the promise of DLT reducing costs across industries and cryptocurrencies disrupting the payment industry, analysts view buy-in across industries remaining muted for a variety of reasons.
Institutional adoption still lacking
- Market is still largely retail driven. While many legacy institutions have opted to explore the space, real participation has been limited to date.
- Participation in the markets from institutional investors appears to be waning as Bitcoin futures volumes as a percentage of total trading volumes on exchanges has fallen to below 1% (vs. 10% high set in mid 2018)
Estimating Bitcoin’s intrinsic value is a challenge
- Metals analyst Natasha Kaneva continues to believe the “lowest cost producer is ultimately the marginal producer of bitcoin, setting the cost floor for the entire market.”
- The team estimates a production-weighted average cost (ex. equipment fixed costs) globally is ~$4,000/BTC, acknowledging that the average is likely skewed given subsidized and low-cost Chinese mining operations which they estimated at ~$2,400/BTC in 4Q18
- Marginal cost estimation includes calculating a daily cost of production as a function of the hashpower deployed, cost of electricity, and hardware efficiency, all over the daily bitcoin inflation schedule.
- The team assumes given conservative assumption and unknown levels of Chinese low-cost opportunities the 4Q18 global marginal cost estimate ~$4,000 is probably skewed upwards.
Lack of material retail acceptance of cryptocurrency
- Payments analyst Tien-tsin Huang continues to expect mainstream cryptocurrency acceptance to be limited.
- The team concedes opportunities for small business and individuals (who have more flexibility in accepting different payment methods) to leverage “workarounds” which indirectly open up acceptance. Examples include leveraging marketplaces on which gift cards can be purchased with cryptocurrencies (like Gyft or eGifter).
Systems require full stack buy-in
- Specifically in supply chains, for gains to be realized, the industry requires a majority of supply chain participants on the same network, or one that is interoperable with other systems.
- Analysts view supply chain companies implementing the tech at a slower pace than banking institutions. Solutions to watch include: Corda, Hyperledger, Digital Asset, Axoni, and Ethereum Enterprise.
- A primary challenge for implementing the tech remains a lack of standardized regulatory frameworks. For example, “the principles of contract and title differ across jurisdictions, it may be difficult to identify which rules apply, particularly when blockchain nodes may be located globally or if erroneous events occur during a transaction.”
- Issues surrounding data privacy (ex. GDPR) and legality of enforcing smart contracts still largely remains in gray waters.
- While Japan explores self-regulating measures, and the U.S. has seen ICE (through Bakkt) and Nasdaq (through their SMART market surveillance tech) push forward core market structure initiatives, the developments to address regulatory concerns are still very early stage.
Cryptocurrency as a portfolio diversifier doesn’t matter
- A more bearish view that hit the media headlines came from J.P. Morgan’s Head of Cross Asset Fundamental Strategy John Normand, who views the value of cryptocurrencies only holding weight in a “dystopian” environment.
- Normand sees similarities between cryptos early-stage valuation problem and other “historical [bubble] assets like gold in the early 70’s, Nikkei in the 80’s, and tech stocks in the 90’s.”
- The group remains skeptical on bitcoin becoming a global reserve asset, “even if novelty value can remain high indefinitely,” and thinks zero to low correlation to broader asset classes doesn’t matter in a prolonged bear market.
- Blockchain adoption has seen limited adoption with confined product market fits as cost efficiency, scalability and regulatory challenges remain substantial.
- J.P. Morgan Global Research maintains the view that DLT “by itself has great potential to simplify and speed up transactions and information transfer, but [is] not convinced that its real value lies in its first foray into the world of currencies.”
- The bank sees blockchain “unlikely to re-invent the global payments system”, but rather a marginal opportunity to offer efficiency improvements.
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