Big banks like blockchain | Financial Times

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Good morning. Ethan here; Rob’s out sick. All eyes were on JPMorgan’s investor conference yesterday. On top of raising its 2022 interest income target, it put in a much-needed good word for the health of the consumer. Consumer credit, executives said, largely looks strong. JPMorgan stock rose 6 per cent, dragging the market up.

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Was it blockchain all along?

“It’s blockchain, not bitcoin” was something you used to hear more often. The idea was that bitcoin was a mostly trivial project with an interesting technology at its heart. Enterprising companies would extract the value blockchain had to offer and bitcoin would become irrelevant. But as crypto expanded past bitcoin, people dropped the refrain. Google searches for “blockchain not bitcoin” peaked in 2017.

Five years on, here’s a story from the FT’s Eva Szalay:

BNP Paribas has joined JPMorgan in using digital tokens for short-term trading in [repo] markets . . . 

JPMorgan’s blockchain allows banks to lend out US government bonds for a few hours as collateral, without the bonds leaving their balance sheets.

Post-crisis regulatory requirements demand that banks hold large amounts of liquid assets — which can be bought and sold easily even during times of market stress — such as Treasuries as a safety buffer. By tokenising these assets banks can temporarily turn them into collateral for a few hours, but without lowering their safety buffers, which are calculated at the end of each day.

The token represents a digital version of a Treasury and borrowers can exchange it for cash.

Details such as the length of the loan and settlement time are governed by a smart contract, which ensures that the cash is in the borrower’s account and that collateral locked up against loans is released at the end of the deal. More than $300bn worth of such short-term loans have taken place . . . since December 2020.

If you’re a long-term holder of (say) ethereum, is this good news for you? It doesn’t look like it. What it looks like is a mainstream institution using blockchain in a way that won’t do anything to encourage adoption of any cryptocurrency. Unlike most popular tokens, JPMorgan’s blockchain is “permissioned”, meaning it gets to select who can participate in the network. It is, in other words, not decentralised. Ethereum-style “smart contracts” are involved, but that’s about it.

There is one theory of how this could benefit the crypto ecosystem, though. The idea is that once banks start trading a few assets as tokens, the efficiency gains will prove enticing enough that they’ll want to move other assets on to a blockchain. Some will go to private blockchains such as JPMorgan’s, but existing public chains such as ethereum can compete for that business too. Perhaps public blockchains could start looking better than private ones.

As one proponent of this “asset tokenisation” idea explained to me:

The banks are going to effectively disintermediate themselves. Not happily, there’s going to be a big battle, but that’s ultimately the direction we’re going in.

One important difference between JPMorgan’s blockchain and a public one, however, is the law. JPMorgan can sign agreements with its partners laying out what happens if there’s a glitch or dispute — smart contracts backed by dumb contracts. Are smart contracts on the open internet legally enforceable? It’s unclear.

The larger point is that if decentralised crypto — as opposed to a blockchain run by a bank — is going to play a big role in markets, that will involve dealing with some very centralised institutions.

Reader responses on bear markets

Yesterday’s letter made the point that a bear market is a time for greed. Long-term prospective returns are improving. As signs of capitulation and indiscriminate selling emerge, so do buying opportunities.

But a number of readers cautioned that we are likely to be a very long way from capitulation. A bubble that took more than a decade to inflate will take more than a few months to deflate. One FT commenter wrote:

I fear that when all is said and done, we will look back at these times and say “remember how [at] minus 20 per cent we thought we were close to capitulation? The adjustment was barely starting”.

About 100 days since the S&P 500 peaked in January, another reader, Paul Hodges, looked back at how long it took past overvalued markets in 1928 and 1998 to bottom out:

We expect it to take a similar 650-700 days to bottom — with obviously some major rallies, or “false dawns”, on the way.

Brian Coleman, a former Goldman Sachs trader, argued that the standard bear market playbook may not work this time. “This does not feel like a traditional bear market. It’s been eerily orderly”, with corporate results and economic conditions not yet consistent with recession.

It might be, he suggests, that what we are seeing is not, or not only, a bubble deflating but a shift in market paradigms, with a generation of low interest rates, globalisation, growth and relatively free markets coming to an end. The end of the coronavirus pandemic, with all its economic peculiarities, muddies the picture further. In all, history may be a poor guide to what happens next. He thinks we need to “focus on known unknowns”: 

If there is an elephant left in the room, it has to be (as always) in opaque parts of the markets. And the last man standing in this regard seems to be privates [private equity and debt]. We have all read about privates not wanting to test valuations, so they raise convertibles etc. Let’s see where that goes . . . 

Our friend Dec Mullarkey at SLC Management is more optimistic:

The sell-off has been broad and deep as investors and companies handicap how aggressive the Fed will be . . . History suggests these monetary episodes don’t end well, but equity markets are pricing a very nasty outcome with an overwhelming number of industries getting pummeled . . . The sell-off has been remarkably non-discriminating. But markets generally need a macro reason to turn. A quick retracement in inflation would help. Therefore, could be a sideways market for a while.

To be more optimistic, what we need to see is “a hint that investors are becoming more discriminating on value as they pore over the wide swath of beat-up valuations”. And on Monday, we saw one such hint, as bank stocks rallied after JPMorgan raised its outlook for interest income, “an indicator of a conservative quality buyer deciding the dividend yield looks attractive given the backdrop of solid balance sheets. Feels like an encouraging step, indicating investors are becoming more comfortable picking over areas that have been savaged.”

One good read

Rana Foroohar is sick of Davos.

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