Cryptocurrencies speculative, but blockchain can bring positive disruption – S&P’s

Global ratings agency Standard and Poor’s (S&P’s) currently views cryptocurrencies as speculative instruments that will have an “insignificant effect on global financial stability if its value were to collapse”, but that blockchain – a shared digital transaction ledger – presents an opportunity for financial institutions.

Blockchain presents an opportunity for financial institutions to cut costs by streamlining back-office operations, shortening clearing and settlement times, facilitating payments and even generating new revenue streams, the ratings agency said in a statement issued on Monday.

“Cryptocurrencies do not meet the basic two requisites of a currency – an effective means of exchange and an effective store of value. Cryptocurrencies are still not widely accepted as payment instruments, although the list of companies accepting them has grown over the past few years.

“Further, the volatility that we have observed over the past 12 months in the valuation of some cryptocurrencies and their market cap is the most meaningful evidence that they fail the test of value storage. For example, in the first ten days of February, the market cap of cryptocurrencies dropped by around $185-billion, S&P’s stated.

Blockchain, however, can be used for many banking services, including bank payments, trade finance, money transfers and post-trade services.

Having a real-time standardised view of transaction data without needing to conduct multiple reconciliations would remove many of the inefficiencies that hinder the financial system and could reduce costs considerably, the ratings agency said.

“Whether cryptocurrencies take off or not, we believe banks’ role in the payment business might change materially in the next decade. Some market participants are challenging the benefit of blockchain, arguing that the technology was created a decade ago and has not yet disrupted the financial system in a meaningful manner.

“That said, we project that, because of this technology and the growth in other peer-to-peer services, smaller and more innovative market participants could have more opportunities to challenge established banking groups' existing product offering.

“We think that the creation of a cryptocurrency backed by a central bank that gives citizens direct access to this central bank’s ledger is potentially a game-changer to banks as we know them. This does not mean that banks will disappear, but it would mean significant changes in the way they do business.”

REGULATION REQUIRED
S&P’s reported a differentiated reaction among regulators and policymakers toward cryptocurrencies.

“Some regulators or policymakers recognised these instruments as a means of exchange while others have banned them. Some countries have introduced tax-friendly regulations for cryptocurrencies, such as Japan, which reportedly eliminated consumption tax on Bitcoin trading in 2017. Others, like Bolivia, have reportedly banned them. To date, European authorities have mainly called for investors' caution when dealing with cryptocurrencies.

“We believe that, if the market is to take up cryptocurrencies, it will imply great regulatory scrutiny and may be on the agenda of the Group of 20 or other supranational bodies. Some of the key risks that regulations may try to address include consumer protection, impeding illegal activity, and central bank backing.”

If cryptocurrencies become an asset class, the impact on financial services firms will be more gradual. S&P’s is of the view that this is because their future success will largely depend on the coordinated approach of global regulators and policymakers to regulate and enhance market participants' confidence in these instruments, the ratings agency averred.

S&P’s does not view cryptocurrencies as an asset class because their total value is not big enough yet. At Feb. 10, 2018, there were 1 523 outstanding cryptocurrencies with a market capitalisation of around $394-billion. By way of comparison, at the same date, this is well below the market cap of technology multinational Apple at around $794-billion.

More importantly, S&P’s believes that blockchain technology – which is what underpins cryptocurrencies, enabling the creation of a shared digital transaction ledger – could be a positive disrupter for various financial value-chains.

“If widely adopted, blockchain could have a meaningful and lasting impact on the celerity, traceability and cost of financial transactions. The financial market infrastructure segment might also see medium-term benefit from cryptocurrencies and blockchain through the launch of new income-generating products, such as futures or exchanges based on cryptocurrencies, or the replacement of current practices by new ones based on blockchain.”