“The Bitcoin Bible” By J.P.Morgan
A few months ago JPM CEO called Bitcoin a fraud, and threatened any JPMorgan trader caught trading cryptocurrencies, but today the largest US bank has released what can only be called the “Bitcoin Bible“: 71 pages of excruciating detail on everything from the technology of cryptocurrencies, to their applications and challenges.
Facts to have in mind of the report:
- J.P. Morgan researchers from across a wide range of expertise analyze various aspects of Cryptocurrency (CC) to gain insight on this market and its potential evolution in this report. CCs’ extremely rapid growth, and then fall, both in terms of number of CCs and prices and their challenge to the current financial infrastructure, are forcing all market participants to closely monitor and understand this new market.
- Cryptocurrencies are virtual currencies that are created, stored and governed electronically by an open, decentralized, cryptography system. CCs can be used to exchange money, to buy certain goods/services or as an investment. There are over 1,500 cryptocurrencies with a market cap of some $400bn as of February 8, 2018, with Bitcoin being the largest representing a third of the market according to CoinMarketCap.
- Launched in early 2009, Bitcoin (BTC) is the dominant cryptocurrency with a market cap of $140 billion (representing one-third of the CC market) and nearly 17 million BTC units in circulation (capped at 21 million). Bitcoin was the first major cryptocurrency and has spawned many competing CCs and technologies, many of which still fall back to Bitcoin as a support currency. Bitcoin itself has split into two cryptocurrencies, Bitcoin and Bitcoin Cash, to improve liquidity.
- It will be extremely hard for CCs to displace and compete with government-issued currencies, as dollars to euros and yuan are virtual natural monopolies in their regions and will not easily give up their seigniorage profits.
- CCs are experiencing heightened volatility and will face challenges from both technology (such as rising mining costs and hacking) and regulators who are concerned about anti-money laundering and investor protection, as CC payments are irreversible and there is no recourse.
- Security concerns have mounted in Bitcoin exchanges as hackers have infiltrated a number of CC exchanges generating large losses, while regulators are challenging anonymity.
Below are some of the JPM team’s observations on what the future could bring for cryptos, with highlights, however the most notable admission is JPM stating that cryptocurrencies “could potentially have a role in diversifying one’s global bond and equity portfolio“, a far cry from Jamie Dimon’s emotional appeal that all cryptos are a giant fraud.
Below we can see some of the feaures on what the future could bring for CryptoCurrency, however the most important fact is (in J.P.Morgan words) “could potentially have a role in diversifying one’s global bond and equity portfolio“. Totaly different from the last Jamie Dimon’s release: “all cryptos are a giant fraud”
- While seeing a potential for the deployment of the underlying Blockchain technology in payments, we do not see cryptocurrencies competing with central bank-issued money for lawful transactions. We note that CCs have not attained the relative stability of value to make them useful as money for everyday transactions. The current set of government-issued fiat currencies — such as the dollar and the euro — provide efficient media of exchange, stores of value and units of account. Some of the early buyers of CC were clearly dismayed by ballooning balance sheets of the major central banks in the aftermath of the global financial crisis (GFC), but the lack of any meaningful inflation since, in both developed markets (DM) and emerging markets (EM), has surely reduced concerns about fiat (legal tender issued by a central bank) money.
- Several central banks, as discussed in Feroli, are investigating whether they should issue CCs in their own currency, but are very far from actually doing so, as any increased efficiency in payments technology does not appear to be that obvious. In addition, the issuance of crypto dollars, for example, would give non-banks access to the Fed balance sheet, and thus could endanger the economically and socially important financial intermediation function of commercial banks.
- We examine the potential role of CCs in terms of offering diversification in a global portfolio, given both their high returns over the past several years and their low correlation with the major asset classes, offsetting some of the cost of high volatility. If past returns, volatilities and correlations persist, CCs could potentially have a role in diversifying one’s global bond and equity portfolio. But in our view, that is a big if given the astronomic returns and volatilities of the past few years. If CCs survive the next few years and remain part of the global market, then they will likely have exited their current speculative phase and would then have more normal returns, volatilities (both much lower) and correlations (more like that of other zero-return assets such as gold and JPY). Based on its historical performance, CCs can be 10 times more volatile than core assets like stocks, or than portfolio hedges, like commodities. Liquidity is also well below most other potential hedges. Extraordinary returns can be generated in the price discovery phase, only to be followed by several years of mean-reversion toward the eventual, long-term average level. In the current market conditions, we do not believe that an allocation to Cryptocurrencies as insurance should be a portfolio’s main or only hedge. Note that even though CCs have improved risk-adjusted returns over the past several years, they have not prevented portfolio drawdown during periods of acute market stress, like the equity flash crashes of August 2015 and February 2018.
What a typical bitcoin transaction flow looks like:
Links for some graphic explanations: