Blockchain, Bitcoin, and fintech innovation

A short history of fintech

Today, financial technology (fintech) is a sprawling ecosystem of digital infrastructure and development that facilitates while transforming all manner of transactions. While it’s frequently identified with phenomena such as blockchain and Bitcoin—and efforts to propel modern economies by reducing certain frictions in economic growth—fintech has a history and a growing impact on physical currencies that’s worth reviewing.

Some might argue that the forerunners of modern fintech go back to the 19^th century, with the inventions of the telegraph and telephone. But the more commonly discussed origins are credit cards and ATMs—inventions of the 1950s and 1960s.¹

Today, in part thanks to the prevalence of smartphones, fintech covers a wide range of activities. While it may be most associated with payment systems, it also covers wealth management, insurance, trading, settlements, and banking. The primary categories of fintech investment opportunities are payments, investment and lending, and financial infrastructure.

Fintech over the years

Source: american-historama.org, 1/9/18; thoughtco.com, 3/20/20; history.com, 2021; simpletexting.com, 2021.

PayPal, founded in late 1998, was one of the early fintech payment applications. PayPal owns Venmo, a payment-sharing application with a social network flavor; Venmo, in fact, recently announced that users would be able to trade Bitcoin and certain other cryptocurrencies.² Anyone with a smartphone has access to a remarkable and growing complement of fintech for transferring and managing money.

Cashing out? The decline of physical currencies

Finding consistent measures of cash usage versus other forms of payment isn’t easy, but the overall trend is clear: Payments are moving away from cash. A fall 2020 McKinsey study³ showed that for selected groups of emerging and developed countries, cash use had fallen significantly between 2010 and 2020.

Still, in the emerging markets, cash was used in 75% of payments in 2020, down from 95% in 2010. In the developed markets, cash usage fell more sharply, from 59% to 28%. It’s noteworthy that the data represented from the McKinsey study didn’t include most advanced European economies, which other studies have shown continue to use surprisingly large amounts of cash.⁴ In Germany, for instance, even in the pandemic, consumers are making 75% of their payments in cash.⁵

Areas of long-term growth in fintech include artificial intelligence, machine learning, mobile (digital) wallets, blockchain, and cryptocurrency. We briefly explore the last two, focusing on Bitcoin in the cryptocurrency field.

What is blockchain and how does it work?

Just as fintech goes back to the 1950s, and possibly much further, blockchain has its origins in ancient practices keeping journals. Depending on your perspective, it can be traced to the 15^th century Friar Luca Pacioli, generally considered the father of double-entry bookkeeping, or even much further—to ancient Mesopotamians’ use of clay tablets to record quantities. But unlike a manually kept journal, or even a spreadsheet, blockchain is essentially tamper-proof or immutable.⁶

Blockchain is a record of information—any information. Each block is a uniquely identified digital representation of a piece of data. When a new piece of data is entered, a new block is created and linked to a previous block. When data is transferred, the blockchain indicates where it’s been and where it is now. These blocks, and any subsequent blocks, “know” when someone tries to tamper with the information in one of the blocks in the chain. Blockchain records are kept on nodes, or networked computers, in which all participants agree to permanent and unchangeable recording of data. Blockchain networks can be public or private.

This has important implications for digital security and, according to the United Nations, even implications for sustainability and human rights. Combining radical transparency, universal access, and an innovative form of digital trustworthiness, blockchain represents a potentially far-reaching disruptive technology that goes well beyond financial markets.

Despite its security, one drawback of blockchain is its speed. It's been estimated that Bitcoin can only process about seven transactions per second⁷; Visa, by contrast, processes about 24,000. This drawback may only be temporary, however, as innovation in this space may well accelerate through advances in computing and AI.

So what about Bitcoin, anyway?

Bitcoin is an example of the use of a public blockchain network. (Another major cryptocurrency, Ether, runs on a different network.) Bitcoin’s fans like to talk about the limited supply—only 21 million Bitcoin will ever exist—as a primary rationale for its value in a world of fiat currency. To some, that limited supply is offset by doubts about whether there’s anything real or officially sanctioned about Bitcoin. Invented in 2008 by the mysterious Satoshi Nakamoto, Bitcoin lives on blockchain and is mined, or created, by nodes using substantial computing power and energy to solve complex mathematical puzzles.  

Put another way, Bitcoin transactions take place using blockchain technology, with a permanent record of each exchange. Those solving them receive rewards, but the size of the reward halves every four years,⁸ so that it ultimately approaches zero, which Bitcoin proponents consider the main source of scarcity and, therefore, value.

Bitcoin has frequently been called digital gold or gold 2.0. This is a bit of a misnomer, as gold, unlike Bitcoin, has both industrial properties and a multimillennium store of value. Some say gold coins go back to 550 BCE⁹; Gold coins, however, have been debased by increasing the number per fixed amount of gold, and gold has storage costs.

Neither gold nor Bitcoin pays income, making them both relatively more valuable during times of low interest rates—like today—since the opportunity costs of holding them instead of interest-bearing assets is minimal. While gold’s price has shown a general tendency to perform well during periods of stock market stress, Bitcoin has yet to exhibit this property, behaving, so far, more like a high beta asset. That said, it’s difficult to compare the two histories at this point, with Bitcoin millennia newer and still emerging from a speculative phase.

Gold has tended to offer protection during some stock downturns

Source: Macrobond, 5/14/21. LHS refers to left-hand side; RHS refers to right-hand side. The S&P 500 Index tracks the performance of the largest publicly traded companies in the United States. It is not possible to invest directly in an index.

Bitcoin also faces regulatory challenges. Treasury Secretary Janet Yellen has expressed various concerns about its efficiency and legitimacy, fearing that “it’s often used for illicit finance” and that “the amount of energy that’s consumed in processing those transactions is staggering.”¹⁰ That said, some argue that in the long term the underlying blockchain technology may be able to address environmental, social, and governance issues, including “supply chain traceability, renewable energy distribution and proxy voting,”¹¹ despite its energy consumption.

Bitcoin has yet to show protection during stock downturns

Source: Macrobond, 5/14/21. LHS refers to left-hand side; RHS refers to right-hand side. The S&P 500 Index tracks the performance of the largest publicly traded companies in the United States. It is not possible to invest directly in an index.

What is the future of digital currencies?

The key question may be not the price of Bitcoin or other cryptocurrencies, but more broadly the future of digital currencies in general, including central bank digital currencies. The liquidity in financial markets has led investors to not only bid up some existing assets, but to also look for new ones. Digital currencies may gradually be entering the sphere of agreed-on investments for institutions, and tools such as Coinbase have made cryptocurrencies accessible. Traditional investors may within some years make exposure to digital currencies a more common portfolio holding, but questions, including regulation and sustainability, remain.

1 creditcards.com, 7/11/17; history.com, 9/8/20. 2 cnbc.com, 4/20/21. 3 cashmatters.com, 10/5/20. 4 statista.com, 8/10/20. 5 npr.com, 8/11/20. 6 See ibm.com, "What is blockchain technology?" 7/31/18. 7 cryptogeek.info, 6/1/20. 8 gemini.com, 3/12/21. 9 thebalance.com, 4/22/21. 10 cnbc.com, 2/22/21. 11 institutionalassetmanager.co.uk, 4/29/21.