Forecasting is a tricky business. In fact J.K. Galbraith summed up the challenge quite nicely with the quip that there are two classes of forecasters: those who don’t know and those who don’t know they don’t know. That’s almost Rumsfeldian. Nonetheless, forecasting is fun, and we all like a punt. So the ambition of this article is to extend the debate around crypto as an investable asset, and broadening it to highlight the activities of the central banks, and their own activities in the space of digital currencies. And along the way, I’ll hopefully attempt to position myself in the first category of Galbraith’s forecasters, rather than the second.

First off, let’s consider what Bitcoin is and some of the ideas that it has demonstrated as being possible. In doing so, put aside all the emotion around Bitcoin being a scam, a framework for laundering money, and a Ponzi scheme. Let’s instead consider what it offers in a purely objective, technical sense.

At its simplest, the Bitcoin technology contains a ledger that records balances associated with units of digital assets that are referred to as Bitcoins. These digital assets can be transferred between the parties that control the balances on the ledger. It’s worth re-reading that statement again and taking a moment to contemplate the implications of what’s described there; a ledger, which records balances of units of digital assets to which value is ascribed, and those units can be transferred securely from one party to another.

What’s novel about this, you may ask? Compared to the traditional, and very separate ledger, payment and store of value frameworks, Bitcoin manages to do something very clever; by combining these three very separate rails, and bringing them together as one; not only is there an efficiency advantage as we don’t now need three systems, but because this is all written in code, it opens up a range of possibilities as to how we configure this single ledger, that has payment and store of value capabilities. For example, we can create another class of asset, which we could refer to as a digital security, which looks like a normal security, that can be transferred synchronously with a payment, so perfect delivery verses settlement. Current settlement infrastructure has separate payment and securities settlement rails.

The obvious opportunity here is mitigating counterparty risk and settlement risk. It’s worth stating that Bitcoin doesn’t generally support securities, and certainly doesn’t support bi-directional transactions in the form of ‘I send you something if you send me something’, but with care, it can be programmed to do so. But the broader question is, would you? The Bitcoin protocol, as clever as it is, supported by some incredibly clever people globally, with it's open source code, lacks state support. That’s not to say it wouldn’t be supported in the event of failure, but support would not necessarily come from the state; and things do fail warranting support from the central banks. But could the central banks take some of the ideas within Bitcoin and use them for their own purposes, so a central bank issued digital currency. Essentially the same as a Bitcoin, but a ‘Britcoin’?

It is almost seven years since the Bank of England published their first paper exploring the implications of Bitcoin, ‘Innovations in payment technologies and the emergence of digital currencies’^[1] It is an excellent piece of writing and provides a very accessible stepping stone into the topic of cryptocurrencies in a general sense. The authors unpack the history of payment systems, developments in the payments space, and then undertake a critical analysis of Bitcoin as a technology and the way in which it mitigates different types of risk, such as credit or liquidity risk. The elimination of intermediaries within Bitcoin technology is cited as an advantage; instead of having a single point of failure, responsibility for settlement is shared across a distributed network of participants.

The obvious further advantage here is that distributed systems should be more resilient to systemic operational risk because the whole system is not dependent on a centralised third party. The paper then raises the bar somewhat by not only highlighting the opportunities in the context of decentralised payments systems using similar types of technology, but flags the broader potential impact of this type of technology. The majority of financial instruments, such as debt, equity and derivatives exist electronically, so the ‘financial system itself is already simply a set of digital records’. The paper elaborates further with the observation that ‘This development could allow any type of financial asset, for example shares in a company, to be recorded on a distributed ledger. Distributed ledger technology could also be applied to physical assets where no centralised register exists, such as gold or silver.’ This is important stuff - we have a central bank saying we can put the financial system on the same sort of technology that Bitcoin uses.

Fast forward to May 2021. Sir Jon Cunliffe’s speech^[2] The Bank of England’s deputy governor financial stability, given to the OMFIF Digital Money Institute again makes fascinating reading. The deputy governor poses the question of whether we need public money? And by public money the deputy governor means money issued by the state to its citizens for everyday use. The speech covers the evolution of money, pointing out that ‘It is not only a social convention, it is a very dynamic one. The forms it can take and the uses to which it can be put have varied materially through history and between societies.’ The headline observation here is that forms of value exchange change over time; when our ancestors bartered, it was one sheep for ten fish. But sheep and fish are not great as currencies. It was the invention of electronics that gave rise to computers, and the ability to create digital, non-physical records of commercial activity, which is much better than fish / sheep based transactions.

And, as outlined earlier, it was Bitcoin that established the principle of combining those records. The deputy governor then tantalisingly uses the term stable-coin^[3], suggesting that ‘[he] will look to the future as well as to the present and to the possible entrance of non-bank issuers of private money such as the ‘Big Tech’ platforms’. So this is privately-issued money, using stable-coin frameworks. The speech positions the stable-coin concept alongside the prospect of a UK issued central bank digital currency, which the bank is forging ahead with, setting up a taskforce to explore the implications. This is reinventing the digital economy, bit by bit, quite literally. 

As investment managers, why does any of this matter? Bitcoin is a profoundly important technology. The Bank of England recognised that seven years ago. The case for investing in digital currencies and the allocation within a portfolio is always a function of risk versus reward, underpinned by some level of fundamental and / or technical analysis. The fact that central banks are exploring how to apply similar types of technology might have interesting bearing on any such decision. And the frameworks for holding these assets are maturing - frameworks for hygiene checks on cryptocurrencies, traded on regulated exchanges, held under safe custody, in a regulated jurisdiction, exist. But that really is just a glimpse of the future. The advent of central bank digital currencies, a “Britcoin”, will provide the trusted, state operated infrastructure, upon which a new financial ecosystem will be built, allowing for the private issuance of new forms of money and securities, traded on venues which clear and settle 24/7. My Galbraithian forecast is that we will see a Britcoin, and lots of them. They will change securities issuance and settlement forever, but they might not necessarily be called Britcoin.