Bitcoin and its related technology blockchain has witnessed significant interest in financial services. In part the success of the technology can be measured based on the number of transactions and the bitcoin price, which now stands at $734. That value could increase by eight-fold in less than a decade, a report predicts. The technology is at an important crossroads, a Canaccord Genuity says, as governance and structural issues need to be addressed in order for continued success.
Financial services industry most impacted by blockchain as transaction settlements streamlined, as investment year over year flattens
Blockchain, the technology behind the transaction ledger of Bitcoin, is likely to have its greatest impact in the financial services because of its ability to reduce third party transaction costs, Michael Graham and his team of analysts noted. In a November 23 report titled “Checking in on blockchain and bitcoin in financial services,” the most significant impact is currently being felt in capital markets and wholesale payments, with a focus on securities settlement, cross-border currency transactions and correspondent banking networks.
Blockchain technology offers financial services new methods of verifying transactions when applied to payments. “It is the process of forming and linking blocks of cryptographically signed data to form an immutable and perpetual database of records,” the report said. One key to the technology is a decentralized ledger, similar to a shared database, that makes the technology unique.
The technology improves transparency, security and efficiency and is particularly useful in recording or transferring ownership of digital property or physical assets. While venture capital investments have steadily grown, estimated to top $1.3 billion in 2016, year over year investments have fallen slightly from $490 million in 2015 to an estimated $419 million in 2016. Increasingly large corporations are partnering with smaller specialty technology firms, but the recent unexplained exit of Goldman Sachs from a blockchain support group, R3, smarts to various degrees. (Public sources indicate Goldman is still interested in the technology, but didn’t necessarily want to participate in the next phase of investment R3 was making in open source blockchain software.)
“We believe bitcoin holds real promise as a potential disruptive force in the currency and payments markets, and we lay out many progress markers within,” the report said, pointing to the bitcoin ecosystem is at somewhat of a crossroads. “In particular, there needs to be resolution to key issues regarding throughput and governance in order become more mainstream.”
Bitcoin competitor has stronger governance and developer involvement
Bitcoin and blockchain technologies have competitors. One such threat to the technology’s dominance is coming from the smaller Ethereum, which is said to have a less restrictive programming environment, a more engaged developer community, quicker mining (processing times) and a more centralized governance.
It is centralized governance that could be a bitcoin and blockchain weakness, according to Canaccord Genuity. The process for making blockchain core structural decisions is not smooth and has resulted in both developer and financial institutions to take pause.
“Attempts to make changes to the bitcoin protocol (increasing the block size, for example) to ensure its sustainability have been met with fierce resistance at times,” the report pointing to three primary issues of block size, miner concentration and governance that is holding back the technology. “Developers and financial institutions may want to see an organized way to make decisions like this before placing more confidence in bitcoin.”
Bitcoin pricing once fluctuated now based on a formula that points to $5,739 by 2025
In the early days of bitcoin’s emergence, pricing of the digital asset fluctuated widely from $177 to $1,147. Such price volatility is often the sign of an immature market without strong pricing guidance.
The pricing formulas for bitcoin remain in flux but are finding definition. “Many factors that might hurt the value of fiat currencies (inflation, war) and drive gold prices higher should also drive BTC prices higher, while stories of hacking and fraud push BTC lower,” the report stated.
For their part, Canacocord Genuity points to a pricing methodology that considers both transactional demand, which can be demonstrably measured, and “store of value” demand, which is more perception based:
Our framework for assessing the value of BTC according to transactional demand relies on monetary theory and is consistent with how many think about money supply for well-known currencies like the USD. For the “store of value” (SOV) component, we think about the gold market as the best proxy for determining how much BTC market participants might feel compelled to stockpile, or hoard.
Using this along with a more complex formula as a framework, the report says that by 2025 the value of bitcoin could reach $5,739. This is based on an anticipated 20 million bitcoins in circulation by 2025. Specifically, the analysts state:
We project that the amount of bitcoin required for these functions will increase from $6.1B in 2015 to $115.0B by 2025. We also can fairly accurately forecast that there will be approximately 20 million bitcoins in circulation by 2025. This leads us to an implied 2025 value per BTC of $5,739, which when discounted to present at a 25% discount rate leads us back to the current market price of BTC.
What about the Winklevossi Bitcoin ETF? The analysts say it could be an option, opining:
GBTC has traded at much higher premiums of up to ~186%, and has only traded at a discount for one day – the market price traded at a (0.1%) discount on 10/28/15. We see this as evidence that demand from nonaccredited investors is at high levels. Usually, this type of price discrepancy would be observed in a closed-end fund (as only a finite number of shares are created in an IPO, allowing increased demand to drive a premium over NAV), and GBTC likely exhibits this type of behavior due to its lockup provision – if accredited investors were allowed to sell shares immediately on the secondary market, the premium would likely decrease substantially (such as typically observed in an open-ended fund).
In time, it is possible this premium may gradually diminish as early investors sell shares. However, we note this same dynamic would expand liquidity of GBTC, improving the risk profile..