Some months ago, I wrote a column that attempted to provide a simple explanation of Bitcoin, and its underlying technology, Blockchain. I used the example of promissory notes, and their dark side, the hawala system, to explain how the technology is designed to work. Pre-defined amounts make up the “block” and the hands it passes through form the “chain” with Internet technology ensuring that the size of the block cannot be tampered with, and that the defined block instantly shows up in the databases of all trading parties in the chain. I had also predicted that national governments would begin to step in to regulate Bitcoin and its competitors, which are still largely unregulated and therefore unsuppressed as cash substitutes.
It appears that the comparison to the hawala system was apropos, after all. Regulation is around the corner. Bloomberg reported on 6 January that the value of Bitcoin had tumbled by over 22% the previous day, before staging a partial comeback. This was largely due to jitters around government regulation of Bitcoin in China.
China—before fees—accounts for almost 98% of the world’s trade in Bitcoin. The Chinese yuan had its biggest decline since 1994 last year, and bonds and shares also fell. Government measures to cool the housing market mean that real estate is headed for a correction. Many investment banks are shying away from the ‘C’ in their bets on emerging market BRICS (Brazil, Russia, India, China and South Africa) currencies. Goldman Sachs has advised clients that it expects the yuan to fall further this year, and continue its slide into 2018. The equity market’s tepid performance, a real estate bubble about to pop, the yuan’s weak outlook, and central bank capital controls are all driving Chinese demand for Bitcoin.
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Bitcoin has escalated in value since early 2015 as Chinese buyers have turned to alternative assets to hedge against the weakening yuan and spirit cash out of their country without using official channels. They accomplish this parallel to India’s hawala by buying Bitcoin in yuan and then selling it in a different currency—and having the sale proceeds routed to financial institutions abroad. China’s government has been worried that some of this trade is a cover for money laundering, and is actively considering regulating trade in Bitcoin. Even though the total value of Bitcoins of around $16 billion is tiny when compared with most traditional asset classes in the People’s Republic, Chinese officials are tightening capital controls and Bitcoin traders fear that their pet cryptocurrency could be their government’s next target. Chinese regulators have shown concern over Bitcoin’s role before. In 2013, the People’s Bank of China barred financial institutions from handling Bitcoin transactions, causing a slide in price akin to the precipitous drop on 6 January.
Bitcoin is called a cryptocurrency by many people, especially consultants like me and employees of information technology (IT) services firms who try to make it seem like it’s only for the technologically savvy. The word itself is intimidating and ensures that your interlocutors will stop asking questions for fear of seeming ignorant after you have pompously used the noun as if it were common parlance! In my experience, few of these pundits realize that Bitcoin is based on a technology that is already eight years old. It’s almost as if we are all still in awe about the release of Android in late 2008.
Despite the verbose smoke-and-mirror tricks of the consulting trade, many mainstream banks are now actively engaging in the use of Blockchain—both for their trade finance transactions that support exports/imports through letters of credit, as well as for other clearing and settlement systems. And to my eye at least, every announcement by a mainstream bank about the use of Blockchain technology always seems to feature some start-up in Israel or Ireland, and not a large US, European or Indian IT services firm. It seems as if the consultants and IT services guys have satisfied themselves by using pretentious language around the technology without yet having done anything to write home about.
That said, this column was intended to uncover an area of technology spending that could turn into the next billion-dollar opportunity for IT services firms, since many of them seem to be missing the Blockchain implementation opportunity. And it is simply this: focus on the regulation that is inevitable as cryptocurrencies gain widespread use.
The Sarbanes-Oxley Act which followed the Enron debacle and the slew of regulation that followed the 2008 global financial crisis turned out to be manna from heaven for IT services firms who wrote millions of lines of computer code for their financial services clients just so that these clients could comply with all the regulation coming out from governments. This was in addition to self-regulating agreements on standards such as those achieved by the meeting in Basel, where several regulatory frameworks were birthed by central bankers. Thomson Reuters says 70% of firms are expecting regulators to publish even more regulatory information in the next year. For any regulated firm to thrive or at least survive into the medium and longer term, consistent investment needs to be made in the risk, compliance and control functions, according to an executive with Thomson Reuters.
There is likely to be a large delivery very soon from both the Beijing and the Basel birthing rooms, and this time, it will be the Blockchain baby. And the newborn could lead to billions of dollars of business for IT services providers in getting the big banks’ systems to comply with it.
Siddharth Pai is a world-renowned technology consultant who has led over $20 billion in complex, first-of-a-kind outsourcing transactions.
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