Some Sovereign Funds and Institutional Giants Sprinkle Capital at Blockchain and Digital Currency Startups

Posted on 01/05/2020


Blockchain, or distributed ledger technologies, are frequently associated with cryptocurrencies such as as Bitcoin. However, blockchain is a network of separate computer systems that interact to make, record, and document transactions. It is regarded as a democratizing tool for decentralized transactions. The World Bank is steering clear of issuing recommendations, but did indicate that blockchain technology “could increase efficiency and lower remittance costs, and potentially improve access to finance for unbanked populations, who are currently outside the traditional financial system.” The World Bank also sees the “potential to transform various other sectors as well, like manufacturing, government financial management systems, and clean energy.”

Early interest in blockchain among institutional investors has been low. SWFI’s latest survey results show that blockchain is seeing investment by a mere 9% of large institutional investors. Despite this, digital asset managers are reporting that most new inflows are coming from institutions. Since institutional investors have such deep pools of capital, it would not require many of them to move the needle in the blockchain markets.

The potential has been theorized but not yet thoroughly tested in many applications in real-world conditions. It is believed that, using blockchain technology, digital assets can be traded at any time of day or night. Holidays and weekends could be irrelevant. Trades could be made through blockchain on any day of the year. High transaction costs, particularly for real estate, are also expected to come down. Innovations can also be made at the institutional level.

State Street’s Blockchain Outlook

State Street is pursuing blockchain use enthusiastically. State Street’s “Blockchain in 5” presentation laid out the potential for blockchain to “speed reconciliation, shorten settlement time, and automate processes.” However, State Street is also wary of “regulatory, governance, and technical challenges” before it can reap what it thinks is “huge potential that will only be unlocked through experimentation.”

State Street’s enthusiasm is tempered with the knowledge that it’s still early days in the blockchain revolution. Security is also thought to be a thorny problem, even though blockchain is supposed to make transactions more secure due to the multiplicity of computers involved, as opposed to a single system that can be hacked or shut down.

Automation has been a theme at State Street, and it has been reducing headcount in IT and elsewhere. State Street’s Vice President of Media Relations Brendan Paul said that headcount reduction would: “Streamline our IT organization and removes unnecessary layers that get in the way of our overall success.” Some IT employees who made up the unnecessary layers have been following State Street’s former Chief Technology Architect Moiz Kohari to Manetu, a data-based startup that treats data as its prime business. State Street still has 38,000 workers on the payroll, and is shifting much of its new hiring to China, India, and Poland, where the costs of doing business are not as high as they are in advanced western economies.

China Supports Blockchain but not Cryptocurrencies

China is emerging as the world’s leader in blockchain thanks to the endorsement of President Xi Jinping. Mr. Xi urged his people to “seize the opportunities” blockchain offers. Although it still isn’t clear how blockchain will be developed or adopted, Mr. Xi called it an “important breakthrough in independent innovation.” Paradoxically, Bitcoin and other cryptocurrencies are highly discouraged in China. That’s because the ruling communist party has no interest in decentralized and untraceable transactions in an era where citizens are already sneaking money outside of the borders. Instead, the government is creating a digital currency of its own which is tied to the yuan. This first ever sovereign digital currency is expected in 2020.

Hainan province is a tropical location that is compared to Hawaii and it hosts China’s blockchain pilot zone. Over 100 blockchain organizations have located there, and more are signing on. US$ 142 million has been set aside by the government to help them study and direct blockchain-based solutions for housing, healthcare, trade, and even the tourism that the island is known for.

Singapore’s sovereign wealth fund, Temasek and China’s HNA Group are there working on improvements in the aviation industry. In 2018 Temasek purchased shares in Hainan Airlines, which HNA controls through the Hainan Province Cihang Foundation. Microsoft has been there for years and founded an Innovation Center. Chinese search engine Baidu is also there. Dubai’s Blockchain Center has agreed to partner with Hainan’s pilot zone and help it to meet its goals. Additional state-owned enterprises are expected to make a transition in the years ahead.

Crytpocurrencies

It bears repeating that it is common for investors to equate blockchain with cryptocurrencies even though crytpocurrencies are merely one use of blockchain technology, albeit the most popular. When establishing an investment in cryptocurrencies, there are a number of open questions that need to be addressed. First, the variety of cryptoassets already available is set to increase. Each cryptoasset may require different security protocols, investment timeframes, and security apparatuses. It would be important to know which blockchain type corresponds to the cryptocurrency being purchased. The specific exchange being used would also need to be evaluated.

One of the most famous exchanges was Mt. Gox. Mt. Gox handled 70% of Bitcoin exchanges at one time before it was shut down by regulators. As many as 850,000 Bitcoins vanished on the computer system and forensic computer investigators attempted the impossible task of tracking them down. Unfortunately, this was without much success. Another company, Quadriga Fintech Solutions operating out of Canada, left investors approximately US$ 200 million poorer after its 30 year old founder died unexpectedly without sharing the access pin to the Bitcoins he had secured for investors through his laptop computer. An employee who could act as a backup could have helped. Since much of the perceived value of cryptocurrencies revolves around the fact that they are an untraceable way of buying and selling, there is generally no counterparty to verify transactions.

Another open question is whether the particular cryptocurrency being purchased is a legitimate currency. Regulators have not yet taken a unified position on this. Neither the Financial Standards Accounting Board nor the International Accounting Standards Board has firm guidance to offer. Recognizing and reporting on these investments in a legal way remains a mystery. It is not yet clear how to properly value or pay taxes on these assets. For the time being, most are opting to count them the same way they count patents or copyrights, as “indefinite-lived intangible assets.” The U.S. Internal Revenue Service (IRS) taxes cryptocurrencies as property, with taxes due upon conversion to dollars. Over time, more specific instructions should become available.

Where some see risks, others see opportunities. Abu Dhabi’s Mubadala Investment Company funded a local cryptocurrency exchange called MidChains. Co-founder of MidChains Mohammad Al Hashemi has been working with Mubadala for over a year. He said Mubadala “wants to become a pioneer in investing in new technologies.” In the U.S., San Francisco-based Coinbase received a Series E cash infusion from partners including Singapore’s GIC Private Limited. Coinbase established government-based currency transactions in 32 countries with Bitcoin, Bitcoin Cash, Ethereum, Ethereum Classic, and Litecoin. Endowments and pension funds are also dipping into the water. Michigan’s endowment bought into CNK Fund 1 from venture capitalist Andreessen Horowitz and Fairfax County, Virginia, had two funds place money with Morgan Creek’s “crypto-focused venture fund.”

Keywords: State Street Corporation.

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