Bitcoin’s lofty valuations are the “stuff that dreams are made of.”
So says Michael Cembalest, J.P. Morgan Asset & Wealth Management’s chairman of market and investment strategy, in a report that riffs on “The Maltese Falcon,” the 1941 film about a priceless artifact that comes to symbolize greed, and which turns out, in the end, to be fake.
“I won’t be buying it even though part of me wants to, regardless of consequences, since that’s what some crypto holders have been counting on from the beginning,” he wrote.
In his 30-page investigation, “The Maltese Falcoin: On cryptocurrencies and blockchains,” Cembalest swoops on what he sees as crypto’s much-vaunted but brittle use cases, such as store of value, cross-border remittances, decentralized finance (DeFi), non-fungible tokens (NFTs) and blockchain adoption in financial services.
Store of value
Starting with bitcoin as a store of value, Cembalest says he understands why people are interested in cryptocurrencies with a fixed supply as a store of value, given the developed world has drowned itself in debt and fiat money, at a pace that dwarfs anything seen in the wake of the financial crisis in 2008.
“Central Banks and Treasuries have created a massive confidence void, and it would have been strange if some alternative to fiat money didn’t appear on the scene,” the report says.
Considering bitcoin as a complement to gold, the store-of-value thesis holds up, in that more people are using it as a digital equivalent, but falls down when it comes to volatility and crypto’s correlation with other systemic risks and inflation.
“Bitcoin’s volatility continues to be ridiculously high, and its volatility often rises when equity market volatility is rising too,” Cembalest wrote.
Such volatility could be the byproduct of bitcoin concentration, the report states, adding that some 2% of bitcoin holders own 72% of its value. “For all the libertarian anti-elitists out there, that’s even worse than the concentration of US household wealth: it takes 10% of US households to get to 70% wealth, rather than just 2%,” he noted.
The report estimates that crypto has only managed to capture about 1% of remittances, a market ranging from $500 billion to $600 billion per year over the last decade.
The potential cost savings are hampered by the fact that recipients would need bank accounts in the destination country to be able to convert from crypto to cash.
“For people with bank accounts, off-ramp costs from crypto to fiat are equal to the cost of converting from dollar-based stablecoins to local currency, and then any cost of withdrawing that fiat,” Cembalest wrote.
Cembalest acknowledges that disintermediation of banks and financial services is ongoing thanks to the rise of various fintech platforms but makes a withering assessment of how it’s done in DeFi.
“From what we can tell, most DeFi lending is simply over-collateralized crypto loans to other holders of crypto so that the latter can either (a) buy more crypto, or (b) obtain liquidity against appreciated crypto holdings without incurring capital gains taxes. Either way, it does not appear to be the kind of lending activity that could survive a large sustained decline in crypto prices themselves,” says the report.
Drawing on the experience of fintech-enabled peer-to-peer lending, Cembalest pointed to data showing higher loan delinquency rates than traditional bank loans, which is mostly a function of weaker underwriting standards. He added that a platform like Lending Club has seen its stock decline by 65% from its recent peak.
As far as a future world of peer-to-peer uncollateralized lending on blockchains goes, Cembalest said: “Good luck with that,” pointing to characteristics that might “terrify participants” in traditional collateralized lending pools.
“Crypto collateral may not be dedicated and assigned solely to the activity against which it is posted. In other words, crypto collateral can be ‘rehypothecated’ to back multiple activities,” the report says. “If you don’t remember what that word means, type ‘rehypothecation’ into Google along with the words ‘financial crisis’.”
Cembalest “oddly enough” does not dismiss the NFT phenomenon, citing the rapid rise of modern art in the 20th century, which many people still find inaccessible or confusing.
“Just because you might not appreciate the artistic merit of Bored Ape Yacht Club NFTs, that doesn’t mean others won’t,” the report says.
One Achilles’ heel when it comes to NFTs is the concentration of ownership, Cembalest said, just as bitcoin ownership is highly concentrated. He cited a study of the SuperRare NFT art platform that revealed just four collectors owned most of its works with only three degrees of separation between them and the 16,000 works of art they collected.
“This is a very high degree of insularity, even for standards of the art market. The study also found that the secondary market was even more concentrated than the primary market,” the report notes, while acknowledging art is one subset of the broader NFT space.
A recurring motif in Cembalest’s thinking is the accelerated change of cultural preferences in recent times. That said, when he circulated his report among some crypto advocates and venture capitalists, the most common response was that he was being shortsighted.
For instance, Cembalest’s piece was like judging the value of the internet in 1995, according to one commentator. Who would have thought a search engine would be worth a trillion dollars back then, for example.
Going further back in time, another respondent said it would be wise to remember the electricity wars of the 1800s.
“The first stage of any innovation cycle is development of infrastructure,” the response said. “The high value applications come later. That’s what happened during the electricity wars when future use cases were vastly underestimated, even by the likes of Junius Spencer Morgan (father of JP Morgan) who thought electricity was a fad and that kerosene lamps worked just fine.”
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