Sophia’s Thoughts on Bitcoin Revolutionizing Finance
Larry Fink, the CEO of the world’s largest asset management company, said that Bitcoin could revolutionize finance. How may this play out?
These are Sophia's Thoughts:
In an interview with Fox Business, Larry Fink said that Bitcoin can revolutionize finance because of its diversification and tokenization benefits. This led to a big hype on social media. But the hype did not translate into big market returns.
We’ve highlighted the strong diversification benefits of Bitcoin. But the diversification benefits are weaker when inflation occurs on a global scale — just as the world is currently experiencing.
Tokenization is indeed a big promise of blockchain technology. But, because of their digital nature, tokenized assets are exposed to the risk of cyberattacks and system malfunctions.
There has been lots of speculation around whether BlackRock will succeed with its ETF application. It will need to convince the SEC that it can prevent market manipulation and contagion in its Bitcoin ETF.
🚀 Last week’s market performance
The crypto market lost 1.1% while Bitcoin (BTC) gained 1.4% last week. The best performing crypto among the largest 100 coins was Solana (SOL). It posted a 16% return, breaking a 600-day bearish trajectory. The worst performing crypto was Decred (DCR), which lost 14% over the course of the last 7 days.
For the first time again after two weeks, Sophia was bullish on coins last week. Sophia picked out the Ripple run ahead of time.
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🔥 Larry Fink’s Bitcoin revolution
Larry Fink, the CEO and founder of the world’s largest asset manager BlackRock, recently spoke with Fox Business to discuss BlackRock’s recent Bitcoin ETF application. Larry argues that Bitcoin can revolutionize finance. He makes two main points. For one, Bitcoin serves to digitize gold and offer a hedge against inflation. The other key argument he makes is that Bitcoin allows the tokenization of assets and securities. He concludes that BlackRock is trying to democratize crypto and make it more accessible and cheaper for investors.
This led to hype on social chatter around the future of Bitcoin and crypto more broadly. The hashtag #LarryFink saw more than 10,000 tweets on July 5, the day the interview aired. The hashtag peaked as the 18th most mentioned hashtag on Twitter that day. Our measurements of crypto sentiment show that social chatter became almost 10% more positive on that day. If nothing else, the interview really ignited a sentiment revolution!
But what’s underneath Larry’s main arguments about the potential of Bitcoin? We inspected this more closely.
⚜️ Bitcoin as digitized gold
Larry stated in his interview that Bitcoin can serve for “digitizing gold.” Because Bitcoin is an international asset, it is not attached to national central bank policies that drive inflation. And so, Larry argues, it can serve as a hedge and diversification instrument.
We have inspected the claim that Bitcoin can serve as a diversification instrument in our last Sophia’s Thoughts newsletter. We documented that introducing Bitcoin to a traditional equity investment portfolio can boost the risk-return balance of the portfolio by as much as 20% through optimal diversification. This is because Bitcoin currently has a low correlation with the stock market. It therefore offers strong diversification benefits for investors.
However, we have also documented that the correlation between Bitcoin and traditional financial markets can change over time. In our Sophia’s Thoughts from March, we documented that the correlation generally spikes when financial markets become more uncertain and investors withdraw from risky investments. In those times, the diversification benefits of Bitcoin are weaker.
As long as currency devaluations and inflation happen in an independent way across countries, Larry’s assessment of Bitcoin serving as digitized gold can hold true. But this is harder to be true at the current time in which we’re experiencing global inflation after the Covid-19 pandemic and the Russia-Ukraine war.
Why Inflation Around the World Just Won’t Go Away (The Wall Street Journal)
Why are interest rate rises not taming inflation? (Financial Times)
💾 The tokenization of securities
Larry also said that Bitcoin serves for the tokenization of securities. He has brought up this point in the past. At the New York Times DealBook in December, Larry said that “the next generation for markets, the next generation for securities, will be tokenization of securities.” And in an annual letter to BlackRock investors in March, Larry stated that tokenization will be “driving efficiencies in capital markets, shortening value chains, and improving cost and access for investors.”
Tokenization is the process of creating a digital representation of real-world assets on a blockchain. Tokenization allows for the trading of fractional assets. For example, you could buy fractions of a tokenized stock if offered on a crypto exchange. But you cannot buy a fraction of an actual stock that is traded on a traditional exchange.
There are many benefits that tokenization brings along. Deloitte, one of the Big Four accounting firms, highlights the following benefits of tokenization:
Greater liquidity by tokenizing securities that are normally private.
Faster & cheaper transactions through the processing with smart contracts.
More transparency through recordings on the blockchain.
More accessibility by breaking down access barriers, like minimum investments.
The adoption of tokenization technologies may foster a more inclusive financial system. But it’s not without its shortcomings. Developers are faced with the hurdle of a lack of regulatory guidelines. The uncertainty around the regulatory framework slows down the rate at which tokenization technologies can be adopted. Also, the process of transforming physical assets into digital form brings about the threat of cyberattacks and system malfunctions. While tokenization is a big technological contribution of crypto, investors must balance out the risks and rewards in this space when considering investments.
👍 Will we see a Bitcoin ETF?
Even though Larry Fink raised good points about the potential benefits of a Bitcoin ETF, regulators still have concerns about its implementation. Bitcoin, while innovative and promising, is vulnerable to fraudulent activities and market manipulations that often occur in crypto markets. The SEC recently raised concerns that BlackRock and other ETF applicants had convincingly argued that a Bitcoin ETF would not be exposed to these risks. This pushed BlackRock to re-file its Bitcoin ETF application with the SEC. In the re-filed application, BlackRock stressed that Coinbase would carry out market surveillance for the Bitcoin ETF.
More generally, central bankers around the world have highlighted that cryptocurrencies pose a unique set of challenges to traditional financial markets. The International Monetary Fund (IMF) states that the risks associated with cryptocurrencies could quickly spread to traditional markets if financial institutions gain more exposure to crypto assets. A recent article in Politico argues that such contagion effects may have played a role in the collapse of Silicon Valley Bank in March.
The IMF also raises concerns that the effectiveness of monetary policies could be weakened if people increasingly use cryptocurrencies as a substitute for fiat money. Such a substitution could lead to capital outflows, a loss of monetary sovereignty, and threats to financial stability.
It is hard to tell whether BlackRock will succeed in its application to run a spot Bitcoin ETF in the US. But one thing is sure: the application has given rise to lots of speculation around its likelihood of success. BlackRock is waging a big campaign to make crypto more accessible and secure. And they are being supported by other big players, like Coinbase, Nasdaq, and Fidelity.
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