The case for decentralisation and blockchain: black swan events
Rewind back to January 1st 2020, and it seems almost impossible to imagine that, come springtime, we’d be living in the midst of a global pandemic.
And yet, here we are.
With talks of the worst global recession of a generation, the question begs: what does this Black Swan or unprecedented event mean for the future of finance - and in particular, cryptocurrencies?
Cryptocurrencies and the blockchain technology on which they are based offer a number of advantages over conventional currencies (especially in times of crisis), the most important of which is their decentralised nature.
It is perhaps unsurprising, then, that Bitcoin, Ethereum and other cryptocurrencies are becoming more attractive to both individual and institutional investors across the globe.
In this article, we’ll take a closer look at why we predict blockchain is going to become more important than ever in the wake of COVID-19, and how it can help to reduce the impact of Black Swan events for businesses and individuals alike.
Crypto Currencies and Macroeconomics
On a macro level, digital currencies such as Bitcoin and Ethereum have the potential to become safe havens for investors in times of high inflation. With the onset of COVID-19 and global self isolation measures enforced, markets did witness exceptional volatility, with liquidations in play and significant price drops to both Ethereum and Bitcoin experienced. As Paul Yardley, Head of Software Engineering at Trustology puts it
“People most likely initially fled thinking they needed cash to buy basics, hence the significant downturn in price. When that sense of panic dissipated, prices started to pick up which we are seeing now, so I think we’ll see a longer trend.”
To understand why this is, we first need to consider how centralised banks typically respond to economic crises.
When wide scale economic hardship hits, central banks engage in monetary stimulus, e.g. quantitative easing. This essentially means that they introduce more money into the system by purchasing government bonds or assets to increase money supply and encourage lending and investment.
This monetary policy is precisely what happened in response to the 2008 credit crunch, and we can see it happening again now with the COVID-19 crisis. The problem with this is that the currencies that central banks control are naturally devalued as a result of this process.
Cryptocurrencies, on the other hand, represent a more stable means of protecting wealth from high inflation.
With prudent management and sound monetary policies, cryptocurrencies could represent the most sensible store of value in such times, protecting investors from wild swings in central bank currency valuations.
As Paul Yardley puts it:
“Crypto currencies will be increasingly appealing to people seeking to protect their assets without the risk of potential inflation of supply by a central entity.If there's another 2008 style bailout (which effectively led to the creation of Bitcoin), we'll see more social unrest and more adoption of cryptocurrencies. How governments handle the economic crisis now will dictate how cryptocurrency is affected over the next 2-5 years.”
Cryptos and Blockchain Technology on a Micro Level
So far we’ve discussed the role of Blockchain at a macro level. But what about for everyday personal finance?
Black Swan events such as COVID-19 force society to take things online, particularly when it comes to finance. In the retail banking sphere, more and more people are now using contactless payment to avoid infection spread.
Whilst such payment options are a convenient (and infection-free) alternative to cash, there remain questions about the robustness of the systems that support them, especially if they have to deal with network outages or other wide scale disruptions.
Crypto currencies have the potential to offer a more resilient solution.
The decentralised nature of the blockchain technology that supports cryptocurrencies theoretically gives them the potential to withstand any and all disruptions. Even if some of the nodes holding blockchain data were to temporarily go offline, the remaining nodes in the pool would ensure the accuracy and security of transactional data until normal service was resumed.
In extreme cases, where an entire network went offline, offline peer-to-peer transactions that took place in the meantime could be synchronised with the blockchain once the network came back online. All this depends on new developments, but the capability is most certainly there.
Trustology CEO and Founder Alex Batlin believes that, whilst crypto currencies are not yet retail ready (as they cannot currently support the necessary volume of transactions), it is possible to address this problem with both existing and new technologies.
Among other things, he believes that if the world wants to improve digital transaction resiliency, it is important to focus on developing “layer 2 protocols that allow you to exchange peer-to-peer transactions, and then post those transactions for eventual catch up on the network”.
This would allow the completion of low-value transactions such as phone-to-phone transfer of assets through Bluetooth, that could be reconciled once the network was back online.
Can, and Should, Blockchain Support Bailouts?
There are some huge questions and issues around how any COVID related bailouts will be handled.
As Trustology CEO Alex puts it,
“In theory at least, [bailouts] shouldn't just go to banks like they did in 2008 (who didn't always then pass those loans back out to the rest of the economy), but directly to people who are going to be affected massively by this coming crisis.”
In cryptocurrency, this direct to consumer transfer is possible at a small scale via airdrops. How and if this could apply at a state-wide level remains to be seen. But there is something to be said about leveraging the virtues of a decentralized tamper proof currency with a finite supply such as Bitcoin over printing cash which has been widely discussed to date. Independence of an issuer of an asset is important, as we’ve seen with Quantitative Easing (QE), where a single centralised entity has inflated the asset supply. Due to globalisation this can lead to negative impacts on other countries, which may not receive the positive impact that the country doing the QE might receive. Lots of countries rely heavily on foreign currencies and are facing issues as a result.
So while blockchain is unlikely to be used for bailout loans in the short term, it does raise some interesting and exciting prospects of how support could be more fairly distributed in the future. Currently, the practice has been that quantitative easing (QE) money is given to large commercial banks with the reliance and onus on them to distribute out to end users. One could argue how many small businesses in fact ever receive the bailout funding issued? However, If more consumers started utilising more blockchains then, there's a better opportunity to distribute funds to end users directly without relying on intermediaries.
“There therefore needs to be a means of creating credit tokens or their equivalent to complement fixed supply currencies and to be able to control the supply of crypto where needed — a fixed supply currency alone is likely to be unsustainable long term.”
Is Blockchain Ready For Mass Adoption Now?
Having something that runs securely and robustly is a cornerstone of why blockchain is so important now. If someone can switch the system 'off' (as they can with a central bank), it's open to massive vulnerabilities. Blockchain protects against this.
That said, it's not perfect, and there are significant issues to address before we see mass adoption.
To give one example: blockchain is also affected by the shock mentality that has affected centralised banking systems. In the cryptoworld, the ripple effect of these shockwaves has the effect of significantly reducing mining capacity.
Head of Software Engineering at Trustology, Paul Yardley puts it this way:
“The shock mentality, particularly with something like Bitcoin, is still there. There’s still a risk that a large shock that takes 20% of mining capacity offline will, in fact, knock it out for a good chunk of time until the algorithm allows the blocktime to return to normal.
This, in turn, slows the whole system down. As Alex explains:
“Suddenly, blocks that could be mined in 10 minutes now take 20-30 minutes, causing massive issues for Bitcoin. Much more work needs to be done to simulate what happens in Black Swan events like this, not only to protect the integrity of blockchain as a decentralised system, but also to build more trust that crypto can withstand these events.”
What we're seeing, though, are not just issues with the core infrastructure, but also with the layers on top i.e. the decentralised application (dApp) or smart contract layer, where developers are building their own app-specific protocols on top of base layer protocols, which are creaking under the pressure of unprecedented events like this.
“These are definitely kinks that need to be ironed out to make sure that this stays a robust mechanism and that the layers built on top of core infrastructure are also decentralised."
What companies such as Trustology are focusing on now is providing both institutions and individuals with the technology they need to safely use decentralised finance (DeFi) apps - dApps - and take advantage of blockchain technology, thereby making it easy for them to complete decentralised finance transactions. In turn, this should encourage the widespread adoption of crypto currencies across the globe.
But, as Trustology CEO, Alex, puts it:
“The whole DeFi space is about modularisation of finance such as lending, trading, borrowing and hedging. It’s about bringing new offerings by stringing together dApps to achieve a specific outcome depending on risk profile and appetite such that it’s simple, fast and easy to integrate with. In order to realise this vision, these modular pieces need to be highly tested and they need custodial wallet providers to bring it all together for it to work on an institutional and retail level. There will never be mass adoption unless all of these modular bits are thoroughly stress tested for Black Swan events like this.”
COVID Volatility Proves That Blockchain Matters More Than Ever
These are unprecedented times, and things are changing so quickly during this pandemic that all rules are off the table.
That said, we can see that consumers, businesses and banks alike are looking for the most secure means to protect against financial and operational damage during this time (and beyond). Blockchain technology is therefore likely to be positively influenced by the terrible events of COVID-19 as an answer to this.
Until now, blockchain technology has been best known for its use as a secure platform for cryptocurrencies, but events such as COVID-19 have made it increasingly attractive to companies outside of the financial sector too. It is now used to monitor supply chains in large commercial organisations and has been tested in areas as diverse as food safety, real estate transactions and copyright protection for music and other digital content.
As more and more people look for solutions that offer cutting-edge security and are not vulnerable to interference by central entities, blockchain technology will only become increasingly important in the coming years.