1871 meets Crypto | Bedell Frazier Investment Counsel, LLC

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Wall Street headlines are designed to be catchy. People on the street are always trying to make a name for themselves. Some go to extremes. Most of the time it’s a lot of fluff. But not always. There was a research report produced this week that stopped me in my tracks. It really got me thinking. One analyst said that an investment in financial technology (FinTech) company Square today is equivalent to investing in JP Morgan a century and a half ago. This is a truly bold statement. Sounds a little ridiculous, doesn’t it? Or does he do it?

America’s largest bank, JP Morgan Chase, has its roots in 1799 on Wall Street. It all started under the name Manhattan Bank, founded by Aaron Burr to counter Alexander Hamilton’s grip on the financial system. These roots are the Chase side of the business tree. JP Morgan was founded in 1871, in the wake of the “House of Morgan”, which was an international financier, headed by Junius Spencer Morgan, father of John Pierpont. It started as Drexel, Morgan & Co. The bank officially became JP Morgan & Co. in 1895. JP Morgan and Chase had their mega-merger in 2000, which shaped the current bank as we know it. . The strategy piece deployed this week compares innovator FinTech Square to JP Morgan in 1871. It was the start of the industrial age. A critical blow to this Wall Street call is the fact that the stock was not available to the public in 1871. JP Morgan did not go public until 1940.

That year, 1871 again became a priority this week. For the prospect, it was 23 years after the discovery of gold at Sutter’s Mill. It was 6 years after the assassination of Abraham Lincoln and the end of the Civil War. It was 2 years after the creation of the transcontinental railway. JP Morgan, the man, was only 34 years old in 1871. The transformative rail system was his main focus at the time. Electricity soon followed. Morgan made a major investment in Thomas Edison. Steel was next. The nation’s economic engine has taken off. Trains have changed everything. Electricity too. Behind Edison’s genius, JP Morgan helped turn on the lights in America. Behind US Steel, having acquired it from Andrew Carnegie, JP Morgan has taken the city skyline from coast to coast.

The digital age has brought significant disruption. Every industry experiences it in one form or another. Competition is fierce and digital solutions are essential. People consume and spend much differently today than ten years ago. Square is the bank of the future, according to a Wall Street analyst. The disruptive San Francisco-based company is evolving into the bank of the future through its Cash app. The app has become the financial hub for Square customers. The Cash app offers a suite of services, from payment to stock trading, as well as the ability to buy Bitcoin. Square was one of the early adopters of cryptocurrencies, and Bitcoin in particular. It has attracted a growing audience, especially the younger generation. Square is expected to add products ranging from tax and insurance to home equity loans to the Cash app. Square wants to be the bank of the future.

Cryptocurrencies are perhaps the biggest change and apparently the biggest opportunity in the financial services space. It has also become quite controversial. It is as if you understand or not. Individuals, banks and governments disagree on the future role of cryptocurrencies. The Bulls regard them as a store of value, of a purity, totally independent of banking or government regulations. They actually look more like digital assets than currency. We think of Bitcoin more like Digital Gold. Price action is more than volatile. Bitcoin started the year around $ 29,000, more than doubling in the spring. He has recouped almost all of these gains and seems to be bottoming around $ 30,000; At least for now.

We are not cryptocurrency experts. We don’t pretend to be. But we have been studying them for a few years. Today, 22 million Americans, or just under 15% of the population, own some form of cryptocurrency. of the holders are between 25 and 44 years old. Bitcoin is the most popular, followed by Ethereum. There are many descriptions of digital currencies. They seem to be broadly divided into 3 categories.

Decentralized cryptocurrency: These are unregulated offerings like Bitcoin, Ethereum, Ripple, and Dogecoin. They are issued by a network, not by a central authority or government. This is perhaps the most critical feature. Although volatile in price action, these digital assets can be traded for goods or services like traditional currencies. An increasing number of retailers are accepting them as a method of payment. Cryptocurrencies use distributed ledger technology, like blockchain, which can confirm valid tokens and securely record transactions.

Stable coins: Like Bitcoin, stable coins also use distributed ledger technology. But they tie the value of digital tokens to something that already exists. By pegging the asset back to a widely accepted form of currency, such as the dollar or gold, these digital currencies become more entrenched and reduce volatility. Facebook’s Libra Project, now known as Diem, is probably the best-known example. However, momentum seems to be slowing down on this initiative.

Central Bank Digital Currency (CBDC): These tokens represent a national currency. This is the way forward for central banks around the world to play a role in the emerging sector as more and more digital money enters the economy. It is still very early and not all the bankers are lined up. Many are concerned about the threat of stablecoins and decentralized finance in general. China is a prime example of reluctance and fear. Control is essential and cryptocurrencies are designed to avoid regulatory control.

A common question is how CBDCs differ from e-money. Traditionally, when you deposit money or a check into a bank account, the institution takes responsibility for that amount of money. The money is then kept in electronic form and can be used on various platforms, but it is limited to the bank’s ledger. This is the traditional banking model. FinTech companies like PayPal-owned Venmo can even track electronic transactions on its own internal ledger system, but the money is still held and tracked by a financial institution. In the case of CBDCs, the government is the counterparty and takes responsibility for the money, while the ledger used can be a very different structure than a commercial institution. This register is called “rails”.

In the United States, it’s all about ACH. The ACH network is the national automated clearinghouse for electronic funds transfers. We use it all the time when initiating transfers on your behalf. ACH is an important part of financial plumbing in America. It usually takes 3 days to clear a transaction as it goes through digital channels. Beyond the ACH, there are also wire transfers and credit card payments that are handled by separate networks. By creating a CBDC, the Fed would develop a new set of rails that could allow money to flow even faster, meaning quick transfers for things like unemployment benefits and stimulus checks. There were a lot of them last year.

In the most recent data from the Fed, which dated back to 2019 (before Covid), 26% of retail transactions were paid in cash. This was down from 30% in 2017. During the pandemic, that number undoubtedly declined further. Debit cards were the most common payment method, accounting for 28% of transactions in 2019. 23% of payments were made by credit card. Almost half of all purchases under $ 10 were made in cash.

Today, you can buy tools at Home Depot, groceries at Whole Foods, and coffee at Starbucks, all in Bitcoin. Momentum for cryptocurrencies is building. Price action remains volatile. It is still early. Is the future of banking today, in the digital age, on the brink of something as big as the start of the industrial revolution? The case was made on Wall Street this week. This is good, good, far too early to tell. It was a bold call. It seems a bit absurd at first glance. That said, innovation continues to charge fast, like a digital locomotive. It’s amazing to think of all the new products, new channels, new ways of doing things that have emerged over the last decade. Imagine what our children and grandchildren will see. It is an exciting time to be an investor. But it’s important to always stay grounded while being focused.

Have a nice week end. We will be back, overnight and early Monday.

Mike

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