Bitcoin – which has seen dramatic climbs and drops over recent months – might not be the type of investment advisors like to suggest to their retail clients. But even advisors who have never anticipated jumping on the cryptocurrency bandwagon still should pay close attention to its underlying blockchain technology.
Why? Although bitcoin and other cryptocurrencies may – or may not – fizzle out, blockchain offers too many advantages and potential applications to forecast it will fade away. Those applications include some that may eventually disrupt the financial services industry, according to advisors, regulators, and lawyers who pay close attention to blockchain developments.
Using blockchain technology, with just a few lines of code, two parties can execute a so-called “smart contract” and record it in a blockchain – otherwise known as a digitally distributed ledger. They can monitor contractual obligations 24/7, confident the technology will bar any unilateral changes or premature terminations. Only the pre-agreed logic of the blockchained contract will allow an exchange of information or value to occur. The contracted parties may also remain anonymous, only giving their blockchain address.
The potential applications for blockchain technology beyond cryptocurrency encompass all the backroom operations of the financial services industry – trade clearances, corporate registrations, and stock ownership registration.
“It simplifies a lot of processes between buyers and sellers,” says Ross Gerber of Santa Monica, Calif.-based Gerber Kawasaki Wealth and Investment Management, which has $650 million in assets under management. Rise, a consultant group that tracks individuals’ social media content, ranks Gerber, who has made it a point to learn about the technology, 41st among the 100 “most influential blockchain people.”
But Gerber is no bitcoin promoter. Although almost every day his clients ask him about price-skyrocketing cryptocurrencies, he deems bitcoin a “super high risk.”
He also argues fiercely, however, that his peer advisors “who want to stay on the cutting edge” have to evaluate where blockchain might disrupt their own and other industry sectors.
They must keep blockchain technology’s potential applications in mind in even in their long-term stock picks and pay attention to companies already steeped in decentralized digital transactions, such as Paypal, which owns Venmo, which allows free online payments between friends.
Regulators too have recently paid more attention to blockchain’s potential. Stephanie Avakian, a codirector of the SEC’s enforcement division, told an industry conference on Oct. 26: “Blockchain technology presents many interesting issues and can of course present legitimate opportunities for raising capital.”
It presents some illegitimate opportunities too, Avakian cautioned. “[L]ike many legitimate ways of raising capital, the popular appeal of virtual currency and blockchain technology can be an attractive vehicle for fraudulent conduct,” she said. The SEC had just formed a new Cyber Unit – the first specialized unit created by the enforcement division in seven years – to focus on cyber-related misconduct, including that in digital currency, Avakian said.
It’s no surprise SEC enforcers would be taking a claim-staking attitude about blockchain technology, given its potential applications. “No one wants to be seen as resistant to it from a government agency perspective because there is a lot of jurisdictional space,” says Gregory Lisa, a partner at the Washington, D.C. office of law firm Hogan Lovells, who served previously as the interim director of the Office of Compliance and Enforcement at the Financial Crimes Enforcement Network (FinCEN) – the Treasury Department’s lead regulator for overseeing and enforcing anti-money laundering laws. If they don’t have jurisdiction, they could start being irrelevant five years from now if most of the economy is virtual, based on blockchain technology, he says.
Financial advisors concerned about imminent disruption in their own industry should focus first on the impacts of machine learning and artificial intelligence before blockchain technology, says Justin Steffen, a partner at the D.C. office of law firm Jenner & Block. But blockchain’s disruptions may not surface until later, says Steffen, who represents financial service industry companies before regulators, and has taken a keen interest in blockchain technology.
In any situation where value or information needs to change hands, blockchain technology could eventually be applied.
“Everybody needs to understand it. It’s already being adopted on some clearings, settlements and syndicated loans,” Steffen says.
Steffen warns against any mad rush to select stocks based on a company’s investment in blockchain technology or its potential applications. It’s not easy picking winners in the early stages of disruption. At the beginning of the internet revolution, both Google and Netscape were unknowns but only one survived, Steffen notes.
To learn about the technology, financial advisors should look for intelligence on the engineers who write and know about the computer coding behind blockchain technology. There’s going to be good and bad code, Steffen warns.
Ultimately, blockchain technology has the power to reduce transaction costs for financial advisors’ clients, says Gerber, who in November appeared in a Kazonomics’ The Kash Cycle internet-posted video as a foil for bitcoin supporters. For their work for clients, financial advisors are lucky these days to get 1%, he notes. But for executing transactions, financial institutions still earn 3%. Blockchain ultimately will reduce those costs, Gerber predicts.