Developments on Digital Assets and Blockchain

Blockchain technology continues to mature and gain acceptance for a wide range of potentially disruptive financial and commercial uses. In the wake of COVID-19, we have seen an increased focus on the research and development of blockchain technology, as well as an increased deployment of the technology for both financial and non-financial use cases.

Growth of Stablecoins

Stablecoins may be the first “killer app” for blockchain.  A “stablecoin” is an asset-backed digital asset.  The term “stable” in the name refers to the goal to maintain a peg with the underlying asset or a set value, most commonly one U.S. dollar.  While the majority of stablecoins are backed (or reportedly backed) one-for-one with respect to the asset they represent (for instance, a stablecoin representing one U.S. dollar typically represents a claim on one U.S. dollar held in custody by the issuer), others, such as Dai, are created by overcollateralizing non-stable assets, such as ether, and borrowing against that position.  We expect to see new variations of stablecoins enter the market as their use case grows.

Stablecoins allow users to transact at a fraction of the cost of traditional means of exchanging money (e.g., Visa, Stripe, bank wire transfers).  This efficiency arises because, in the legacy financial system, intermediaries take a percentage of each transaction whereas blockchain permits transactions directly between users (e.g. a merchant and a customer) with the only expense being the network transaction fee.  Blockchain reduces this inefficiency, circumventing the existing system and reducing costs for both merchants and consumers.

In 2019, the largest stablecoin, Tether (USDT), settled transactions with approximately $212 billion in value globally.  In June 2020, stablecoin transaction volume hit an all-time monthly high, with a transaction volume of $54.9 billion.  Stablecoin transaction volume in the first half of 2020 has now surpassed transaction volume for all of 2019.  In the wake of recent market volatility and the flight to safe, dollar-backed assets, the total supply has also reached an all-time high. 

Emerging market governments, foreign financial institutions and international businesses are competing for a global shortage of dollars, and stablecoins are one way to access dollars.  As we continue to see more assets move to the blockchain, such as the recent approval of a registered closed-end fund, the shares of which are issued and transferable on the Ethereum blockchain, we expect that stablecoins will continue to gain market share as a means of transacting due to their ease of transferability, low fees and interoperability with a growing blockchain-based financial system.

Emergence of state-issued digital currencies

There has been much talk over the past several years of individual countries issuing their own digitized currencies. In April, the People’s Bank of China released a test pilot of a digital currency in four Chinese cities. To date, a number of large Chinese companies and banks are engaged in the first phase of the pilot.  In July, the Bank of Japan announced that it will begin experimenting with a digital yen; days later, it was reported that the Japanese government will include the consideration of a digital yen in its economic plan.  This comes in sharp contrast to the Bank of Japan’s position in July 2019, when it stated that it had no plans to explore the feasibility of a state-issued digital currency.  According to one report, Japan is now accelerating preparations for a digital yen on account of developments in China.

Also in July, the Governor of the Bank of England, Andrew Bailey, acknowledged that the Bank of England is considering the issuance of a digital pound.  Bailey stated, “We are looking at the question of, should we create a Bank of England digital currency. We’ll go on looking at it, as it does have huge implications on the nature of payments and society. I think in a few years’ time, we will be heading toward some sort of digital currency,” For the United Kingdom, digitization of the pound could provide an advantage over major rival currencies like the U.S. dollar and the euro because of the efficiencies of blockchain technology, such as reduced transaction costs and settlement time.

In the United States, early drafts of the stimulus bill proposed by the House of Representatives in response to COVID-19 reportedly included references to using a means of distributing “digital dollars” as aid to those impacted by the pandemic.  Furthermore, the former head of the Commodity Futures Trading Commission, through the Digital Dollar Project, is lobbying for the research and discussion of the advantages of digital dollars in both the private and public sectors.  In line with the efforts in the United States, a recent report by the Bank for International Settlements notes that the push by countries to research and develop a national digital currency may be accelerated by the impact of COVID-19 on retail payments, which have seen a sharp decline in cash payments due to concerns over viral transmission.

State-issued digital currencies, also referred to as central bank digital currencies (CBDCs), are in their infancy and have many questions to answer.  One is interoperability.  Unlike stablecoins, the majority of which are issued on the Ethereum network and are therefore interoperable with the growing Ethereum ecosystem, we do not yet know how countries will issue their respective CBDCs and how they will interoperate with legacy retail payment systems, banks or blockchain networks.  Unless cross-chain and cross-network (for legacy systems) interoperability problems can be solved, barriers such as interacting with various payment systems could prevent a CBDC’s global adoption. Another unsolved issue is privacy.  While many transactions in the current financial system are conducted electronically (e.g., bank wire, credit card transactions), transactions conducted with a CBDC would be directly traceable by a central bank and potentially susceptible to targeting by criminals.   Such a system could eliminate financial privacy and pose a danger to citizens in countries with limited freedom.  It is yet to be seen whether a CBDC would seek to replace and eliminate cash, which is inherently private, or whether the CBDC would co-exist with cash.

Decentralized Finance

We have continued to see growth in the Decentralized Finance (DeFi) movement in 2020.  DeFi is a broad term to describe a variety of blockchain-based financial primitives and protocols.  The DeFi movement promises a global, open alternative to traditional financial services – including lending, saving, trading, derivatives and insurance. Some DeFi projects are merely the blockchain version of the traditional finance counterpart, while others are novel inventions that evolved with the needs of the blockchain ecosystem.  The goal of DeFi is to make these services accessible to anyone in the world who has a smartphone and an internet connection.  DeFi protocols built on existing blockchain technologies, such as the Ethereum solidity smart contract language, are emerging to provide additional means of liquidity to cryptocurrency users. Some of these DeFi protocols allow for peer-to-peer lending without a centralized authority in a way that is cryptographically secure. New products and services are being developed to take advantage of these decentralized peer-to-peer technologies.

Supply chain tracking and trade settlement

COVID-19 has revealed weaknesses in our supply chains, an inability to deploy resources where they are most needed to address the pandemic, and difficulties in capturing and sharing the data needed to make rapid decisions in managing it.  While there has been much talk of implementing blockchain technology for supply chain management in the last several years, we are seeing a renewed interest and breakthrough deployment on account of COVID-19.

Two examples of the increased deployment of blockchain in response to COVID-19 are Rapid Medical Parts and MiPasa.  Rapid Medical Parts uses a blockchain-powered platform to enable a decentralized manufacturing process in which customers can order and print parts, for example for medical devices, for use where and when they need them. The blockchain ensures tamper-proof design and printing instructions.  In March, the Pentagon awarded the company a contract for converting the abundant supply of sleep apnea machines into ventilators. The conversion requires additional parts that Rapid Medical Parts will print, and at a tenth of the cost of a new ventilator.

Organizations including the World Health Organization, IBM, Oracle, Microsoft, and other tech companies, government agencies, and international health organizations are partnering in building the blockchain-based open data hub called MiPasa. The platform, created by the enterprise blockchain firm HACERA, aims to quickly and precisely detect COVID-19 carriers and infection hotspots around the world. MiPasa will securely share information among individuals, hospitals, and authorities that will aid in public health analysis.

While we have recently seen governments devote increased attention to the development of CBDCs (as described above), we have also seen an increased focus by private entities, particularly banks, in the development of blockchain assets to be used for cross-border and interbank settlement.  As with CBDCs, these blockchain assets could potentially reduce settlement times and costs.  Because payments on a blockchain would settle in real-time, users could substantially reduce settlement risk, counterparty risk and market risk in transactions that, in the legacy system, may take days or weeks to settle.

Blockchain technology is beginning to provide some of the benefits that have been on the horizon for the last several years.  To rebuild disrupted networks, trust and the ability to verify information will be essential. Blockchain technology offers the building blocks to provide trading partners and consumers the transparency of trusted and secured data, and to synchronize processes through a mutually agreed ruleset. This potential is especially attractive for businesses contending with supply chain disruption due to the pandemic, global settlement and increased efficiencies in commerce.