The digital financial world is diverse and complex, monetary innovations have a variety of guises. Until now, most companies have had virtually no contact with private currencies and financial tokens. But it shouldn’t stay that way, because it’s customers and investors who determine success.
In the beginning there was Bitcoin
According to Coinmarketrate.com, it all started more than fourteen years ago with Bitcoin, when its domain name was registered. A simple idea: to create digital money that can be safely transferred and maintain its deficit by limiting the money supply. The results are staggering: the one who bought Bitcoin for one US dollar ten years ago now has a fortune of about 14.5 million US dollars.
Yes, cryptocurrencies are worthy of all sorts of honors, but it’s not quite working out with money yet: Bitcoin is a speculative object, at best a financial investment. The money itself meets other requirements, it is (mostly) stable in value and is a generally accepted means of payment. However, over the past three years, the value of Bitcoins has fluctuated between $3,400 and $68,900. And payments with the help of BTC are extremely rare.
Although metrics now records cumulative sales of more than $200 million in Bitcoin and other cryptocurrencies, this is only 0.000,000 3 percent of traditional non-cash payments in one year in the eurozone alone. And even if Paypal now accepts digital currencies, Bitcoin will not celebrate a breakthrough as a means of payment.
The volatility of Bitcoin and cryptocurrencies disqualifies them for payment transactions. This weakness of unsecured digital currencies has given rise to an alternative form, the so-called stable coins. In fact, they are part of the classical system, since they are based on the value of, for example, gold, classical currency, or even a basket of currencies. An early attempt to create such a currency (Libra) caused a considerable stir.
Stable coins definitely have a chance to win a place in the financial system, but probably not with us. A significant part of humanity lives in countries where there are no stable currencies or functioning financial systems. For them, cryptocurrency can become a substitute for their own currency, especially if currency rules prevent them from fleeing into traditional foreign currencies. Stable coins with a stable value are likely to be much more attractive to them than Bitcoin and other crypto.
Central bank currencies are becoming a serious threat
However, central bank digital currencies may put an end to stable coins. This is something completely different than electronic money. In the traditional monetary system, central banks print and mint cash and create virtual money (book money) in the form of loans to banks. Banks, in turn, create additional virtual money by lending to non-banking organizations.
The problem is that paper money is always tied to bank accounts. On the other hand, the central bank’s digital money could be issued directly to citizens, and storage and transfer could be carried out independently of the banking system. The ECB is currently intensively promoting the digital version, and the Chinese have been testing this concept with might and main since mid-October 2019.
Bitcoin Loans are Unattractive
No matter how interesting digital money is, for most small and medium-sized enterprises, private cryptocurrencies will not play a role in payment transactions, and digital currencies of the central bank will not matter. So-called crypto assets become interesting when it comes to financing.
“Established” cryptocurrencies, such as Bitcoin, are unlikely to play a role here. The euro financing market is tried and tested, mature, diverse and deep both in the banking segment and in the capital market segment. The feasibility of companies obtaining financing in cryptocurrency depends on the same principles as for foreign currencies. Either interest rates are lower, or financing allows for natural hedging that compensates for currency risks from operating activities. However, this requires payments in cryptocurrencies to a large extent – neither one nor the other should be expected.
Moreover, nothing works without hedging. This is how stable coins, which can be easily and cheaply hedged, differ from free-floating cryptocurrencies such as Bitcoin, for which hedging is possible only at great cost, if at all. Stable coins, however, do not have advantages for many companies.
The issue of trust has also not yet been resolved. Treasurers are evaluated not by innovation, but by reliability. Destroying or changing the balance of a cryptocurrency account as a result of technical manipulations or defects is a nightmare for the finance department,” says Andreas Sova, head of Treasury at McKesson Europe and member of the Board of the Association of German Treasurers. “Fraudulent market manipulation is the second major concern of companies.”
Service tokens and venture capital
Financing with the help of self-created “currencies”, the so-called tokens, works quite differently. The market is divided into service tokens and security tokens. So far, the first type has dominated, but security tokens are on the rise.
Service tokens provide investors with access to the issuer’s services or products, and therefore are similar to vouchers. Therefore, they have intrinsic value. However, since the promise of efficiency is often made at a very early stage in the development of a company and a product, its value is very difficult to assess. The market attracts mostly tech-savvy but ill-informed private investors, and there are also cases of fraud.
Well, it is also possible to pre-finance risky projects of existing companies, which gives the investor cheaper access to the product. While this means that some of the margin is lost, it also does not create liabilities that must be repaid regardless of success. Such models of pre-financing by clients are possible without tokens, but they are practically not used. Probably, in the future it will be attractive only for a few small and medium-sized enterprises.
Security tokens are something completely different. They grant the right to dividends, (limited) participation rights, repayment or payment of interest in classical currencies. Thus, they are similar to classical debt and equity financing, and are always on the passive side of the balance sheet. The advantage lies primarily in calculations, namely in the immediate delivery of assets and simple clearing, and calculations are an important point for financiers.
Are security tokens the future?
“The regulator has long discovered this innovative financing. Security tokens are treated like classic financing tools,” says Rudolf Haas, a financing expert at the law firm King & Wood Mallesons.
“While this holds back some innovation, it also creates recognition and trust because many market players feel more comfortable under the umbrella of regulation.”
A breakthrough in the field of token financing can only happen with the participation of institutional investors. When using security tokens, the step is small. And in conditions of huge liquidity overhangs and negative interest rates, investors tend to try new ways. If we talk about Europe, global financial assets amount to more than 300 trillion euros. If at least one percent of this amount is invested in crypto finance, the market will explode.
Although technically tokens are outside the financial system, they are likely to become a playground for banks. Increased regulation helps them gain a competitive advantage. And in the end, even cryptocurrencies are just financing with corporate clients on one side and institutional investors on the other. DAX companies are only accumulating experience. All parties will learn from this, and the market can be very useful for small and medium-sized businesses in the near future.