Incumbent Financial Sector Doesn’t Have to Be Left Behind in the Cryptoeconomy
Crypto. DeFi. Security Tokens. Smart Contracts. These are components of the “Cryptoeconomy”, the term used to refer to a new open financial system built upon crypto and underpinnings like blockchain. As I am writing this, the eagerly anticipated IPO of Coinbase, the bell weather company in the crypto ecosystem just began trading on Nasdaq sporting a market capitalization of about $100 billion. For many, this event legitimizes the blockchain, cryptocurrencies and related technologies that were born only 12 years ago when the first Bitcoin was minted.
In Coinbase’s IPO prospectus, the company states, “Our mission is to create an open financial system for the world. Today, the way that we invest, spend, save, and generally manage our money remains cumbersome, inaccessible, expensive, and regionally isolated. In contrast, the internet has transformed our society by connecting the world and enabling the seamless exchange of information. The legacy financial system is struggling to keep pace with the speed of technological advancements in a global and digitally interconnected society, resulting in the need for a new, natively digital financial system.” In JP Morgan’s recent 2020 annual report, CEO Jamie Dimon’s annual letter to shareholders, often viewed as a must-read in financial circles, acknowledges, “Banks already compete against a large and powerful shadow banking system. And they are facing extensive competition from Silicon Valley, both in the form of fintechs and Big Tech companies (Amazon, Apple, Facebook, Google and now Walmart), that is here to stay. As the importance of cloud, AI and digital platforms grows, this competition will become even more formidable. As a result, banks are playing an increasingly smaller role in the financial system.” [My emphasis in the two quotes added.]
The above statements, as well as some prognostications that blockchain can completely upend the structure and architecture of the financial markets, seem to be very ominous for the legacy financial system. However, at our company RedSwan CRE, we don’t believe that is a foregone conclusion. In fact, the emergence of the cryptoeconomy provides exciting opportunities and new sources of growth for traditional players in the financial services sector. In a prior piece I published called “Amazing Bitcoin Real Estate Tax Strategy No One Knows About”, I mentioned that we are exploring ways we can help our clients borrow against their crypto holdings in order to invest in our commercial real estate backed security token offerings. To recap, an investor could borrow 80%, or perhaps more, of the amount of his CRE investment and put up his crypto as additional collateral to effectively lower the total LTV. In doing so, the investor would be able to receive a very attractive interest rate on the loan and earn a nice spread between that rate and the yield offered by the underlying CRE property. The beauty of this approach is the investor avoids selling highly appreciated crypto to fund his investment and hence avoids capital gains tax. I mentioned that RedSwan CRE is engaged with new DeFi firms as referral partners on this type of crypto lending. However, it is important to note that we have approached institutions in the traditional banking sector, and they are also very interested. Crypto lending will be a strong growth driver for the banking sector now and in the future. Based on Federal Reserve data, total loans and leases outstanding in the US bank system grew at a compound annualized growth rate of 3.5% from the end of the Great Financial Crisis to today. Compare that to growth in assets on platform at Coinbase of 430% in 2020 and 147% in just the first quarter of 2021 (though to be fair, a big portion of that was due to appreciation in the value of Bitcoin and other cryptocurrencies in the past half-year or so)!! Partnering with RedSwan CRE on crypto lending, the regional bank could achieve incremental annual loan growth of mid-single digit percentage just from this relationship alone. For most US banks, such an incremental growth rate would be considered enormous. It would make sense for banks to expand their product portfolio into crypto lending and stake a strategic winning position in the new cryptoeconomy.
Other examples abound. At RedSwan CRE we often emphasize how tokenization of CRE equity into digital shares introduces the opportunity of liquidity and early exits, which historically has never existed in CRE investing. Established exchange players in the US capital markets have optimized their market making and surveillance technology to serve the burgeoning digital assets industry. This would be a win-win scenario for digital assets and the exchanges as the latter’s recognized names and brands provides a halo of trust for the digital asset class and simultaneously, they can reduce their dependency on revenue streams tied to traditional “analog” stock and bond trading.
Another compelling example hits right at the core of what we do here at RedSwan CRE. Consider a publicly traded Real Estate Investment Trusts (REITs). Often, due to information opacity and the fact that buildings infrequently trade hands, REITs trade at a discount to their net asset value. What if a REIT that owns and manages hundreds or thousands of properties tokenizes the equity capital stack for a fraction of their properties that is representative of the total portfolio (while still maintaining control)? Once those tokens trade on an active secondary market, you can imagine REIT investors would then have a way to see the precise value market participants are placing on those properties and hence be able to value the entirety of the REIT more confidently. That would further help support the REIT’s stock market value and facilitate capital formation.
Outside of tokenization and CRE, we see many initiatives being implemented by long standing financial institutions to succeed in the new cryptoeconomy. CME Group, originally the Chicago Mercantile Exchange founded in 1898, offers Bitcoin futures contracts that currently trade in excess of 10,000 contracts per day. In Europe, Coinbase launched a retail debit card with the Visa network to allow customers to spend their crypto assets with merchants. The Visa network is now over 60 years old. As yet another example, Fidelity Investments, well known as a retail mutual fund giant founded 75 years ago in Boston, has launched Fidelity Digital Assets to provide institutional grade prime brokerage services specifically for cryptocurrency. These are just a handful of case studies of traditional financial services companies trying to position themselves in the new cryptoeconomy.
In closing, I am excited about the road ahead. At RedSwan CRE we are enhancing the real estate tokenization vertical, but we don’t believe in going at it alone. Through strategic partnerships with established building owners and financial institutions we plan to accelerate our road map much faster, creating an ecosystem that lifts business for all involved. Their reputation and experience combined with our pipeline of quality commercial real estate deals would make a powerful combination. Indeed, the incumbent financial sector does not have to be left behind in the cryptoeconomy!