The world, and its monetary system is in a big mess, so the conditions for introducing and promoting alternatives to traditional money have probably never been more favourable.

Banks have lost, and - in many cases - deserved to lose the trust of their customers. Central banks even more so, and governments most of all.

Therefore, I think it is natural for us to look at the space of Bitcoin ( ) and cryptocurrencies, and even more importantly, to fully understand both the opportunities inherent in - and the threats to - the traditional banking model from the idea of decentralised transaction confirmation, smart contracts and derivatives.

This is a paradigm shift in its early days, and early movers will be able to gain big competitive advantages by embracing and understanding this space.

The Internet Lesson

Having been an early starter in the online trading space, scepticism towards cryptocurrencies was reminiscent of the comments in the mid-1990s, when it was predicted that a very large proportion of clients would one day be executing their trades via the internet.

This new channel was a temporary fad, people would always want to trade on exchange floors, clients would never trust the internet, private clients would always have to rely on sales persons and analysts for information and advice.

In other words, forget it. In those days, trading foreign exchange was a preserve of rich people. They were, in essence, made to pay a very high price due to the lack of transparency and dubious practices of their trusted advisors.

Today, private-client foreign-exchange trading is a huge part of daily spot FX volumes, and Saxo Bank, commanding around 5-7 percent of the global volume in that space, is regularly to the found inside the Top 30 FX banks in the world, a list that otherwise only counts massive multi-billion dollar corporations with a hundred years of history. Actually, we supply infrastructure to many of these big banks to help them service the lower end of their client segments better than they can themselves. So transformation can happen.

We have recently accepted our first Bitcoin operator in Denmark, and we are hoping to support more in the future, although it gets more complicated when the businesses are very international, spanning multiple jurisdictions.

Regulation’s Tentacles

Regulation is everywhere today in the traditional financial markets. Anything that remotely resembles a financial instrument will eventually be regulated. This will for sure include Bitcoin and other cryptocurrencies. What can be regulated, will be regulated.

The traditional banking system is extremely cautious about areas that are weakly regulated, or where regulatory confusion exists. This is not because we love excessive regulation as it reduces our ability to service and assist our clients in their own best interest, leads to tremendous extra cost and complexity for no other real purpose than political cover-my-backside objectives.

But the reason banks fear unregulated markets is that, too often, regulation is introduced with the benefit of hindsight, and with retrospective consequences for financial institutions. Bankers, therefore, are looking for regulatory certainty and clarity, and would rather forego a business opportunity than run unknown risks.

So in that sense, regulation will maybe turn out to be a blessing in disguise for this space, as Bitcoin will not be fully embraced by the financial system, merchants, investors etc, before such, hopefully relatively light touch regulation is in place.

Light touch, rarely happens of course. While opening new doors to new investors and partners, it will also add tremendously to the cost of running a Bitcoin business. Today, regulatory compliance is a major cost line in any financial institution's results, and it is very difficult for smaller brokers and even banks to continue to trade profitably as such costs soar and soar.

Clearly, many of the very lowly capitalised players in the crypto space will find it very difficult to deal with a substantial extra layer of costs. So it is very wise to already now prepare systems and business procedures to secure compliance with the inevitable demands of anti-money laundering procedures, client data, risk disclosure, investor protection, insurance schemes etc. This kind of stuff is definitely coming to your town as well, and maybe sooner than you think. It will also be very wise to be proactive in engaging with regulators and explain to them the peculiarities of this space, rather than to try to fly under the radar.

Another valid objection is the lack of liquidity. I know from my own modest trades in Bitcoin, that the available liquidity is very poor. In reality, sizable transactions need to be sources off market, between individual buyers and sellers if institutionally-meaningful trading sizes are involved. A vicious cycle ensues. Very few larger traders are in the market, creating little economic incentive to banks providing this type of service, in particular with the regulatory risks inherent in the process.

Direct involvement by established financial institutions will therefore be very limited. You really have to be an enthusiast to get involved. A cynical risk/benefit analysis will not work out.

The virtues of enthusiasmBut, fortunately, enthusiasts exist. A substantially larger number is following the market from a distance, and the underlying technology and its possible much wider application than just cryptocurrencies is beginning to be appreciated among some business analysts and technology people also in the banks.

For Saxo Bank, the possible use of CFD - contract for difference - like derivatives, is of at least intellectual interest. We know about the construction of such derivatives and turning them into smart contracts is definitely intriguing.

Also, there is a certain appeal in being at the forefront of things. It is not always the most rational thing to do in direct economic terms as often the later entrants win out. But for an organisation such as Saxo Bank where our clients expect at least an occasional innovation, Bitcoin can play a role image-wise that should not be underestimated. Normally, banks are concerned about reputational risks, but reputational benefits are also possible, and this could definitely be one.

As the enthusiasm in the space is big, and communication between Bitcoin users quite efficient, there is good potential for a viral effect that could generate an interesting group of new clients although some kind of minimum transaction levels would like have to apply.

There are multiple attempts at building cryptocurrency exchanges with aggregate liquidity, but it is worth remembering that in the fiat foreign exchange space, most volumes are generated on single-bank platforms, not aggregate liquidity platforms. As the Bitcoin market is struggling to reach a reasonable liquidity situation, a brave bank market-maker prepared to take calculated risks of matching its clients inside a reasonably liquid spread may well turn out to be at least a short-term winner of this competition, just as it was in the traditional FX space.

Double-Edged Sword

Volatility is a double-edged sword, although it seems periodically to be subsiding. It is clearly a negative in the commercial space, where merchants will be reluctant to carry real exchange risk on such a fast-moving means of payment. I have heard many merchants unwilling to take this point risk, even for short-term exposure. This could of course easily be automatically converted by a merchant-payment solution provider, securing immediate conversion into fiat currencies, at least for small ticket items.

On the other hand, certain investors actively look for volatility. Take the . The world’s most important cross is at all-time lows, and yields are in general extremely low by historical standards. In such a market, the volatility offered in Bitcoin could well be an attraction to some traders, if spreads were acceptable and liquidity deep enough to put on meaningful trade sizes.

There remains a puzzle with Bitcoin. It is clearly in a downtrend since the bubble-like rally above USD 1,200 late last year. It’s been down more than 70 percent since, in spite of the enormous attention Bitcoin has recently received from the media. Normally, you would expect this explosion in demand to result in higher prices, or at least for a more moderate dip from the highs than what we have recently seen.

Bitcoin’s Potential



It would appear that there must be a substantial overhang of selling interests out there, probably from miners or early investors that are offloading heavily to meet the demand. It will be most interesting to see what happens when this selling subsides, in particular if at the same time more hedge funds and institutional interest of longer-term placements and investments in Bitcoin step in.



In a very small market of just USD 5-6 billion market cap, with a limited and probably net-reducing freefloat, it would seem there could be potential for significant price rises, barring heavy regulatory restrictions. So I will be looking at buying dips towards the USD 350 level. Of course, like any market analyst, I am wrong pretty much as often as I am right.



So to conclude, for the short to medium term, I see limited adoption by the bigger banks. Smaller, more innovative, and more aggressive banks, may well see an opportunity to both build a meaningful trading business and a new distribution channel that could generate some considerable visibility.



But for the long term, I think Marc Andreesen’s recent comments could well be prophetic. The underlying technology does hold significant potential to be a real paradigm shift.



We know that here is a potentially very revolutionary and disruptive idea, replacing centralised and fallible institutions of trust with decentralised and secure confirmation of transactions. The threat to central banks, commercial banks, governments, jurisdictional institutions, exchanges, payment solution providers and many, many other such centralised trusted institutions is substantial.



But he is also right that this is comparable to the internet in its early stages. The potential is there and predictable, but how exactly to exploit it and benefit from it is unpredictable.



That potential will be continuously unfolding, as smart young people work it out in thousands of both failed and successful experiments. The most important inventions, including in the financial area, are unlikely to come from establishment players, and certainly not from old traditional banks. Look elsewhere for that to happen.

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