The big question: Is investing in crypto worth the risk?

By Anjani Trivedi,
This is one of a series of interviews by Bloomberg Opinion columnists on how to solve the world’s most pressing policy challenges.

Anjani Trivedi: You’ve been a long-time investor in traditional banks and have followed the journey of global financial services firms and the financial system. As the chief executive officer for Asia for the hedge fund Marshall Wace, you’re now focused on cryptocurrencies, blockchain and fintech. When did the switch happen and what’s driven it?

Amit Rajpal, chief executive officer, Marshall Wace Asia Ltd.: About a year back, I came to the conclusion that we’re moving from a process that’s been about redesigning financial services by leveraging technology to one that’s about actually redefining financial services, by changing the architecture that underlies our financial system.

Read more: Visa says spending on crypto-linked cards topped $1 bn in first half this year

There have been a lot of great fintech entities, but they’ve operated more or less at the fringes of the conventional system. I now see a move where fintechs will become the mainstream. Unless the mainstream adapts, it will be forced to shrink and operate only in boundaries where the current technology architecture allows for traditional firms to be competitive. From a public investment standpoint, we've continued to allocate a larger and larger share of capital to publicly-listed fintech and payments companies. We’ve also started a digital-finance crossover strategy, which allows us to invest in late-stage private equity in a way that we capitalize on this evolution, rather than wait for it to materialize at the time of an IPO.

Also read: China's central bank office closes software maker over cryptocurrency trading

AT: When you say that traditional banks will increasingly be restricted, can you give an example of a part of the financial system where this is happening?

AR: In most developed countries, the financial system accounts for somewhere between 5%-10% of GDP. That’s the revenue base it generates to intermediate savings flows – the fundamental job of the financial system. We see the greatest degree of transformation in payments, which according to McKinsey is a total addressable market of $2 trillion. Much of the infrastructure that underlies payments today was set up years ago to facilitate business-to-consumer payments, trade finance and supply chain flows. A lot of these payments have a standard template, heavy manual overlays and are generally expensive. With the evolution of blockchain technology at scale and with the right compliance solutions underlying it, we can get a fundamental shift where we move from manual to automated and from heavy economic rents to a much more efficient way of intermediating savings.

Most central banks already acknowledge this. They’re just finding the right modality to allow for this new technology to be able to mainstream itself without creating negative consequences.

AT: Does this feel like a watershed moment around how investors are looking at the financial system? During the financial crisis, the regulation brought to the industry caused a major shift. Is this an analogous moment?

AR: These are very early days. There are some constraints from an investor’s standpoint. First, there’s a lot of noise and confusion. Crypto is an ecosystem. It’s noisy and volatile. You have the whole evolution of non-fungible tokens, or NFTs, as well as blockchain’s ability to redefine processes and flows. Because there are so many moving parts, there isn’t clarity around how this will evolve, which is resulting in diluted investor appetite.

As with anything new, it’s never a straight-line process. It’s always very volatile, which is what’s creating this opportunity for investors like us. The general investor base doesn’t recognize that this is the moment in which financial services are moving from the fixed-line era to the smartphone era. The investor recognition of that change is definitely not in sync with the opportunity.

AT: There’s a difference in the way retail investors look at these assets as an investable opportunity versus how institutional investors do, right?

AR: The opportunity set is fundamentally different. I break it into three areas: Consumer-facing business models — companies like Coinbase Global Inc. or Japan’s Monex Group Inc, which give you access to digital assets. Then there’s the infrastructure in building the ecosystem as a mainstream — things like payment applications, scaling, compliance and regulation solutions.

The third is the evolution of DeFi, or decentralized finance. As more assets get digitized, the opportunity set for these protocols will build.

These are things that are not straightaway accessible to retail. These are in the private markets or early-stage listings in the public markets. For retail, its [still] cryptocurrencies and NFTs.

AT: What are the risks for retail investors?

AR: A lot of the trading venues are not regulated. Obviously, we’ve seen significant hacks where exchanges have been cleaned out and investors who underlie those exchanges have lost their investments.

There’s also a lot of leverage that goes into trading in futures on crypto. If you deal in a highly volatile asset class on leverage, it’s a combustible combination. Having said this, volatility is not new. People who are active here understand full well the kind of risks that they’re taking on. The regulatory architecture is gradually improving and more of the exchanges are getting compliant. Trading venues are also becoming more mainstream in a way they just weren’t three to five years ago.

AT: Is there a broader risk to the financial system?

AR: I still think it’s small. The total value of crypto assets just exceeds $1 trillion. To put that in context, there are many big U.S. technology companies that have double the market value and some of them triple that. If you benchmark the value of crypto assets against the value of all financial assets outstanding in capital markets, it’s less than 50 basis points. While crypto attracts a lot of attention due to the volatility and the nature of its being new and trying to disrupt the conventional asset classes, the reality is, it’s still too small to be able to create any forms of systemic risk.

AT: You mentioned regulation, or the lack of it, as a risk. Innovation and regulation are rarely in sync. Is that the case here?

AR: I’d focus on how the U.S. is approaching it. At this stage, six regulators are fully focused on adopting or mainstreaming blockchain technology into the financial system. You start with the Office of the Comptroller of the Currency (OCC); then you have the Federal Reserve, the New York Department of Financial Services, the SEC and the Financial Crimes Enforcement Network (FinCEN). They’re all approaching this in ways that are trying to encourage innovation, but limit the bad actors.

What the OCC has done just this year is pretty significant. They’ve awarded three digital bank licenses this year. These are banks but they don't deal in fiat currency — they deal only in digital assets. This is a big deal. The U.S. also allowed public blockchain to integrate into the conventional payment system, in a way previously it wasn’t allowed. This is allowing innovation.

Other regulators are focused on limiting bad actors. FinCEN has announced that the travel rule, which applies to transactions above a certain threshold, will be applied to all digital asset transactions as well. In order to create equivalence with the mainstream system, they have said that know-your-client and anti-money laundering processes will have to be followed. This is the right approach.

Having the right regulation could ultimately become a competitive advantage in this space. So far, the U.S. has the right approach. It’s for the other countries, including China, to be more open to encourage innovation while limiting the bad-use cases in a way that allows the system to become more efficient.

AT: Your hedge fund, Marshall Wace, has set up a crossover strategy focused on investments in the digital-assets space. Where do you see the biggest opportunities?

AR: This strategy is designed to capture the redefinition of financial services. Our priorities are twofold: the application of blockchain in redefining financial services; and within the financial infrastructure layer, payments.

We’re very focused on India. I see the potential for a huge digital leap financially. That’s because India starts from a very manual point: digital payments remain a small proportion of total payments. It also starts from a low point of inclusion, so the adoption of new technology can make a big difference. More importantly, India has the right infrastructure to allow it to leapfrog.

Scale is going to build very rapidly. We think being ahead of time is a huge advantage rather than waiting for the IPO itself. And, the investor base is still lagging in their interpretation of the changes that are coming.

AT: What are some real-world examples of how blockchain is redefining financial services?

AR: One example is a publicly-listed company here in Hong Kong called Linklogis Inc. It’s used blockchain to verify supply chains, starting with big anchor customers all the way to six or seven levels down. This data is updated in real-time. It’s also tokenized through things called digital payment obligations. Banks can get on the blockchain and finance these invoices straight away, helping small businesses access financing in a way that was previously impossible. This is a real-world example of how the architecture around supply chains and trade finance could change very significantly as we as we look forward.

Other examples are more generic. There are lots of states in India, for example, which have very poor manual records on real estate and property and who owns the title. There’s always a fight for title. Many firms are now moving to blockchain to update records in real-time and cut out the litigation challenges that come with title, which is a big feature of emerging markets’ real estate ownership. These have been huge pain-points for decades with no solution, other than people going to court or settling out of court.

AT: Building out and scaling up underlying blockchains requires high energy consumption. As the space moves from proof-of-work, where anyone can solve complex equations, to proof-of-stake, where you have to have skin in the game, do you see this changing?

AR: Proof-of-work is the way the original blockchain was structured by Bitcoin. And Bitcoin intends to stick to that. Over time, I expect the balance to keep shifting in favor of proof-of-stake, which is much more energy-efficient.

Proof-of-work is environmentally degrading because you become a victim of your own success. If the price of the crypto asset – let’s call it Bitcoin – keeps going up, more and more people are incentivized to solve the equation. So the equation becomes harder, which needs greater computational power, and that creates an environmental impact.

The mitigating factor is that Bitcoin mining can go to the source of energy — unlike gold mining, where you have to go to the source of gold. Even today, Bitcoin consumes less energy than gold mining does. Forty per cent of all Bitcoin mining is already happening through renewable forms of energy. And if you take China out of the equation, that number is a lot higher.

This trend could be accelerated if policymakers decided to impose a carbon tax on Bitcoin mining. That’s a very plausible thing to do. With the right set of incentives and checks and balances, Bitcoin mining can become substantially renewable. This is a solvable problem. And this is only Bitcoin. People should understand that the rest of the blockchain is environmentally positive. It consumes such little energy relative to what it’s replacing that as more things move into the context of proof-of-stake, our net consumption of energy will decline. With the right amount of focus and attention, Bitcoin mining will reduce its carbon footprint, making it more sustainable, and ultimately, more investable.

AT: How many years will it take other investors, the lagging investor base, to catch up and begin to look at this asset class in a more positive light?

AR: It will probably happen in a 3-to 5-year window. The banking system, for instance, does a lot of great, productive social tasks that we all need day in and day out. Things like payment applications are basically a messaging system where you have to keep picking up the phone to talk to each other, keep filling up paper and documents, keep going to your bank branch to wire money somewhere. You use a lot of paper. Anything that uses paper, that’s manual. It requires a real estate footprint. The financial system’s carbon footprint is about seven to eight times bigger than Bitcoin mining.

If we replace mundane tasks now performed by the banking system with a proof-of-stake, where the energy consumption is much smaller than in conventional tasks, then the whole debate will flip. Blockchain will become a net contributor to improving our environmental or carbon footprint, rather than as it’s commonly perceived. These things are wheels in motion. They take time.