What is the role of Crypto and Blockchain in future society?

Michael Kometer and Wolfram Klingler, Partners at Neuronomics AG

Key Fundamental Drivers for Economic and Societal Growth

The basic prerequisite for successful economic activity is trust. For growth and gains in productivity, we need increased efficiency. This is true especially for our developed societies and often makes the difference between whether an economy and society ultimately succeeds or not, even more so for an individual company and again more so for a single business transaction. If the other side doesn’t trust you, they are unlikely to enter into business with you. Similarly, new technology and the massive gains in efficiency are vital for economic and societal growth.

The Problem of Trust in the Financial Industry

With blockchain, cryptos and embedded smart contracts, an extremely powerful new technology has emerged providing trust at an unprecedented level of efficiency. The “trust manufacturing” market is highly dysfunctional and inefficient today. While consumers see financial institutions as somewhat competent, they do not see them as ethical or trustworthy. The numerous and ongoing banking scandals over the last decades and hundreds of billions in fines have led to a fundamental erosion of trust, which is also true for many other trust manufacturing businesses, for instance auditors. Similarly, many processes in our financial system are inefficient, are still running on decades-old technology, have high cost and often lead to unfair outcomes. Many of these processes are ready to be fully automated with today’s technology and will only cost a tiny faction of todays costs once this has been achieved.

A New Technology-based Approach to Trust Manufacturing

The fast-developing blockchain-based technology, including Decentralized Finance (DeFi) applications, Crypto tokens, NFT’s and other applications, will disrupt the trust market and substantially increase efficiency in a more fundamental way than most of us understand today – even if many problems regarding trust still remain to be solved as the frequent hacks show. Smart contracts on the blockchain used to automate business processes allow for a scale of disruption that is potentially larger than the internet. The technology allows to “manufacture” trust and provide extremely scalable and efficient business processes at a tiny fraction of the cost we spend today. Blockchain does not offer absolute security, but a level of security higher than any other technology today. Because Blockchain is decentralized and fully transparent, it is very hard to manipulate and inherently trustworthy. Any transaction that took place on blockchain, remains there and leaves publicly visible traces forever. 

With the introduction of smart contracts, for which Ethereum is the pioneer, entire business transactions are now running on blockchain, making them fully transparent, accessible and verifiable for everyone. Money has become programmable – Crypto tokens and their platforms enable a monetary revolution like the invention of paper money. All common banking functions have been coded into smart contracts and are running on blockchains already. This is unprecedented and revolutionary, given how inefficient much of our banking system still is. If you compare this development with the disruption caused by the internet, it has an even larger potential. 

Many “Crypto natives” believe that we are with blockchain technology today where the internet was in the mid-90ties. However, the adoption of Crypto is already enormous, with an estimated 25% of the population in the US owning Crypto and 4% of the world population.

Defi – The Future of the Financial Industry?

DeFi (Decentralized Finance) is a good example to showcase the disruptive potential of the combination of blockchain, Crypto tokens and smart contracts. Many Crypto ventures are now successfully substituting traditional financial institution simply with lines of code, there is not even an institution anymore – it’s just software. 

Various DeFi-Cryptos have been developed to enable decentralized exchanges. In contrast to traditional centralized exchanges, these exchanges mostly work in a fully automated and decentralized manner, without a centralized order book or expensive accounting processes. In addition, decentralized exchanges do not require external market makers to act as intermediaries between purchasers and sellers (stifled by ever increasing capital requirements). Instead, all these functions run automatically through blockchain- based smart contracts powered by Defi-Cryptos. Fully automated market maker processes with liquidity pools at its core have already been discussed and theoretically studied in science since a decade. With the introduction of Defi-Cryptos, such processes now run in the real world and have meanwhile enabled the exchange of billions of assets in a fully automated way. Importantly, these coins not only address various inefficiencies within financial markets as explained above, but are also able to provide a fairer and more inclusive distribution of gains. While current centralized exchanges only benefit the exchange providers and some large market makers, Defi allows small companies and retail investors to participate and generate fee income in the process. The cost of running a decentralized exchange is a tiny fraction of the costs of our current centralized exchanges.

Crypto Assets and the Energy Consumption Problem

As the technology is still very young, many problems remain to be solved – and they either are being solved or will be solved. Two of the main topics serve as a good illustration:

One of the major points of (justified) criticism of the Crypto industry is its energy consumption needed to verify transactions on a decentralised blockchain.

• In the proof-of-work method, on which Bitcoin and other Crypto currencies are based, miners compete against each other in the verification process. Those who first solve a complex mathematical problem are those who receive the authority to add the new block of transactions to the blockchain and receive a reward. The redundancy is enormous and so is the energy consumption.
• In proof-of-stake, the verification process is already a lot more energy efficient, as in this process, participants in this process stake Cryptos as collateral and vote in favour of a potential new block to be added to the blockchain and receive a reward if the block is added. This method is also much more scalable.
• New methods, such as zero knowledge proof, massively increase the transaction throughput while the energy consumption is significantly reduced. In Zero-knowledge proof, an encryption method is used to mathematically proof the truth of a specific transaction.
  The way this technology is evolving is a powerful demonstration how innovation in the space leads to ever increased feasibility of the technology allowing to manufacture trust in a secure, fast and ultra-low-cost manner.

Is Money Laundering the Primary Purpose of Cryptos?

Another major topic is the use of Crypto currencies for criminal activities. This is met, on the one hand, with increased regulatory pressure regarding KYC processes. More importantly, there is a rapid development of solutions that allow to map the blockchain and wallets on it in a manner that allows to identify problematic wallets and transactions and further wallets connected to them. Since every transaction on the blockchain leaves a permanent trace, the technology is uniquely able to create transparency and trace flows of money. If you compare this to bags of paper money, it is evident that the future of Cryptos and blockchain is not enabling criminal activity, but manufacturing trust. Also, while hacks are still an enormous problem for the Crypto space, the major custody solutions used by professional investors have never been successfully hacked to date and are capable of providing investors with an institutional-grade level of security.

Many problems that still exist, most notably the massive presence (and successes) of hackers, are being worked on by some of the brightest minds that this space has been able to attract. New problems will arise with the wider adoption of the technology; however, it is close to reckless to dismiss Cryptos and the accompanying incredible innovation and disruptive potential that comes with them because of some of the early problems and “childhood” diseases of a transformative new technology.

How to Invest?

As institutional investors do not want to give up the potential of this new technology and, as shown above, ethical questions about the technology arising from early challenges should not cloud the fact that this technology will allow society to function on a higher level of trust and, therefore, as a whole, is highly likely to have a substantial positive ethical impact on society. It is this technological change that allows us to solve some of the massive ethical problems we are struggling with today, in the financial industry, as well as in many other areas that rely on trust as a fundamental condition.

One approach to investing is to simply build market exposure. This is challenging for institutional investors, given the volatility of the market, the early stage of the technology with most likely some major fallouts ahead. Neuronomics offers a different approach; a moderated exposure to this market, exploiting the volatility and the neuronal reactions neuroscience can observe in a systematic manner while overall maintaining a low average market exposure. This leads to significantly reduced volatility; better risk-adjusted returns and has helped to avoid major drawdowns.

To make the strategy investable, Neuronomics has partnered with GenTwo, a Zurich-based innovative securitization specialist offering a new generation of financial products. Through GenTwo's securitization platform, the strategy is available to professional investors, and despite an underlying Crypto portfolio, fully bankable with a Swiss ISIN.

About GenTwo

Zurich-based innovative securitization specialist GenTwo has created a new generation of financial products. The company builds securitization platforms for its institutional clientele and enables professional investors to securitize not only bankable but also non-bankable assets with a Swiss ISIN. The focus on so-called off-balance-sheet investment products solves the problem of declining margins and growth barriers for many financial market players. It opens up new performance potential by creating access to a theoretically unlimited world of asset classes. Financial intermediaries, including banks, can use GenTwo setup to realize their own product and business innovations.

About the author

Michael Kometer and Wolfram Klingler
Partners at Neuronomics AG

https://www.neuronomics.com/