Mega-bank Goldman Sachs has announced its intention to become involved in cryptocurrency. In a departure from the usual bad-mouthing of bitcoin from traditional banking outlets, Goldman Sachs plan to treat the cryptocurrency as another financial tool.
While it's still just dipping its toe into the market, Goldman's preemptive move is causing waves on Wall Street as additional traditional banking outlets give cryptocurrency a second glance.
Goldman Clarifies Position
Rumors swirled late last year that Goldman was preparing to open a cryptocurrency desk, with June 2018 as the targeted release date. According to reports in many mainstream financial publications, those plans are on track and Goldman could open its cryptocurrency branch within weeks.
Goldman has had a troubled relationship with bitcoin. Its current CEO, Lloyd Blankfein, covered the gamut of possible bitcoin positions last November, all while denying that Goldman had an interest in the volatile currency. In early November, Blankfein said bitcoin could be the next big revolution in money, similar to the shift from gold coins to paper dollars. By mid-November, as bitcoin's price rose, he was calling the market a bubble waiting to burst. By late November, Blankfein was certain bitcoin was a fraud.
Blankfein, perhaps not coincidentally, is slated to step down from his current position by the end of the year.1
Although Goldman has confirmed that it indeed plans to begin working with cryptocurrencies this year, the company still seems uncertain about its future value - and inherent risk, according to a Feb. 26 filing with the U.S. Securities and Exchange Commission.
"Additionally, although the prevalence and scope of applications of distributed ledger technology and similar technologies is growing, the technology is also nascent and may be vulnerable to cyber-attacks or have other inherent weaknesses," Goldman told the SEC in its 10-K filing. "We may be, or may become, exposed to risks related to distributed ledger technology through our facilitation of clients' activities involving financial products linked to distributed ledger technology, such as blockchain or cryptocurrencies, our investments in companies that seek to develop platforms based on distributed ledger technology, and the use of distributed ledger technology by third-party vendors, clients, counter-parties, clearing houses and other financial intermediaries."2
With Blankfein on the way out, it will be up to the new leader of Goldman to further clarify the company's position on cryptocurrencies. All signs point to baby steps being taken, at first.
Despite the screaming headlines linking bitcoin with Goldman Sachs, the company will not actually be trading bitcoin itself when it opens its new cryptocurrency desk.3
Goldman will enter the cryptocurrency market with a layer of insulation intact, offering futures and derivatives trading rather than direct bitcoin trading.
These derivative contracts will use Goldman money as their basis, while still satisfying a healthy amount of internal skepticism regarding the project, according to several media reports.
However, actual bitcoin trading is a possibility. Goldman is reportedly looking at the regulatory and risk angles before it jumps more completely into the market.
Bitcoin derivative contracts have been seeing an uptick recently as old-money investors look for a way to invest in bitcoin without exposing themselves to the notoriously fickle raw cryptocurrency market. This so-called paper market for bitcoin might eventually dwarf the bitcoin market itself, much as the paper derivatives market is several times larger than the physical stock or commodity markets. The reason for this is leverage. Derivative contracts can be leveraged to produce gains - or losses - many times that realized in the physical market as investors swap risks and positions. This kind of trading most famously made the news alongside the 2008-2009 Great Recession, when credit default swaps ultimately crumbled and took the U.S. housing market with it.4
Although it's received plenty of bad press since the Great Recession, the derivatives market remains alive and well because it offers investors a way to mitigate risk. In a cryptocurrency market where double-digit swings in a day aren't unusual, risk mitigation is necessary to lure traditionally conservative investors, like hedge funds, off the sidelines.
Follow the Leader
Goldman's entry into the crypto market runs counter to the traditional Wall Street narrative. Even legendary investor Warren Buffett has pooh-poohed bitcoin in the media, describing it as "rat poison squared."5
Yet Goldman's entry gives bitcoin and other cryptocurrencies a new air of respectability, some market observers say, and that could possibly pave the way for future institutional investment.6
One of the main things that big banks like Goldman bring to the table is liquidity. Highly illiquid markets are susceptible to manipulation by whales and other large capital holders, who can change the market's price points simply by buying or selling substantial amounts. Very few investors can bring the kind of money that Goldman offers, creating a liquid and more stable market. That, in turn, will attract new institutional investors seeking to benefit from a relatively calm, predictable market, further under-girding bitcoin's stability.
Banks are only the beginning, some observers note. Once banks are assured that bitcoin won't get them into serious regulatory or financial trouble, the door swings wide open for hedge funds, insurance pools, retirement funds, and other major sources of institutional cash.7
The Original Vision
While Goldman's entry into the cryptocurrency sphere has generated excitement and optimism among most holders, at least one core group of bitcoin fanatics remains skeptical - devotees of bitcoin creator Satoshi Nakamoto's original vision. In his landmark bitcoin white paper and subsequent announcement, Nakamoto presented bitcoin as an alternative to traditional bank and government intermediaries. By effectively eliminating a trusted third party via the blockchain, bitcoin would allow users to transact peer-to-peer with complete safety and anonymity.
Bringing the banks into the bitcoin market, these devotees say, perverts the original purpose of the coin, as does the creation of a wholly divorced bitcoin derivatives market.
Some are even calling for the entity known as Satoshi Nakamoto - still unidentified a decade after bitcoin's creation - to come out of the shadows and champion bitcoin's original anti-bank, anti-government status.8 After all, these folks say, bitcoin's first big adoption case was the Silk Road, a black market specifically created to circumvent mainstream control.
Banks and Bitcoin: Partners or Pariahs?
It's unclear whether banks and bitcoin can - or should - coexist happily.9 Goldman's entry into the cryptocurrency market is likely the first wave of a new surge in institutional investing. Goldman's tacit stamp of approval is likely to lead other banks, hedge funds, and other financial market movers into the cryptosphere. These will also likely drag regulatory agencies along for the ride, as government forces simultaneously seek to protect investors and profit from the ongoing action in crypto.
While it's greatly different from Satoshi Nakamoto's original vision, there is no doubt that bitcoin is growing and expanding its reach. What's at stake, however, is the peer-to-peer nature that formed the basis of the original bitcoin code. Much as fiat dollars are now inextricably linked with the governments that issue them and the quasi-private banks, like the Federal Reserve, that regulate their use, bitcoin might soon find itself fairly bootstrapped into the existing system by a tangle of intermediaries and regulations. That runs exactly counter to its purpose, and so alternative coins may have to spring up to keep bitcoin's original vision alive.
It's ironic to think that bitcoin, a tool designed to shatter banks' centralized power, might soon become another line item in their yearly reports. Only time will tell whether this ultimately strengthens the cryptosphere or forces it to evolve in a new direction.
1) "Goldman Sachs CEO to Step Down, Bestowing Complex Bitcoin Relationship." CCN. 20 May, 2018.
2) Goldman Sachs 10K. Feb 26, 2017.
3) Popper, Nathaniel. "Goldman Sachs to Open a Bitcoin Trading Operation." The New York Times. 2 May, 2018.
4) Davidson, Adam. "How AIG Fell Apart." Reuters. 18 Sep, 2008.
5) Kim, Tae. "Warren Buffett Says Bitcoin Is 'Probably Rat Poison Squared'." CNBC. 6 May, 2018.
6) "Goldman Sachs Entering Crypto Will Lead to Bitcoin Price Surge: Matonis." CCN. 2 Apr, 2018.
7) Ell, Kellie. "Wall Street to Follow Goldman Sachs on Bitcoin, Blockchain Venture Capitalist Says." CNBC. 4 May, 2018.
8) "Bitcoin: A Peer-to-Peer Electronic Cash System." Bitcoin - Open Source P2P Money.
9) Hernandez, Will. "Will Satoshi Emerge to Restore Bitcoin's Original Vision?" Square | Blockchain Tech News. 26 Feb, 2018.