May 6, 2019
Cryptocurrencies have attracted widespread market attention, but it’s the underlying blockchain technology that really matters. Over the past year, significant progress has been made in moving blockchain beyond experimentation to use in payments, smart contracts, record keeping and decentralized applications. Its expansion comes as mainstream institutional cryptocurrency acceptance remains challenged, with the crypto market falling from an all-time market value peak of $800 billion at the beginning of 2018 to around $125 billion in Q1 of 2019. In this report, J.P. Morgan Research evaluates the latest developments in blockchain implementation and obstacles that lie ahead.
Blockchain technology started with the advent of bitcoin, as a way to record transactions in a transparent, secure, immutable and efficient way. Progress has been made on blockchain solutions, including expansion to include conventional USD payments, but barriers remain significant, including scalability, security and regulatory challenges. Although widespread blockchain adoption with scalable solutions is at least three to five years away, progress across various sectors is growing. The most impactful verticals are ones where third parties are prevalent like real estate, IP licensing and auto dealerships for which smart contracts could be a potential use case. In terms of record keeping use cases, verticals like healthcare, financial services and supply chains are most affected.
Although blockchain is unlikely to re-invent the global payments system, many banks are increasingly seeing the value of blockchain technology and its ability to reshape how business is conducted. While blockchain solutions have yet to transform banking with scalable solutions, J.P. Morgan views there is significant long-term potential to streamline cost bases for global banks and to digitalize hard-to-automate processes in certain areas. Trade Finance is likely to benefit most. Globally, greater progress has occurred outside of the U.S. The adoption of blockchain technology among stock exchanges is expected to offer significant scope to improve the efficiency around settlement/clearing and collateral management, while traditional capital markets are at early stages of adoption. Countries like Spain have established a leadership position as early pioneers by using blockchain as an electronic transaction-processing and record-keeping system, which allows all parties to track information through a secure network.
Outside of Spain, most banks are in the early stages of exploring ways to maximize the benefits of blockchain. A few have been running trials in parallel with existing processes as technologists and regulators iron out the new technology and its challenges. These include interpreting existing legal and regulatory frameworks in the application of this new technology, investing in blockchain-based applications that are enterprise grade and scalable and integrating these systems with legacy technology.
Trade Finance has made significant strides into live production for several platforms as it represents one of the areas that have most to gain from distributed ledger technologies. The Documentary Trade segment of Trade Finance is a $2 trillion industry that comprises roughly 15% of global trade, but is paper heavy and yet to be digitalized end-to-end. Blockchain offers a path to increased digitalization, with the potential to provide end-to-end solutions with lower risk and open up sources of revenue growth.
Speed and the opportunity to replace a middleman are some of the biggest advantages that blockchain offers. While most development efforts at enterprise blockchains (private or consortium) are being driven in-house, public cloud providers like Amazon Web Services, IBM or Microsoft Azure are helping enterprises to take on the nascent technology, with pre-configured protocols that save enterprises the time for developing the entire logic by themselves. By redistributing trust from centralized entities to a network of nodes (computers), blockchain-as-a-service (BaaS) offerings have allowed customers to leverage cloud-based solutions, develop and use their own blockchain apps, smart contracts and other blockchain functions while cloud-based service providers address necessary tasks and activities related to infrastructure.
Digitalization of the supply chain is still in its infancy and requires more automated inputs as the blockchain network must include the whole supply chain for maximum efficiency to be realized. For transportation and utilities, many of the current initiatives are focused on efforts to automate processes and data entry to achieve back office efficiencies. From manual processes to legacy information systems, blockchain has the potential to address the fragmented nature of the transportation and logistics industry. Blockchain could be used to streamline receivable collections and payments, effectively cutting out the middleman and decreasing the number of disputes that arise from such transactions. Automated delivery notifications and usage in pricing also represent possible uses for blockchain.
Finally, blockchain could also be used to track and isolate damaged or spoiled goods, increasing accountability and decreasing the waste from product-wide recalls. In terms of scale and integrating blockchain, these solutions are currently limited to a small number of parties and have yet to be implemented on a larger scale across the supply chain.
Through the facilitation of faster transactions, peer-to-peer networks and utilization of smart contracts, blockchain has the potential to disrupt the energy and utilities market. A wave of technological innovation could coincide with an unprecedented transition from a centralized utility model to micro grids in a distributed services-based marketplace.
Since the energy value chain comprises of a number of relatively stable, low-margin, cash-generative businesses, the industry is an obvious candidate for technology-driven cost rationalization, if not elimination. The costs associated with settlement, contract and invoice monitoring are a significant burden for the industry. However, distributed ledger technology could provide an alternative complete transactional history that is visible to all participants and tamper-proof, secure and permanent. The utilities industry faces both opportunities and threats in the future widespread adoption of blockchain, but the technology is still in its infancy and utilization is currently limited to a relatively small number of wholesale and retail trials.
As blockchain evolves, the outlook for cryptocurrencies remains challenged. Over the past year, the cryptocurrency market has become even more dominated by individual investors, as participation by financial institutions has faded. The asset management industry has yet to gain SEC approval to launch a cryptocurrency ETF and no major retailer added cryptocurrency acceptance in 2018. The potential for fraud and manipulation, limited market size and lack of regulation of the underlying products remain barriers to institutional adoption. Cryptocurrencies’ value as diversification remains unproven in most environments other than a dystopian one, characterized by a loss of faith in all major currencies and in the payments system.
Diminishing volume remained a consistent theme for the crypto market in 2018. Market capitalization of cryptocurrencies shrunk significantly with the market, facing an 85% loss in value from its 2018 peak. Moreover, bitcoin’s share of total cryptocurrency market capitalization has increased to 53% compared to an all-time low of around one third at the turn of 2018, meaning other cryptocurrencies continue to suffer disproportionately more during the past year’s correction phase.
Key flow metrics such as daily median transaction sizes have also shown a dramatic downshift in trading activity across all cryptocurrencies. Sharp fluctuations within the daily median transaction size for bitcoin, which spiked to a peak of around $5,000 heading into 2018 and down to only $130, proved that crypto assets are not immune to market forces.
Cryptocurrency market capitalization (in $billion)
Source: CoinDance, J.P. Morgan
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