From Wild West to Wall Street
Blockchain is about taking the “open source” philosophy and applying it to everything. The two primary values of open source—transparency and accessibility—are combined with a third value of trust through simplified authentication. Blockchain enthusiasts envision a world where governments publish a public ledger of every contract signed or tax payment made; where automated machines like driverless cars speak directly to each other on the road; where our birth certificates are digital and provided to everyone; and where “banks” are just algorithms running independently on computer networks.
Given its potential, Blockchain will ultimately transform many systems of transactions involving secure data. At the same time, the most promising uses of Blockchain are in areas that are often slowest to change—finances, internal controls, and personal information such as healthcare records—meaning its adoption will be slow and carefully tested, with a few proven names gaining widespread use thanks to the network effects of users sharing a single platform. Currently, a number of these use cases are being tested “sandbox” form by large names in finance, such as Visa, Nasdaq, and bulge bracket banks, with companies like Amazon Web Services (AWS) and Microsoft providing the technological know-how on creating functional and secure solutions. Ultimately, the first players to establish trust with users will pick up share much more quickly and dominate their respective markets, but growth remains an on-going process for now.
Blockchain originated with Bitcoin, but the former has a number of applications outside of its use as a currency and will ultimately prove to be of much greater value. Bitcoin gained poor press as criminals were initially attracted to its value in laundering money and selling illegal goods outside of the financial system. Blockchain, the technology on which Bitcoin is built, works by creating a public ledger of information that can be accessed by anyone but is protected through encryption technology against interference or falsifying records.
The simplest application for Blockchain then would be in reducing intermediaries. With two counter-parties, consumers could transfer money directly from their accounts through a public “wallet” system without the need for a bank or other institutional middleman. Likewise, a “smart contract”—an algorithm that executes transactions appropriately—could be used for transferring money in royalty or licensing agreements, subscription services, or even for lending purposes.
Through a centralized ledger system, Blockchain users could also authenticate a number of goods and services—meaning IP could be more easily authenticated, or stock exchanges run centrally without broker-dealers and designed to test automatically for insider trading. Assets, such as cars or housing, could be transferred directly— someone renting a car could pass the car on to another user without having to return to a central agency, as both users would be validated based on a digital signature. This type of transaction would require identity verification applications as well; secure systems of record could replace credit agencies and significantly reduce the cost of background checks needed to open a bank account. An internal Blockchain could likewise record all internal financial processes and eliminate the need for audits. Although many of these applications are often technical or “behind-the-scenes” within firms, they still promise major increases in efficiency which will eventually reach the consumer—like the PC or the Internet in the 90s, familiarity through enterprise will probably lead the way to eventual and more popular retail uses.
In an Open World, Privacy Still Valuable
Although we think there is great value in this transition, we think there is a natural tendency for humans to value privacy and resist the fully transparent nature of public Blockchains. This will slow adoption and likely fragment Blockchain first into“side chain”technologies—internal Blockchains that are public within companies, organizations or communities that still serve a similar, albeit less ambitious purpose.
Similarly, the economics of Blockchain suggest initial adoption will be slow but eventually quickly accelerate. Like other platform type businesses—such as Uber or Airbnb—that create value by connecting users, Blockchain benefits from network effects, meaning its usefulness increases exponentially with larger numbers of users. To succeed, platform businesses must first gain the trust of users and provide a means for users to trust each other. Like the driver ratings on Uber, Blockchain companies will need to find a simple way of communicating the security of the platform to its users.
For financial services, a number of large banks would have to simultaneously adopt Blockchain technologies to make the system useful. The banks are currently experimenting with some of these technologies through a consortium called R3CEV, which uses bank data on a secured Microsoft cloud system that would allow all of the institutions to access a shared system of record.
Early Movers Grow the Market
Currently, Blockchain technologies remain somewhat fragmented, with a number of small players experimenting with different forms and data sources. Blockstream is one such company with funding of $75 million after a Series A round led by Horizons Ventures and AXA Strategic Ventures. Chain, another promising player with $44 million in total funding after a Series B round, provides an online platform which helps developers to build bitcoin applications by providing access to the block chain – with a major focus in the financial services vertical. This area in particular has many entrants, given the costs of clearinghouses and other over-the-counter markets like derivatives that need greater centralization and transparency and high willingness to pay amongst large financial institutions.
Previous platform businesses attained market leading share by not just replacing current systems—taxis, hotels—but by creating new forms of interactions that were more useful to users—ride-sharing, peer-to-peer accommodations. Blockchain innovators have the potential to provide similar impact in the next decade, but for the time being specific applications with proven track records will pickup the early funding and lead the way forward.
May (Not) Jobs
Payrolls and employment are sending worrying signals and markets are tunnel visioned in on the interest rate implications. A large and growing body of evidence suggests that the economy has been and continues to roil many and disappoint even more.
Unemployment numbers, drawn from the household survey, keep improving and fell to 4.7% (narrowly defined) in May 2016. We had expected 160,000 net new jobs in May, in line with initial reports of April 2016. The establishment survey revealed 38,000 net new jobs in May – 24% of the expected level of job growth. The weakness was widespread in May and we saw downward revisions to previous months as well. We saw downward revisions in the March number by 22,000 and downward revisions of 37,000 in April. Spring 2016 is shaping up as very weak for employment, averaging just 116,000 net new jobs a month.
One area of the May Non-Farm Payroll Report struck us as worthy of greater discussion but did not receive it generally. There seems to be a marked increase in part-time workers who want and are seeking full time work but are unable to get it.
There was a meaningful increase in the group “Part Time for Economic Reasons.” Involuntary part time employment increased by 468,000 new workers across May. There has been a gentle downward trend in this group but the numbers have been much more stubbornly elevated. If we combine long periods of stagnant wages, declining labor force participation and many stuck in part time work, we get insight into the levels of discontent fueling insurgent candidacies and public expressions of disaffection.
One of the enduring factors of the great downturn has been years of persistently low participation rates. Troublingly, we saw participation rates return to their recent lows in May. The economy lacks the vigor and allure to pull people back who were pushed out or dropped out during the long swoon, 2008-2010. Participation rates for younger people have been even more difficult to get back to pre-recession levels. Persistently low participation is very problematic, particularly among members of the next generation of earners.
Stagnant wages and rapid shifts in areas of labor demand have left many behind. Participation continues to closely follow from the levels of educational attainment. As education levels rise, so too does labor force participation. However, participation has fallen and stayed low across age and educational attainment. Thus, we know the issues here are structural and will require a real and consistent effort to fix. We see this and the stagnant wage performance as the leading issues being under explored. There is clearly a high and rising economic and political price tag associated with our participation and wage issues.
Most attention is focused on Fed policy decisions in June and July. We see the big fallout from jobs numbers coming in the election cycle. The voter groups breaking with convention share profiles and issues with the groups highlighted as contributing to May’s weak Non-Farm Payroll Report. Our focus is on and will remain on wages and participation. When and if we see improvement in those numbers we anticipate a more aggressive Fed policy and more settled political process. Until then, we are bracing for an involuntarily exciting run of political and economic data.