null Episode 19: Decrypting Cryptocurrency
Double Take podcast

Episode 19: Decrypting Cryptocurrency

00:51:15
Double Take podcast Audio Thematic Equity Multi-Asset Index
June 2021
Episode 19: Decrypting Cryptocurrency

Our latest episode of Double Take explores how investors can assess valuations and risks of companies increasingly exposed to cryptocurrency.

Rafe Lewis: Hello, and welcome to Double Take, a podcast by and for investors seeking clarity in the fog of charts, themes, and noise deluging anyone who's trying to make sense of the public markets. I'm your co-host, Rafe Lewis.

Jack Encarnacao: And I'm your other co-host and clarity seeker, Jack Encarnacao. On today's episode, we dive into the money that has no bank notes, the specie that was never minted, and the legal tender with no nation standing behind it. That's right, cryptocurrency. Is it money? Is it an investment? Is it a fad? Is it art? I'll be honest, Rafe, one of the main reasons I wanted to do this episode is because I'm genuinely flummoxed and need some guidance here.

Rafe: And guided ye shall be matey. For today, we have two bright minds to help us navigate this perilous seaway. The first up is Erik Swords who manages the Blockchain Innovation strategy at Mellon. So I think he knows where of he speaks. So Erik is a veteran tech analyst. He's been watching crypto since the long past days when people were actually buying pizzas and cars with this funny currency before some of these so-called coins became valuable enough to buy a home or a small country. So Erik will help us understand what equity investors need to know as public companies begin to expose their businesses and their balance sheets to crypto.

Jack: Excellent. And for our outside guest, we will have Mike Demissie. He's the head of advanced solutions, meaning machine learning, AI, blockchain, digital assets for The Bank of New York Mellon, which it so happens is our parent company. Mike will give us a better sense for what it takes for big, sophisticated companies to get into the crypto game and how this currency is held for safekeeping. But first, just a quick note, remember, we are still at long last recording these podcast episodes from our home offices. So do please excuse any background noise like dog barks and doorbell chimes. And also, a friendly reminder if you like what you hear and don't want to miss another episode of Double Take, take a moment, hit the subscribe button, tell your friends and relatives about us, and your enemies for that matter. Remember, you need to keep those closer.

Rafe: It's downright biblical at this point. So well said, Jack. All right, let's dive in. Shall we? Erik, welcome to Double Take.

Erik Swords: Rafe and Jack, thank you very much for having me today on Double Take. Super excited to discuss crypto with you guys. It's been a fascinating topic that we've been fortunate enough to be doing research on for the past several years now.

Rafe: Yeah, it's been a long haul. I mean, I miss actually seeing you in person in the office doing that work. So hopefully that happens again soon. Well, why don't we start by just addressing the elephant in the room, Erik. So, I'd like you to try to define cryptocurrency in that, is this money? Is it just an investment vehicle? Is it just a random series of numbers and letters signifying nothing?

Erik: Yeah. I mean, look that is the elephant in the room. And that's the question that I think people tend to struggle with. I think you need to take a step back and sort of look at the roots of where blockchain was born out of which, was exactly the same thing as Bitcoin. Just remember, those two things from the beginning were synonymous. They helped create one another. And in thinking about the system itself, I mean basically what it was designed to do, and this is Bitcoin early days, so over a decade ago, it was designed to be a peer-to-peer money transfer system. And there were a series of protocols and different things that went into this. But the underlying concept was that this was something that would sort of free society of being tied to a central governing authority, be able to create a system that was unique in the sense that it was using computer programming, as opposed to shovels and picks and the dirt pulling up gold and things along those lines. And there are costs associated with it.

Erik: So it's not like it's just something that's created out of thin air. There's a realistic cost that goes into mining each Bitcoin or other cryptos for that matter. But look, at this stage in the game, I think we're still very, very early days as far as how the market is understanding not just cryptocurrencies but blockchain and how that fits in, the different types of cryptos that exist in the marketplace, and then defining what they are. As you pointed out from the outset, it's is this a store of value? Is it a trading vehicle? I mean, at this point, I think you could say the answer is yes to all of the above and that's okay. That's part of what's happening with the marketplace.

Jack: So Erik, of course, you're a fundamental bottoms-up analyst. How do you go about doing that type of analysis for companies that have Bitcoin or any other crypto on their balance sheets or are somehow trafficking in this stuff? And how do you get to the underlying real value of crypto in that context of doing the bottoms-up analysis?

Erik: We've been fortunate enough to be able to, first of all, leverage the great research team that we have at our firm to be able to take a look at different scenarios and different analyses, as far as how other people look at commodities, precious metals and things of that nature. There's in any type of situation like this, where you're talking about something that is being utilized as a store of value or some sort of an exchange mechanism, you're trying to figure out ultimately, what is that worth? And we have written a white paper on this as far as how we think about Bitcoin's valuation. That can be found at our website. So that's worth taking a look into. But at the end of the day we found a number of similarities between the analysis that's been done over a very long period of time with gold. As I pointed out before, there are costs that are associated with mining Bitcoin.

Erik: And that's one of the big topics these days too, which it ties into electricity consumption and things of that nature, which I'm sure we'll talk about a little bit later. But at the end of the day, it becomes something that, in my opinion at least, it's fundamentally a more functional exchange of currency in some cases, but I think that's going to graduate into being just something that functions more as a store of value. Now you asked the question as far as evaluating companies. We've seen some interesting scenarios out there where companies are receiving big premiums, even to their just core enterprise value of a company, because they've purchased Bitcoin and held it on their balance sheet. In one particular case, and it's fairly well known out there, one of the publicly traded companies was more or less being used as the equivalent of a Bitcoin ETF because in the United States there have been no Bitcoin ETFs that have been approved so far.

Erik: To me, it's kind of an unrealistic way of valuing that particular equity, or what does that mean for the underlying token itself and as far as the value of that? In my opinion, those things, obviously they don't go together as far as the value itself of the company, because there is an underlying software business in this particular case, and that's still running on a standalone basis. All Bitcoin's doing is functioning as an asset on their balance sheet. So, a company receiving a premium for that, I'm not sure that, at least in my mind from a fundamental perspective, that makes much sense. The bigger picture here though in thinking about this and in sort of what was the tipping point for us was just the fact that you started to see a greater level of acceptance and it wasn't just from consumers, and that's the point that you guys are getting to is, okay, so what's kind of caused some of these enterprises to be thinking about putting Bitcoin on the balance sheet?

Erik: And this goes back to, I think probably last summer, I would say. Obviously we went through major transformations on the digital front as far as what was going on because of the pandemic. And as part of that taking place, I think one of the things that was sort of left behind, because remember when we went through the pandemic early days it was all about how can we stay connected? Do people have video conferencing capabilities? All that stuff. So it took a few months to sort of sort through all that. Get to the summer time and it's starting to realize, look, all of the transactions that we're doing are online. All of the orders we're placing, they're done digitally. We're connecting with people digitally, et cetera.

Erik: So, the bigger point here was that there was a rationale to start thinking about the function that a digital currency or a digital store of value could have its place in society. And it was kind of interesting in the sense that it was right around that time period where we started to see a number of enterprises talking about putting a Bitcoin on their balance sheet. And similarly, the acceptance from merchants, which is significant in this particular case, has gone up exponentially. And there was another company in the payment space that basically opened up transacting with cryptocurrency, but I think it was Bitcoin specifically, with all of their merchants. And this was over a million types of merchants that are out there, and I think it was multiple millions of merchants.

Erik: That's enormous when you think about how that's opening up sort of the wavelengths as far as how people are utilizing trafficking and subsequently storing value of their own with others. So I think that it's kind of a fascinating topic in the sense that we've really come a long way in a short period of time, but I feel like that was primarily driven by what happened as far as the pandemic and accelerating digital transformation as a whole.

Rafe: Well, Eric, you've been an analyst and investor for a long time. If we take two companies side by side that are essentially identical, as a matter of fact they are identical in every way, except one of them is including some transactions involving crypto and the other is just using good old-fashioned currency. Which one gets the higher valuation? Which one has the higher risk? I'm just curious how you look at it these days now that you effectively have to.

Erik: Yeah, it's another great question, Rafe. And I think today, on a standalone basis, the answer would be the company that is doing something with crypto, whether it's transacting in or holding on their balance sheet, would get the better multiple. I think part of that is just due to the market sort of trying to figure out who is more forward thinking as far as what this next digital society is going to look like. In the end, it may not be Bitcoin that is the Trojan horse or the store of value. It could be something else. I don't think that's super likely given where we are today. However, it just shows an appetite to take on risk that is associated with our society moving more digitally. And I think that's something fascinating from a societal perspective, but it makes sense.

Erik: If you think about where we are as far as generations growing up and digital natives being a bigger part of society today. I mean, these are things that the members of these generations, they understand these things like no other. So it's fascinating to run through the use cases that in this particular case are more functional for the younger cohort of people that are out in society. But in general, look, I think the companies that are utilizing it are showing that there's an appetite for risk that's associated with being a fully digital company.

Jack: That's great, Erik. You mentioned Bitcoin and whether or not it will become to be thought of as the Trojan horse in this transformation. What, if anything, actually in your mind distinguishes one crypto from another?

Erik: Yeah. I mean, look, I think it's the purpose that it serves in the end. It's been established so far that Bitcoin can be thought of in a few different ways. It's the store of value, the exchange of value, and a few other, I guess, tangential use cases that are not as relevant. If you look at that in comparison, and I think that there's hundreds of cryptocurrencies that exist today. And I think using the word currency is kind of a mistake in a way, because I'm not sure that they're necessarily classified, or what I would characterize, as a currency itself. In many cases they're blockchain networks that are being valued by the market. And one of the things that I typically try to point out is, if we make the distinction between Bitcoin and what that does in comparison to something that's fairly popular with Ethereum, the way I look at it, and I'm not saying this is a hundred percent accurate, but just for argument's sake, gold and Bitcoin have some similarities. Whereas oil, which kind of powers and serves as a fuel throughout the globe, is very similar to the way Ethereum works.

Erik: And allowing the market to value what that network is worth in the same way that the market can evaluate what oil futures are worth, et cetera. So, there are distinctions just based on what each crypto is doing. So, what purpose is it serving? What networks is it involved with? And what problems are they solving? So, one of the things that you're hearing a lot more about these days is decentralized finance and there's many different networks that are out there, but that's in large part tying into the Ethereum network. And that's one of the reasons why I think over the past several months now you've seen more and more interest in Ethereum because there's this realization from the marketplace, that decentralized finance aspect of Ethereum in being able to power those types of applications, is a very, very large market. So, it's a long-winded answer, but it's each one of these are functional in different ways. So, what Bitcoin is, is not necessarily the same as what some other cryptocurrency is characterized as.

Jack: You mentioned decentralized finance. Can you delve into that a little deeper for us, Erik? How do you think about that? What's revolutionary about that?

Erik: Yeah. I mean, Jack, think about it real simply as far as the banks that we use today. I was in a situation a few months ago where there was actually, believe it or not, but my parents owed me some money for something that was unrelated to anything to do with work or anything like that. It was just something from the past. And just say it up front, so the check was for $18,000. And I go to deposit that in a Bank of America account, and to cut to the chase it basically took 11 days for that check to clear into my account, despite the fact that there are funds available in my account and so on and so forth. People are just tired of that. It's like, why can't I have my money right now? So one of the things that blockchain technology brings to the table is being able to settle transactions in real time, have the documentation and everything else that goes along with said transaction, put it on the blockchain, have network participants, whether there's a consensus mechanism or not, but network participants saying, “Yes, this is a transaction that did place.”

Erik: It should be updated, uploaded to the blockchain and documented there immutably. That's a very compelling case. So what you're starting to see is this is moving into all sorts of areas, whether it's you're starting with crypto trading. And we've seen a very large company came public somewhat recently, and that's a crypto trading platform. Where we're moving next to is into traditional finance, so consumer banking and moving people over from fiat into a digital world, so having a wallet. The next thing we move into our areas like financial applications that are associated with things like loans and insurance. These are all things that are very inefficient today. There tends to be a lot of back-office activity that takes place, and these are just ways to help solve problems using technology from a very low cost perspective in the end.

Erik: So it's really about creating efficiencies. And again, using that framework of thinking about what does a digital society look like in the future? These are applications that are being powered by blockchain technology. Let the market evaluate whatever that is worth. And people can trade around that if they'd like to. They can be network participants if they'd like to. But in many cases, what the end solution is, is trying to help create economic value that network participants can participate in. That's a big thing. So, that's a big change. That's like Bank of America, instead of them giving you $5 back every month or something, they're writing you a check because you did 500 transactions. You're participating in that network activity and actually benefiting from it. So, there's things like that, Jack, that I think are super exciting, and they're not far off. I mean, we're seeing a bunch of these use cases finally actually take hold in the marketplace. And there's been some really exciting things that I think people are seeing. This is a great way to extract value from otherwise sort of inefficient businesses that exist today.

Rafe: Oh, and I don't want to kind of deflate the balloon because that stuff is very exciting, but you did bring it up earlier, and I think it's worth following, that there's an ESG component to some of this coin mining that goes on. And that said, it takes a heck of a lot of electricity and a lot of servers spinning 24/7 to mine these coins. Right? So I guess what I wonder is, and we got into it a little bit earlier talking about all things being equal, two companies, one transacts or holds crypto, the other one doesn't. Right? There is an ESG question here. So if a public company starts parking material amounts of money in crypto or doing a lot more transacting in crypto, does this ding their ESG rating somehow? Do they have to go out and find kind of clean power sources to ensure that their exposure is kind of offset somehow by the carbon footprint problem here?

Erik: Yeah. And this is a very big question. A lot of people have been bringing this topic up for the past several years now, Rafe. There's no perfect answer, but where I sort of start with this is the fact that we're talking about E, S and G, that's number one. It's because people tend to get just hung up on the energy consumption aspect of it, which I agree is a real issue. It's something we should discuss. But there's not enough time that's spent thinking about the S and the G angles to this. And where I come out with this in the end, to really just get to the point, when you add up all the factors that come into play from an ESG perspective, I think this is actually a positive thing and would deserve a positive ESG rating as far as what it's bringing in terms of governance and societal benefits.

Erik: People may disagree and there may be some aspects of this where the E part does actually outweigh some of the benefits that would be brought by the social aspect and certainly governance. But look, I think this is, and specifically when we're talking about Bitcoin, and there's a bunch of numbers that are out there, and I don't want to start quoting wrong numbers, but it's something in the neighborhood of 75% of Bitcoin mining is using renewable sources. If you think about the way the network is architected, it's basically encouraging Bitcoin miners to be using the lowest cost energy sources that are available, which in many cases are renewables. And so that is sort of just built into the network itself. So you have producers that are constantly searching for the best price, which in this case is electricity.

Erik: I feel like that's going to continue to push the envelope in terms of not only embracing renewables, but also trying to find sources that didn't necessarily exist before, that could help power some of these blockchain efforts. So I see enough that the industry is doing at this point. It's not to say that energy hasn't spiked. It's not to say that Bitcoin doesn't consume a lot of energy. It does.

Erik: But I think there's other things that we could probably use in comparison that would put it on a more level playing field, like the expenses associated with running the traditional finance systems that exist today in the world. The costs of that dwarf anything that's going on with Bitcoin mining. Similarly, the amount of gold that's taken out of the earth per year and what are those costs look like in comparison to Bitcoin mining? Again, that's a number that's much higher than what exists today, as far as Bitcoin. So, there's a number of ways that this can go, but what I would leave you with on this topic specifically is that in my opinion, the S and the G outweigh the risks associated with the E.

Jack: Wow, all bases covered on the crypto front. Our own Erik Swords, joining us here to orient us at the top of Double Take. Thank you so much, Erik, for taking us through this and giving us a sense of what to keep our eye on going forward.

Erik: Thank you both very much. I appreciate it. And keep it real on the webcast. I enjoy what you guys have been doing, great topics and worth a follow. Thanks guys.

Rafe: Mike Demissie, head of the Digital Asset unit at Bank of New York Mellon. Welcome to Double Take.

Mike Demissie: Thank you. Thank you, Rafe.

Rafe: It's great to have you. And I would have to say you're a non-fungible guy when it comes to this role at the bank. So, it's a pleasure to get you. You are a one of a kind around here I think when it comes to us being able to find someone who can really describe the business side of crypto and how companies are actually going to be dealing with this kind of currency going forward. So it's really great to have you. So, Mike, let's start at the very beginning. So Bank of New York Mellon, this is a bank that has its origins in a financial institution, founded in the 18th century by Aaron Burr of all people, Alexander Hamilton.

Rafe: How the heck did a bank that old, this storied, find its way into cryptocurrency or as some are calling it, right? It's in your title, digital assets. The digital assets business, how did this bank get involved in that business? And then perhaps more importantly, why?

Mike: Absolutely, Rafe, and we get that question a lot. I think the answer is actually rather simple. It's been primarily led by our clients. So, I don't think it would come as a surprise to you or the listeners that we've been seeing a great deal of interest on digital assets across the board. And this has been true for the course of the last year, I would say it's been accelerating even more. And our clients are saying, "Just because we're getting exposure to a new asset class, it doesn't mean we're looking for a new service provider." Right?

Mike: So they're looking at us as their trusted service provider and saying, "Can you extend what you do for us today across all our other assets, to this new segment as well." And for us, we look at it as not just a recent phenomenon, but as part of a larger trend of assets, going digital. So, we see it as emerging as a formidable asset class and it's continuing to grow. So, we saw it both as a market imperative and our responsibility to support our clients. So it was a fairly easy decision to get into this with conviction.

Jack: So many ways to come at this Mike. I wonder if maybe you can just level set for us in terms of what precisely is BNY Mellon doing with these crypto assets? How do you hold a bunch of ones and zeros for safekeeping?

Mike: Yes. I mean, that's a great question as well. I think, when you look at our bank, one of our core services—we have an array of services—but one of the core that we're well known for is being the largest custodian in the world. We have more than $41 trillion worth of assets in our custody. And that's primarily the trust factor. And the fact that we have this long record that we just mentioned, is the reason why clients are coming to us. So, when you're thinking of digital asset, like ones and zeros, custody takes actually a different form. In essence, if we use maybe Bitcoin as an example, this asset has different keys.

Mike: So one is a public key. Think of it as an account number, an address where you can actually store the asset. And the other key is a private key and think of it as a password that you can use to actually direct the movement of this asset. And in essence, custody means actually safekeeping the key needed to move these assets. So, we do have the technology infrastructure and when this technology goes live, our clients will be able to move their assets to their accounts at BNY Mellon. And the system will generate a new set of keys that actually only BNY Mellon would know.

Mike: And safeguarding those keys means safeguarding the client's assets because you cannot move assets without it.

Jack: Yeah. I'm glad you brought that up. Is there a risk that a bank can lose someone's password? They're locked out of their money or, maybe more seriously perhaps, is the risk of being custodian to crypto any different than being a custodian to good old greenbacks, euros, yen?

Mike: Yes. There's a lot to unpack in that question. So, the system that we have—and we spent a lot of time actually looking at it from different angles, and we'll continue to examine it from all different surfaces—is a robust, secure infrastructure that actually allows us to maintain these keys without them being available to any individual. So, even at BNY Mellon, any individual would not be able to know these keys to move the asset. So the system safeguards against that. And there's no single point of failure.

Mike: And we've minimized the risk of losing these important keys by having it in this highly resilient, secure infrastructure that has different safeguards. But are there risks involved in this asset that are unique compared to others? Absolutely. And that's why it really requires a new type of technology, it requires a new way of handling. One of the common threats is cyber threat, right?

Mike: But that's not new to us. I mean, safeguarding against cyber threat is also required for our traditional asset custody and management as well. So it is being able to extend those capabilities to really accommodate for the nuances that are brought on by the digital assets of the world. Just along the lines of the key management that I described earlier, as well as different types of security infrastructure that actually, in some cases, you may choose to actually completely move it offline.

Mike: And so you can actually just reduce the chance of it being attacked by an external threat. So, you hear these different terms about cold storage and hot storage. And the simplest way, what it means is whether that is online and something that can be accessed, or versus it's air gapped and it's not actually connected to a network. Our solution will have both because, to accommodate different client needs, and that actually balances out availability of those assets and the security needs as well. So all of these considerations are thought through when you bring this type of product to the market.

Rafe: And are these crypto assets as liquid as traditional currencies and things like that? Can these corporations and these corporate clients and business clients of yours access this money the way they would access anything else? Or is it a little more complicated than that?

Mike: It is not as liquid as traditional currencies as you would expect. Just because it's a very nascent market, it's not fully developed but you're seeing it grow quite dramatically. I mean, literally every week you're seeing different moves. And as more and more institutions are getting into this space, the infrastructure and the marketplace itself, you see it being transformed into what you would expect from a more robust market. So, I still would think of it in a fairly early growth stage, but just rapidly transforming.

Jack: Mike, there are so many new coins coming out all the time, so many names to keep track of. And I wonder in the seat, you said how necessary it is running a business like this to stay on top of the dizzying array of different coins that have come to market. I mean, is crypto, crypto? Or do you expect that financial institutions will find themselves having to, I don't know, almost in a way legitimize certain coins and not others?

Mike: That's an important question as well. I think when you look out today, you see thousands of coins out there. But that number can be a little bit misleading because the entire market cap today of crypto is around $2 trillion. And just Bitcoin and Ether amount to a significant majority of that. So, not all crypto is the same. I think another important consideration, especially from a regulatory angle, is the different characteristics of these tokens. So when you think of something like Bitcoin, it is deemed not as a security, and that actually has important implications when you think from a regulatory angle.

Mike: But there are tokens that actually have entities behind them and there's no hard cap in terms of how many of them that you can create. And all those factors are important considerations because when you hear the term about Bitcoin being digital gold, because it has this by design, this scarcity built in. There's only going to be 21 million Bitcoins. And that actually leads to a certain type of characteristic as an investment. But not all coins subscribe to that. And then, when you go under the cover in terms of the different consensus mechanisms that they use, these are different validations of each of the transactions.

Mike: So there are really a lot more nuances to these. I think it is part of the early growth stage, again, you can almost go back to the internet companies, and the proliferation of that. But who will eventually be successful—it's not going to be the thousands of coins that you see out there, but a few that would actually manage to get to the critical mass and utility globally.

Rafe: Mike, you guys, if memory serves correctly, this was launched, this digital custodianship business, was launched earlier this year. I think it was February. I'm curious, just generally speaking, the kind of demand you're seeing for this service, is it large corporations? Is it all the way through the small and medium-size organizations? And how fast is it growing? Give us a sense for this.

Mike: Sure, sure. And one thing I should note as well. Yes, our formal announcement happened in February, but this has been in the works for quite some time. And we've been engaging our clients, you can call it, in bilateral ways and some were ready for this more earlier than others. But we saw actually a momentum build up towards the end of last year, the last half of last year and continued into 2021. What's remarkable about actually the level of interest that we see in this space is, it's very broad, it's across all our client segments.

Mike: Not everyone is at the same level of comfort, or some are just dipping their toes and others are more comfortable and they have actually invested significant amount in the space. But you're seeing a level of engagement literally across the board, including significant interest from our wealth management clients as well. So you can consider 2020 the year these types of assets actually became mainstream. And we see that continuing through 2021. And that didn't happen just by accident.

Mike: There were a number of important factors actually that led to that, including seeing actually other credible institutions getting into the space, seeing additional regulatory clarity about the space in terms of banks being able to provide custody services or being able to work with stable coins. We started to see clarity on the direction of travel and I think that continued to give investors more and more confidence.

Jack: With those clients Mike, if you could take us a little bit into the mentality that you're seeing prevail here. Are these folks that really believe in a crypto future and have sort of bought into this being a permanently baked in part of the financial system? Or is it more, do you think honestly, not wanting to miss the wave? Just get me signed up whatever way you can because of the incredible eye-popping numbers we sometimes see from the crypto space. Which of the two is more common do you think at this stage?

Mike: Look, I mean, there's definitely an aspect of, I think people not wanting to miss out. At the same time, there is a growing level of confidence, particularly with Bitcoin. The digital gold narrative is taking hold right now. If you go back to the genesis of the creation of Bitcoin itself, the novelty of it is as a payment utility, for two individuals like you and me being able to transfer value without actually having an intermediary. That was the novelty of the solution.

Mike: But today I think you can safely argue, Bitcoin, the narrative that it's not a payment utility but rather a store of value, an equivalent to the gold investment pieces, is what you're starting to see. And credible investors, investors who have proven track records, starting to make these type of assertions, and you're starting to see more and more of that and people getting comfortable with that piece. I wouldn't say that it is a settled debate, but it's something increasingly people are getting comfortable with.

Rafe: This is so fascinating to me, Mike, because you take a traditional custody bank relationship with their clients. And it's really about holding something that's a lot more stable usually, right?

Mike: Right.

Rafe: With currency, traditional currency. And yet this is almost like being the custodian for investment assets that can be wildly volatile. And at the same time, you've got this other narrative going on out there of our governments getting nervous. So, is their currency going to be replaced by something with a dog on it or something? So, what I would ask is this, are you getting any phone calls from central banks? From officials in governments who are just asking questions and wondering about this a little bit?

Mike: There's a lot to unpack in that as well. I think just going back to the first part of your question in terms of the type of assets that we typically work with and how different this is. When you look at actually these assets, how they originated, in terms of the fact that you can operate without an intermediary was a big selling factor. And there were even arguments and theses that you would hear out there that people saying, “This doesn't need trust to operate.” At a design level, that is true. But what we're seeing from investors is trust and risk management and security are very, very important when it comes to this asset class.

Mike: And so in some ways, when you look at it from that angle, it's not surprising that you find clients coming to us to say, "Okay, we trust you with this asset", or "We would only get in when we see that type of secure infrastructure." And going to the central banks arguments and in terms of currencies, at least certain parts of these cryptos have moved away from the payment argument and they’re more of as an investment asset. That said, they've definitely woken up the debate about the need for digital currency.

Mike: And I would argue, they have accelerated the move towards actually creating a more stable type of digital instruments, digital coins, including the ones that would be issued by central banks, to provide those characteristics. So we see that picking up for sure. I think a recent research quoted more than 80% of central banks doing some level of studying or investigation and actively looking into this space. So that tells you how central banks around the world are taking this seriously.

Rafe: And are they talking to you guys at all? Are they actually talking to the big banks they would normally work within the system?

Mike: Sure. BNY Mellon, for instance, is one of the financial institutions working on a stablecoin called Fnality. And it is a digital currency that would be backed by deposits at the central banks. So we're actually actively working with central banks on that. And so, short answer is yes, and you're going to see that to continue. But there are some big design questions that need to be answered. So it still may take some time for this to materialize. That said, regulatory engagement goes beyond the digital currency or CBDCs.

Mike: There is very, very robust and active engagement with our regulators. And along the line of what you would expect in terms of how to provide these services in a safe and secure manner, what does the risk management process look like? And I personally am involved in a lot of these conversations, which I would describe as very constructive. It’s really trying to understand the nuances that we talked about earlier and come up with a safe and resilient ecosystem that actually provides investors protection and the proper governance and risk management.

Mike: And so the firm, like BNY Mellon, getting into this, that actually has the history of dealing with those types of requirements. And that is in a heavily regulated segment and tells you as well in terms of the maturity of this space.

Jack: I'm not sure of the degree to which tax treatment is part of your purview there in advising clients on this stuff. But I think it's been in the past few years, accountants have been asking, do you own any crypto assets? Have you bought any crypto assets? And when you think about it, as you've talked about, Mike as a unit of exchange, that's one thing. But if you're sitting on it as sort of an investment vehicle, as a proxy for maybe gold or a replacement for gold, just to use an example. How does that impact the capital gains liabilities? The kind of way in which owning these assets is viewed in terms of Uncle Sam.

Mike: Right. I'm sure you've seen that the news reports on this. Definitely, IRS and tax regulators are paying close attention to this. And part of the requirements that are coming out are just ensuring the level of transparency and reporting tied to these investments and to really just bring them up to the same level of other investments as you would expect. So that's definitely moving at a rapid pace and we would expect it to get a level of scrutiny and treatment, because of the increased participation that you see in that space as well.

Mike: And it is one more reason, again, for clients actually to work with an institution, someone that can provide that level of reporting and compliance and tax treatment tied to these assets as well. So, absolutely, that's a key consideration.

Rafe: Well, Mike Demissie, the middleman for the currencies that weren't supposed to have a middleman. Thank you so much for joining Double Take, this was really interesting. I've got to say we've had a lot of guests, I learned a ton this time. Thank you. My pencil is out of lead at this point. So, thank you so much for joining us.

Mike: Thank you, Rafe. Thank you, Jack. A pleasure.

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

Mellon Investments Corporation (“Mellon”) is a registered investment advisor and subsidiary of The Bank of New York Mellon Corporation (“BNY Mellon”). Any statements of opinion constitute only current opinions of Mellon, which are subject to change and which Mellon does not undertake to update. This publication or any portion thereof may not be copied or distributed without prior written approval from the firm. Statements are correct as of the date of the material only. This document may not be used for the purpose of an offer or solicitation in any jurisdiction or in any circumstances in which such offer or solicitation is unlawful or not authorized. The information in this publication is for general information only and is not intended to provide specific investment advice or recommendations for any purchase or sale of any specific security. Some information contained herein has been obtained from third party sources that are believed to be reliable, but the information has not been independently verified by Mellon. Mellon makes no representations as to the accuracy or the completeness of such information. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment and past performance is no indication of future performance. The indices referred to herein are used for comparative and informational purposes only and have been selected because they are generally considered to be representative of certain markets.  Comparisons to indices as benchmarks have limitations because indices have volatility and other material characteristics that may differ from the portfolio, investment or hedge to which they are compared. The providers of the indices referred to herein are not affiliated with Mellon, do not endorse, sponsor, sell or promote the investment strategies or products mentioned herein and they make no representation regarding the advisability of investing in the products and strategies described herein. Please see mellon.com for important index licensing information.