Wall Street headlines are designed to be eye-catching. People on the Street are always trying to make a name for themselves. Some go to extremes. Most of the time, it’s a lot of fluff. But not always. There was a research report produced this week that stopped me in my tracks. It really made me think. An analyst made a call that an investment in the Financial Technology (FinTech) company, Square, today is the equivalent of investing in JP Morgan a century and a half ago. That’s a really bold statement. It seems a little ridiculous, doesn’t it? Or does it?
The largest bank in America, JP Morgan Chase, has its roots all the way back to 1799 on Wall Street. It began as the Manhattan Bank, founded by Aaron Burr to counter Alexander Hamilton’s grip on the financial system. These roots are the Chase side of the corporate tree. JP Morgan was founded in 1871, in the wake of the “House of Morgan,” which was an international financier, run by Junius Spencer Morgan, John Pierpont’s father. It started as Drexel, Morgan & Co. The bank formally became JP Morgan & Co. in 1895. JP Morgan and Chase had their mega-merger in 2000, which shaped the current bank as we know it. The strategy piece rolled out this week compares the FinTech innovator Square to JP Morgan in 1871. That was the beginning of the Industrial Age. A critical knock against this Wall Street call is the fact that the stock was not available to the public in 1871. JP Morgan didn’t IPO until 1940.
That year 1871 became a focus again this week. For perspective, that was 23 years after Gold was discovered at Sutter’s Mill. It was 6 years after Abraham Lincoln was assassinated and the Civil War came to an end. It was 2 years after the Transcontinental Railroad was established. JP Morgan, the man, was just 34 years old in 1871. The transformative railroad system was his primary focus at the time. Electricity followed soon. Morgan made a major investment in Thomas Edison. Steel was next. The nation’s economic engine took off. Trains changed everything. Electricity did too. Behind Edison’s genius, JP Morgan helped turned the lights on in America. Behind US Steel, after acquiring it from Andrew Carnegie, JP Morgan sent city skylines soaring from coast to coast.
The Digital Age has brought significant disruption. Every industry is experiencing it in some shape or form. Competition is fierce and digital solutions are essential. People consume and spend much differently today than they did even a decade ago. According to an analyst on Wall Street, Square is the Bank of the Future. The disruptive San Francisco-based company is evolving into the bank of the future via its Cash App. The app has become the financial hub for Square customers. The Cash App offers a suite of services, from payment to stock trading, as well as the ability to buy Bitcoin. Square was an early adopter of cryptocurrencies, and specifically Bitcoin. That has attracted a growing audience, particularly the younger generation. Square is expected to add products that range from tax services, to insurance, to home equity lending on the Cash App. Square wants to be the Bank of the Future.
Cryptocurrencies are perhaps the biggest change and seemingly greatest opportunity in the Financial Services space. It has also become quite controversial. It’s like, you either get it or you don’t. Individuals, Banks and Governments do not agree on the future role of cryptocurrencies. The Bulls consider them a store of value, with purity, completely independent from a Bank or Government regulation. They’re actually more like Digital assets than currency. We view Bitcoin more like Digital Gold. The price action is beyond volatile. Bitcoin started the year around $29K, only to more than double over the Spring. It’s given nearly all of those gains back, and seems to be finding a floor around $30K; At least for now.
We are no expert on cryptocurrencies. We don’t claim to be. But we have been studying them for a couple of years. Today, 22 Million Americans, just under 15% of the population, own a cryptocurrency in some form. ¾ of the holders are between the age of 25 and 44 years old. Bitcoin is the most popular, followed by Ethereum. There are many descriptions of digital currencies. They seem to be broadly broken down into 3 categories.
Decentralized cryptocurrency: These are unregulated offerings like Bitcoin, Ethereum, Ripple and Dogecoin. They are issued by a network, and not any central authority or government. That is perhaps the most critical characteristic. Though volatile in price action, these digital assets can be exchanged for goods or services like traditional currencies. A growing number of retailers are accepting them for payment. Cryptocurrencies use distributed ledger technology, like blockchain, that can confirm valid tokens and securely log transactions.
Stable coins: Like Bitcoin, stable coins also use distributed ledger technology. But they attach the value of the digital tokens to something that already exists. By pegging the asset to a widely accepted form of currency, like the Dollar or Gold, these digital currencies are more grounded and reduce volatility. Facebook’s Libra project, now known as Diem, is probably the most familiar example. The momentum seems to be slowing on this initiative, however.
Central Bank Digital Currency (CBDC’s): These tokens represent a national currency. This is the path for central banks around the globe to play a role in the emerging industry as more digital money comes into the economy. It is still very early days, and not every banker is in alignment. Many are concerned about the threat of stable coins and decentralized finance in general. China is a prime example of reluctance and fear. Control is essential, and cryptocurrencies are designed to avoid regulatory control.
A common question is how CBDC’s differ from electronic cash. Traditionally, when you deposit cash or a check into a bank account, the institution takes responsibility for that sum of money. The cash is then held in electronic form and can be used across a variety of platforms, but it’s limited to the bank’s ledger. That is the traditional bank model. FinTech companies like Venmo, owned by PayPal, can even track electronic transactions on its own internal ledger system, but the money is still being held and tracked by a financial institution. In the case of CBDC’s, the government is the counterparty and takes liability for the money, while the ledger that’s being used can be a very different structure than a commercial institution. That ledger is referred to as the “rails.”
In the US, it’s all about the ACH. The ACH Network is the National Automated Clearing House for electronic funds transfers. We use it all the time when initiating transfers on your behalf. ACH is a major part of the financial plumbing in America. It typically takes 3 days to clear a transaction as it travels through the digital pipes. Beyond ACH, there are also wire transfers and credit card payments that are handled by separate networks. In creating a CBDC, the Fed would develop a new set of rails that could allow money to move even faster, meaning rapid transfers for things like unemployment benefits and stimulus checks. There’s been a lot of those the past year.
In the most recent Fed data, which was in 2019 (pre-Covid), 26% of retail transactions were paid in cash. That was down from 30% in 2017. During the pandemic, that number no doubt declined even further. Debit cards were the most frequent method of payment, accounting for 28% of transactions in 2019. 23% of payments were made by credit card. Nearly half of all purchases under $10 were made in cash.
Today, you can buy tools at Home Depot, groceries at Whole Foods and coffee at Starbucks, all in Bitcoin. The momentum for cryptocurrencies is building. The price action remains volatile. It’s still early days. Is the future of banking today, in the Digital Age, on the precipice of something as big as the beginning of the Industrial Revolution? The case was made on Wall Street this week. It’s way, way, way too early to tell. It was a bold call. It seems a little preposterous on the face of it. That said, innovation keeps charging fast, like a digital locomotive. It’s incredible to think about all the new products, the new channels, the new ways of doing things that have emerged in just the last decade. Imagine what our kids and grandkids kids will see. It’s an exciting time to be an investor. But it’s important to always stay grounded while focused.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
