Crypto, CBDCs, DeFi and the Treasurer

Published: August 06, 2021

Ingka Group, the largest franchisee of the IKEA brand, with 390 stores in 32 countries, is not currently using digital currencies, but is following their progress closely. It is building its knowledge and understanding of the market, and assessing when the right time might be to engage, and how. TMI talks to Michael Aandahl, Head of Digital Treasury, Ingka Group, about the firm’s approach.

Cryptocurrencies are often talked about today in the context of huge investments – and their attendant controversies – made by personalities such as Elon Musk. But bringing them back down to earth, and into the realm of corporate treasury, raises the question of how such a volatile currency fits with the risk-averse nature of corporate financial professionals.

As such, the quest for a digital asset that exhibits similar behaviours to that of, say, an investment-grade sovereign bond, is rather challenging, notes Aandahl. “When it comes to some key aspects of risk evaluation, the traditional means of assessment that are deployed with a bond, for example, are not available, and similarly, there are no immediate underlying connections to collaterals.”

So, while he acknowledges that the crypto world is keen to address these issues, he asks, on behalf of all treasurers, at what point will a direct and transparent link be available to enable proper risk assessment?

Of course, there is no ready answer to this and Aandahl accepts that because crypto is a completely new way of financial ‘doing’, it almost certainly requires a new way of financial ‘thinking’. As a corporate treasury technologist, he is genuinely excited by the notion of crypto, and in particular the wider notion of blockchain-based decentralised finance (commonly referred to as DeFi). So much so that he is ready to anoint DeFi as “the internet of the capital markets”.

Not least of his reasons are that DeFi has no reliance on traditional central financial intermediaries (brokerages or banks) to deliver financial instruments, instead calling upon blockchain-based ‘smart’ contracts.

With most cryptocurrencies having a linked digital wallet, if peer-to-peer (P2P) transfer of substantial value is permitted using these wallets, then cross-border payments for corporates would be transactable at virtually zero cost and in real time. In theory, says Aandahl, this could threaten to disintermediate banks; it would certainly shake up the status quo.

In the case of central bank digital currencies (CBDCs), their use as a payment instrument would also rewire the customer relationship. But it is not the position of central banks to undertake client management roles, tackling processes such as know your customer (KYC) and anti-money laundering (AML). The preferred model is likely to be one where the commercial bank still owns the customer (and all that this entails), but the customer, as an owner of central bank money, has a direct balance-sheet relationship with the issuing central bank.

This is why in both the Chinese, EU and US CBDC projects, for example, Aandahl says currency architectures are being discussed that aim to “respect” the existing banking system. However, he adds, this would place a new and very serious emphasis on new forms of global governance, possibly blockchain-based.

Treasury fit

While for many treasurers the broad concepts of crypto and DeFi remain something of a ‘watch and wait’ tool, Aandahl is working with his Ingka Group colleagues to try to categorise where they might fit in the general interests of treasury. “Typically, treasurers have only the Bitcoin paradigm thrown at them. But actually, Bitcoin is just a value-holding mechanism; it’s not intended to be directly compared with traditional tools, such as the sovereign bond, so it naturally falls into the scope of alternative investments.”

As these only ever make up between 2% to 6% of a corporate balance sheet, Bitcoin faces stiff competition from many other types of investment in this category. And although it has been proposed as an interest-rate hedging instrument, and even seen as a form of ‘digital gold’, its current volatility suggests these are merely suggested as “illustrations of what it could be”.

Treasurers may therefore consider adopting the approach of what Aandahl refers to as ‘staking’ cryptocurrencies. As per a bond, cash is allocated into an investment that is held for a specified period. That ‘stake’ then becomes available to a liquidity pool, contributing to the overall liquidity of the system, assuming a profit is made.

However, Bitcoin volatility cannot be depended upon for positive yields, so here the category of stablecoin may provide more comfort, he says. Stablecoins typically use a ‘buy and sell contract’ to peg value to a more stable fiat currency, such as USD.

There is a need to be wary of stablecoins mimicking bonds by offering fixed annual returns, cautions Aandahl. Underlying volatility in this space persists, and often inflation is built into these currencies, not only through the supply and demand effect of the coin itself, but also at the hands of the currency to which it is pegged. Although some cryptocurrencies may engage in so-called ‘coin burning’, which slows down inflation by taking coins out of circulation, he warns that good returns may only be for the medium term as the model is not sustainable itself.

That said, Aandahl feels that the crypto ecosystem in general is becoming more aware of the need for stability. Indeed, regulatory compliance may well be necessary for its long-term success. This may not sit well with the anti-establishment philosophy of many crypto supporters. But there is a natural challenger here.

“The big game-changer could come if certain central banks decide to plug their CBDCs directly into the DeFi ecosystem,” he says. If key CBDCs could be pegged in a single basket with equal parts, yuan, US dollar and euro, for example, “it could create the perfect world coin”. Currency stability would prove “a huge attraction from a global trade perspective” and would almost certainly outflank some of the current stablecoin offerings in the process.

Raising concerns

For treasurers who are on the verge of crypto adoption, a decision must be made as to whether to engage directly or through exchange-traded funds. “Initially, many will not wish to bother with the technology, risk and compliance set-up, and so will approach via the traditional markets and custodians,” suggests Aandahl. The third-party exchange model, he adds, may help treasurers better allay the fears of senior management.

There is another burning issue that may be holding back some treasury investors; that of current environmental, social and governance (ESG) concerns around certain cryptocurrencies. Recent controversy around power consumption and coin mining being front of mind for many.

“Any cryptocurrency that employs the proof-of-work mechanism is using too much energy,” states Aandahl. Indeed, bitcoin has seen considerable backlash against its computing-intensive mining and validation processes, potentially making it “a no-go area” for most if not all publicly listed companies.

However, Aandahl notes that Ethereum is already starting to shift from the proof-of-work concept to one of proof-of-stake. The proof-of-work process uses intense computing power to solve complex calculations that verify transactions to earn coins.

This encourages miners with considerable capital at stake, through their equipment investments, to keep using the energy-intensive process. A new governance structure within Ethereum is empowering its network of approved validators to select future protocols as part of the proof-of-stake model.

At a practical level, this enables the network to validate transactions in alignment with how many coins each participant holds. The more coins owned, the more mining power they have.

From an ESG perspective, this is progress. And for Aandahl, the argument offered by some ‘traditional’ miners that they are using renewable energy and therefore are not contributing to climate change is “weak”. He states that renewable energy should be used to replace dirty energy and not try to greenwash an unnecessary use of energy.

He feels this because the constant energy requirements of mining cannot be matched by the unpredictable nature of renewables production (such as solar, wind and wave power), and that fossil fuels have to take up the slack. This is an issue investigated by PwC researcher Alex de Vries.

Prepare for change

As more experiments are conducted in the crypto space, treasurers must continue to educate themselves as to what these developments may mean, advises Aandahl. “I think that there’s no need to worry about how the ecosystem itself is constructed, but instead the focus should be on the end solutions. We need to understand the risk elements of each, and then find the best use cases.”

As one of the key technologies in this space, blockchain has already started carving out a niche in supporting the digitisation of trade finance. But it has a role to play across many other functions and, says Aandahl, treasurers should be aware of any and all new opportunities.

The role of digital wallets may also expand, with portfolios potentially running across multiple wallets and different exchanges. Already in the consumer space, the trend for fintech-developed financial ‘super-apps’ is bringing together complementary services from providers such as Google and PayPal. This, says Aandahl, raises the prospect of broad-based ‘lifetime’ financial services marketplaces in B2C (business-to-consumer) and B2B (business-to-business). This has interesting possible consequences.

It may mean KYC obligations being imposed on wallet-holders for each cryptocurrency address, but if a Big Tech player requires banking licences somewhere in its ecosystem, super-apps could replace the need for separate bank accounts, says Aandahl.

With Alipay in China having already challenged the system, he says it’s clear why the Chinese authorities are pushing its CBDC, the e-yuan. It’s not just about monitoring and visibility over transactions, it will also prevent the central bank from being left out of the system. Indeed, he notes, “there’s an underlying power game developing between Big Tech and the traditional banking world as the boundaries blur”.

The future holds many possibilities, including cryptocurrencies declining in popularity. While Aandahl knows that treasurers do not always need payments to be rapidly free-flowing – bulk payments have their place – it is his hope that current creative thinking around CBDCs and cryptocurrency digital wallets will eventually facilitate more real-time, cross-border payment capabilities for corporates.

With DeFi and digital money also enabling financial inclusion of the world’s unbanked, and super-apps potentially reducing demand for traditional bank accounts, digital currencies have the power to disintermediate and democratise in equal measures.

As crypto becomes more mainstream and controls are put in place, many will be concerned by data privacy – internet protocol (IP) wallet addresses can be forensically reconnected to individuals with relative ease – but Aandahl’s view is that there are distinct advantages for those who choose to use them wisely, including corporate treasurers. The bottom line for him is that with the world of money and financial instruments becoming ever more digitalised, treasurers need to adapt accordingly.