Cryptocurrencies like Bitcoin and Ethereum have captured the eye of many investors, pundits, and even politicians.
With such support, the asset class is now seen as a must have for our digital future. But despite the promise, cryptocurrency investments remain as volatile as ever with large— price swings and the potential for heavy losses until paying for crypto becomes commonplace.
So, it might come as a surprise that the volatile crypto market is making for strange bellows within the conservative municipal bond sector.
State and native governments aren’t issuing bonds in Bitcoin. Nevertheless, they’re beginning to use a few of crypto’s processes to remove the barriers to purchasing/selling muni bonds. With that, adding these assets could grow to be much easier for smaller investors, reducing wide bid/ask spreads and creating transparent pricing.
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Blockchain Is Not the Same because the Currency
When investors take into consideration crypto, they accomplish that from the standpoint of the asset. Normally, it’s cryptocurrencies like Bitcoin or Litecoin. It’s understood we’re trading “digital dollars” from wallet to wallet and individual to individual. We spend our Bitcoin online to buy goods and services. The thought is that Bitcoin and other cryptocurrencies can function a medium of exchange or be traded between parties.
A lot of us don’t think in regards to the process behind the scenes that makes Bitcoin work. But that background process is what puts the “crypto” in cryptocurrency.
With no central bank just like the Federal Reserve or regulatory authority backing them up, digital assets like Bitcoin use cryptography/encryption to secure transactions and control the creation of additional currency units. The fifth-grade definition of cryptography is that computers fact-check these transactions by completing complex equations. After that, they store the transaction on a ledger. This decentralized digital ledger is known as Blockchain, with each “block” containing data and linked in chronological order or “chain.”
This ledger has gained popularity with currency. While cryptocurrencies use blockchain, blockchain isn’t cryptocurrency. There’s nothing stopping you from using this digital ledger to secure transactions of any asset — real or digital. And that’s necessary to notice.
This brings us to the sleepy municipal bond market.
Most investors don’t realize that the worldwide bond market and its trillions of dollars price of value trades are based on a number of phone calls and handshakes. After the initial issue, bonds trade on the over-the-counter bulletin board or OTCBB. For many bonds — except for very liquid Treasuries — brokers will literally call one another and make deals over the phone. This creates wide bid/ask spreads and a scarcity of trading volume for a lot of bonds.
For the municipal bond sector, that is a significant headache. And with that, investment banks that underwrite bonds for clients have began to have a look at Blockchain as a approach to improve this process. JPMorgan created its Digital Debt Service, while Goldman Sachs has created a rival service. Each use blockchain to assist with the transaction process and smooth out any kinks which have often plagued the muni sector.
These latest platforms have moved beyond the proof of concept into prime time. Michigan State University is looking into issuing a $38 million muni bond on Goldman’s platform to assist pay for a latest multicultural center. At the identical time, JPMorgan has seen the City of Quincy, Massachusetts, issue roughly $10 million in bonds on its platform. Those bonds were later purchased by asset manager BlackRock for its iShares Short Maturity Municipal Bond Lively ETF.
Transforming Finance
The creation of those platforms is important, and using Blockchain within the sleepy municipal bond market may very well be a game changer for all stakeholders: issuers, underwriters, and investors.
The municipal bonds sector is a $4 trillion industry featuring vast inefficiencies. As we said, buying and selling munis is already tough. Traditional municipal bonds typically trade just a couple of times a yr. Nevertheless, by utilizing blockchain, there may very well be more frequent trading of bonds. And when there’s increased trading of any asset, increased liquidity brings reduced risks. Pricing information can quickly be disseminated by all parties. Investors trying to sell have buyers to sell to.
Other than the liquidity aspect and reduction of risks, there are other advantages to blockchain within the muni bonds sector.
Certainly one of them is the reduction of settlement time. While settlement times have improved and quickened pace, there remains to be a lag time between when money and assets are exchanged between parties. These middlemen and clearing houses also take their share, with market-makers making a profit on the bid/ask spreads. This drag time can reduce gains and add friction to the method. But with blockchain, once the cryptography process is complete, the transaction is complete. This fast transaction creates a zero-wait settlement time for a lot of asset classes.
This eliminates costs and redundancies across the normal bond-buying platform and method. Issuers get their bonds to market more quickly, and investors have the chance so as to add these assets or sell them if obligatory.
Just Getting Began
Ultimately, blockchain has the potential to remodel the municipal bond market. Despite its huge size, trading, and accessibility to munis remain out of reach for a lot of investors. Blockchain could improve that performance and accessibility.
Already, some states have begun considering issuing so-called mini-munis on to individual investors at prices as little as $25 per bond. Blockchain ledgers would make this type of transaction possible.
Furthermore, BlackRock’s use of JPMorgan’s platform to purchase assets for an energetic ETF can be impressive. This allowed the asset manager so as to add a needed bond to its portfolio without skipping a beat.
Now, there are potential risks available. Much of the low volatility related to munis may very well be gone. The investor base tends to be a buy-and-hold group. Adding liquidity is great but could bring an unintended consequence to the sector. Many investors who use munis — insurance funds, pensions, and endowments — count on munis trading for roughly the identical price for his or her history. Mark-to-market accounting could hinder a few of their financing and regulations.
Nevertheless, the advantages of using blockchain could outweigh most of the potential pitfalls, and investors may very well be joyful with the technology’s potential inside the muni sector.
Bottom Line
With a successful sale and future issues, blockchain has come to the world of municipal bonds. By utilizing a digital ledger for transactions, many inefficiencies related to municipal bonds and their buying/selling at the moment are reduced. For investors, issuers, and underwriters, it is a huge win.