Bitcoin, Ripple, Ethereum – is it all just too cryptic?
Hardly a day passes without a news story about cryptocurrencies (known as cryptos) and there are now more than 1400 cryptos in circulation with exotic names such as Bitcoin, Ripple, Cardano and Ethereum. These cryptos have been around for over five years and generally comprise of two components. The first is the accounting of the currency and transactions, the second is the “digital coin”.
To maintain an accurate, secure, digital record of the currency and transactions, developers rely on an innovative technology called Blockchain. This is a safe and efficient way to store various pieces of information in a de-centralised fashion. The information is encrypted and then stored on different computers, which makes it secure from hacking, and can still be re-assembled and updated in real time. Blockchain as a technology spreads beyond the cryptos and is now being considered or used by some banks, payment processors, health care services and record management agencies.
The second part is the digital coin, which is usually linked to a platform or service built by an entrepreneur. These “coins” normally have a cap on the number that will be issued which prevents their value being eroded by future issuance. The proponents of those cryptos suggest that they provide better security against “paper” currencies which have been devalued by Central Banks who have printed evermore money over the years. In addition, they provide real competition in banking services and could allow the current 50% of the global population without a bank account to send and receive funds electronically.
To be a suitable replacement for money, a digital currency such as Bitcoin needs to be a medium of exchange, a store of wealth and must be believed. Money requires trust, as the piece of paper or electronic deposit has no 'true' value. Therefore, there has always been a need for a Sovereign (monarchy, government or a corporate) to back the paper money and punish those that try to counterfeit it. Unlike Sterling, there is no legitimacy to Bitcoin as legal tender. This means that you cannot buy anything, and so is not a means of exchange, unless the vendor chooses to accept it as such.
As a store of value, this digital asset also fails because, if Bitcoin was the only asset you owned, your net worth would have halved since mid December 2017.
How about the trust factor? True believers of Bitcoin will tell you that it can fulfil the functions of money and that its use will soon be universal given the security and efficiency of Blockchain technology. However, until countries and their monetary authorities fully accept this digital asset as legal tender, it will be difficult for, say, the UK population to trust it, if the Bank of England does not.
Finally, there is the issue of control and countries have previously linked their currencies to the gold standard which prevented them from printing further notes to pay the bills. The gold standard eventually collapsed and it is difficult to see the UK, which refused to forgo its ability to print Sterling to join the Euro, signing up to a new digital gold standard in the form of Bitcoin.
Bitcoin is one of the most popular cryptos both in terms of market capitalisation and press coverage. The total number of Bitcoins is set to be capped at 21 million (although this could change) and they are created by “miners” who use special software to solve the complex math problems need by Blockchain, approve transactions and generally keep the Bitcoin network secure and stable. There is no issuing sovereign, nor is there any monetary authority to control its price or supply. Consequently, its value is variable and has risen sharply due to demand driven by a perception that this digital asset can challenge the status quo and herald a new digital “gold” standard.
Despite the current shortcomings as a currency, we recognise the potential for cryptos using Blockchain technology to reduce the cost of payment processing or cross border transactions and the disruptive impact this could have on current means of transfers such as SWIFT or BACS. However, unlike the coins in your pocket, a digital coin is traded and the value can change every second meaning your transfer might be worth more, or less, than intended when it arrives.
During the 'dot.com' boom, many start-up companies came to the market to raise funds by selling their shares despite having no business plan, no profits and just ‘dot.com’ in the name. These companies commanded eye-watering valuations and similarities can be seen in the cryptocurrency sector today. Simply including block chain into the name of a company or a news release is causing share prices to move higher. Our sense is that just as with dot.com boom, (remember the predictions that most shops would close due to internet shopping), there will be a few big crypto winners, but the technology will spread much more broadly into other companies. We have yet to see incumbent banks and other businesses adapt but we expect that they will either buy-out exiting Blockchain platforms or find ways to integrate it into their own business.
As real return investors we would rather buy a share in, or lend money to, a company that is embracing the developments in blockchain technology rather than trying to find 3 or 4 winners from the 1400 cryptos that currently exist. Call us 'old school', but we invest our clients’ capital into assets that generate returns ahead of our inflation targets and we like to get paid in real money rather than a crypto fad.
First Published in the Tenet Investment Update Q1 2018
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