Cryptos and blockchain and bubbles, oh my!
It's been almost a year since crypto currencies burst into the public consciousness. There was debate as to exactly what they were, but a soaring price was sufficient to entice new buyers. What ensued was a bubble of classic proportions -- inevitably the price came back to earth, leaving latecomers underwater.
Bitcoin was the first and is now the largest of the so-called cryptos, debuting in 2009. Early buying came from Southeast Asia, which tells us something about its primary utility -- as an alternate currency -- one not subject to influence from a central bank, free of currency controls, and invisible to tax authorities. (China outlawed cryptos in September 2017, at the time the source of 90% of bitcoin trading.)
As total bitcoin valuation climbed from nothing towards its peak of $324 billion, so did perceptions of its legitimacy, overshadowing obvious flaws. High transaction costs, limited commercial acceptance and price volatility have stood in the way of bitcoin becoming a reliable store of value. We can’t resist noting that its environment profile is dismal -- the annual electricity consumption of computers that ”mine” for new bitcoin is estimated to be equivalent to the electricity used to power 3-4 million US homes!
Like gold that must be extracted from the ground, there is by design a finite supply of bitcoins that can enter circulation. But there are no constraints on the proliferation of new crypto currencies (now about almost half of total crypto value), which tend to trade in concert with bitcoin. An estimated $8 billion was poured into initial coin offerings (ICOs) during an eight-month window in late 2017 and early 2018. A dearth of regulation leaves these offerings subject to fraud and manipulation.
The enabling technology is blockchain, a shared public ledger in which all bitcoins created and transacted are recorded. Chronology, anonymity and integrity are maintained with the use of cryptography. Broader adoption of the technology underpinning cryptos could be revolutionary, reducing transactional costs for producers, service-providers and consumers, particularly where speed and trust are of the essence. Blockchain is already being tested by banks and stock exchanges and has the potential to push middlemen of all sorts out of their accustomed roles -- but not for many years.
Today, blockchain is a process, not a product. A “killer app” is yet to come, as are direct investment opportunities tied to the technology. Much of the unfolding blockchain activity is embedded deep in big banks and tech companies or in private start-ups. A number of ETF’s are attempting to capitalize on the space, but don’t currently appear to have much investment merit.
We believe that crypto fascination relates to distrust of governing and financial institutions worldwide, a sentiment held by many gold fanatics. In general, however, fear is not a good reason to commit to an untested concept.
We invest for our clients when we believe an asset is available at a discount to its underlying economic value. Like credit cards and the internet that came before it, blockchain may prove to be a highly important advance for commerce and consumers alike. It too may prove to be investable in the future. As for crypto currencies, a rising price is by itself not a reason to buy anything, particularly an asset that defies valuation. We acknowledge that we may be missing something -- there is always a chance of being wrong. Cryptos may continue to appeal to speculators, but the rest of us will do better looking elsewhere for our investments.