17 November Cryptocurrencies: the future of currency or the road to ruin?Cryptocurrencies: the future of currency or the road to ruin?
By Paul Gambles
The world seems to have suddenly gone mad for cryptocurrencies. But could this just be a fad – and a costly one at that?
Recently, there’s been a tendency that has spread to Canada for tech companies to raise funds via initial coin offerings (ICO). These are similar to initial public offerings (IPO) but, instead of receiving shares in exchange for their money, investors are given digital coins.
The trend is widespread enough to have attracted the attention of the Canadian Securities Administrators (CSA), who advised in a recent press release:
The coins/tokens can be similar to traditional shares of a company because their value may increase or decrease depending on how successfully the business executes its business plan using the capital raised.
That may be true. But, as the CSA release also points out, ICOs raise concerns regarding volatility, transparency, valuation, custody and liquidity. They also acknowledge that investors are prone to unethical or illegal practices and, given the relative newness of ICOs, may not understand exactly what they are buying into.
ICOs are the latest stage of the so-called ‘cryptocurrency’ phenomenon. The best-known example is Bitcoin, which has raised more than a few eyebrows recently. On September 1st, it closed trading US$4,904: not only an all-time high but also because its price was “just” US$2,377 only six weeks earlier; after only breaking through the US$1,000 mark on 2nd February this year.
For devotees of Bitcoin, this price action led to calls that it should now be taken seriously as a legitimate currency, little realizing that this actually highlighted the logical fallacy inherent in cryptos: while they can remain hidden and unused (other than as the base currency of the dark web), they’re attractive to holders who’d rather keep their private asset holdings away from prying eyes, such as those of governments. But the minute that these cryptos actually come out into the light, their main value as a furtive contract disappears.
This is especially the case as they become a visible target on the radars of genuine issuers or purveyors of currency. Jamie Dimon, CEO of JPMorgan Chase, sees the virtual currency as a “fraud”, noting that trading Bitcoin was against his bank’s rules, “stupid” and “far too dangerous.” Other critiques include Howard Marks’ recent view that cryptos are “pyramid schemes”, and Ken Rogoff’s warning that cryptos are “fool’s gold” and will burst under government pressure, whilst Warren Buffett has described them as a mirage and Jeffrey Gundlach commented, perhaps not particularly helpfully, that he’d advised his 86-year-old mother to steer well clear.
The argument that they’re not currency because there are no coins or notes doesn’t hold water. As economist Hyman Minsky wrote, “Anyone can create money; the problem is to get it accepted.” Nowadays, many goods and services are bought with virtual money, which never becomes hard cash – in most of the world’s largest economies today, cash plays a minor role. It’s estimated, for example, that somewhere between just 3% and 5% of all the money circulating in the UK economy is made up of actual notes and coins and you can actually buy goods with cryptocurrencies now. Download the Bitcoin wallet onto your smartphone, for example, and you can use your crypto to buy food, drink and even clothes by swiping your phone on a reader. If you’re running out, go to a specialist ATM or bureau de change and get some more. One online travel agent accepts Bitcoin to buy flights, holidays etc. and you can also purchase Microsoft products directly from its website. Retailers who already accept cryptocurrency, seem to like it because it doesn’t carry the transaction costs incurred using cards or even more expensive payment methods like those frequently used for remittances.
So, Bitcoin – and potentially other cryptos – are just like Baht, Dollars, Pounds and Euros, right? Well not really, no. To start with, a search of how many businesses accept Bitcoin reveals that in the most crypto-friendly part of Canada – urban Toronto – there are only 45 shops, tellers or ATMs which deal in Bitcoin. In fact, in the whole of Canada there are just 257 Bitcoin ATMs or tellers; although this may even decrease, as the trend is the earliest-adopter countries is for Bitcoin to become an option on a normal cash ATM. The other issue is that, at the moment, verification processes are proving to be too slow to be practicable.
In Thailand, there are plenty of people mining Bitcoin (i.e. being paid for validating transactions between two unconnected parties) but there are few places that actually accept it – 23 in the Bangkok area at last count (including an 80-year-old noodle business).
In terms of the investment opportunities of cryptos, this is a whole other conundrum. Bitcoins can be bought through unregulated exchanges – the largest of which at that time, Mt. Gox collapsed leaving huge losses for participants – or there are exchange-traded vehicles. However, the Winklevoss twins (of Facebook fame) have so far failed to get regulatory approval for their offering, leaving 2 Swedish Exchange Traded Notes, or ETNs, as the standard-bearers. The twins have also failed to manage to actually replicate the performance of Bitcoin, leaving us to wonder how the Swedish offerings, with far less resources, have managed to do so. As ETNs these are really credit instruments or just promises to pay by the issuer. If we look into them we can see that their eventual guarantor is a Jersey-based company which itself had less than GBP10,000 (less than C$17,000) in its bank account as of its most recent filing in June this year. Yet it appears to have issued over C$500 million of promises to pay investors, a value that is based on the price of Bitcoins, which the wealthy American twins, with seemingly greater resources available, were unable to track.
Added to that, Bitcoin and closest rival Ethereum are in no way in as such widespread use as digital transactions of national/regional currencies using bank or credit cards. But these are early days.
At the moment, Bitcoin is highly volatile. In 2013, a story came out about Norwegian Kristoffer Koch who, in 2009, had paid NOK150 (around US$24) for 5,000 Bitcoins. He completely forgot about them until he heard about Bitcoin in the media in April 2013. By then, his tiny investment was supposedly worth NOK5 million (US$886,000). Koch managed to exchange 1,000 of his Bitcoins into Kroner and bought an apartment in a prosperous part of Oslo. However, if he’d have remembered about his Bitcoin holding at the beginning of that month, he’d have cashed in 41% less; and if he’d have sold two weeks later, he’d have received 61% less. I don’t know what he did with the other 4,000 Bitcoins but if he’d held onto them until the latest peak on 1st September, they’d theoretically be worth US$19,619,600!
All that sounds fantastical. In many ways, it is. If national/regional currencies behaved in such a manner, investors would stuff cash under their mattresses until what they thought was the right moment and my job would consist of throwing dice at a craps table.
Whilst the downsides to Bitcoin and others may one day fade away, that doesn’t mean that the Blockchain technology they use will. In fact, three countries (Ecuador, Senegal and Tunisia) are already using it for digital currency, and others are studying the possibility as either a currency or payment system for public sector contracts.
Paul Gambles is co-founder of MBMG Group MBMG Group is an advisory firm that assists expatriates and locals within the South-East Asia Region with services ranging from Investment Advisory, Personal Advisory, Tax Advisory, Corporate Advisory, Insurance Services, Accounting & Auditing Services, Legal Services, Estate Planning and Property Solutions.