Are Cryptocurrencies The Best Investment Opportunity Of The Next Decade? Part Two
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This is part two of a comprehensive primer on cryptocurrencies and distributed ledger technology (DLT) that reviews a large sample (over 50 sources) of recent information, from International Monetary Fund (IMF) and Goldman Sachs reports to cryptocurrency “expert” analyses to crypto-industry updates. Combined, both parts provide the user with an interpretive template for application. Part one covered understanding cryptocurrencies, blockchains, and DLT in the context of value, advantages, and returns. The focus in part two is on the risks of investing, an update on the current state of the crypto markets, and how to invest.
As I noted in part one, gold was discovered in California in 1848 leading to the largest land migration the world has ever seen. The next “gold rush” may be under way but the migration is to what Goldman Sachs has called a “new technology of trust.” The “rush” is to digital currencies, such as Bitcoin, Ethereum, Litecoin, and others, that have exchange value with fiat currencies and that are based on the technology of blockchain. However, it is not primarily the currencies but rather the blockchain and DLT that may end up transforming financial services and a myriad of industries in the future. The currencies have exchange utility, but are also the digital representation of a future technological revolution on the verge of breaking out.
According to Coinbase, a large crypto exchange, there are currently more than 800 cryptocurrencies worldwide. The top 10, including the three listed above, account for most of the capital. The market capitalization of Bitcoin today is over $40 billion. All cryptocurrencies are valued at over $100 billion. According to Aswath Damodaran, a professor of finance at NYU Stern, one dollar invested in Bitcoin at the beginning of 2012 was worth $1,026 on July 29, 2017. According to Michael Lebowtiz, since Bitcoin started trading in July of 2010 its value has risen over 51,000%. There are those who invested $50,000 in Bitcoin a few years ago who have seen it grow to $2,000,000 today. The two-year gain as of late August 2017 is 1,870%.
According to Ronnie Moas of Standpoint Research, in July of 2017, an investment in select cryptocurrencies could bring returns of 12x within the next decade. A 1,200% gain is a conservative estimate based on 1% of global assets moving into the space.
An analyst writing in Forbes predicts a $619,047 price for Bitcoin in 10 years. Another analyst has a 2027 target of $100,000 for Bitcoin. He predicted in December 2016, when Bitcoin was at $754, that it would hit $2,000. Bitcoin hit that target in May 2017. Moas’ 2027 target on Bitcoin in late July was $50,000 (it was about $3,760 on September 25). That assumes 28% compounded annually for 10 years. His three-year target is $15,000-$20,000. His price target for next year is $7,500.
However, even Moas, one of the recent spokesmen for cryptocurrencies on business channels like CNBC, expresses caution and states there are numerous risks.
What could go wrong?
On risks and what could go wrong
Analysts like Peter Schiff and Jim Rickards believe that cryptocurrencies, Bitcoin especially, are a bubble that will crash. (But, remember, both analysts have also incorrectly predicted a major financial crash repeatedly for years). Mohammed El-Erian, economist and former head of PIMCO, stated recently that cryptocurrencies will never see wide use due to government regulations. Still, he takes the underlying technology seriously.
In the meantime, more than one researcher has noted, “Netscape and AOL shareholders can tell you that early market leadership does not always translate into future market dominance.” At the least, the cryptocurrencies you choose to invest in could be the key to your future gain or loss. It is also possible that one of the lesser known currencies today might dominate the market tomorrow.
Cryptocurrencies are volatile. There has been as much as an 84.2% difference between highs and lows in Bitcoin over the last two years. According to Moas, since he initiated coverage the Bitcoin price moved from $2,571 on July 5 down to $1,950 on July 16 – then, by July 22 it was at $2,900. In three weeks that was a 30% drop, then a 50% increase.
As one International Monetary Fund (IMF) paper reports, “The stability of the [present] system depends on the trust vested in the central bank as an honest broker and its ability to safeguard the central ledger from tampering or failure.” In turn, the future stability of blockchains, cryptocurrencies, and DLT relies on users’ ability to demonstrate consistent security and trustworthiness within its use.
Other risks? The primary ones follow.
A sophisticated individual or government could hack a cryptocurrency or exchange especially if the system has security flaws. The Mt. Gox Exchange in Japan, where investors lost hundreds of millions to hackers, is a recent example. According to the SEC, Mt. Gox subsequently filed for bankruptcy and Bitcoin users on the exchange were left with little recourse. The recent Equifax breach is another example of the vulnerability of any digital system. A nation could also attempt to gain control of the crypto-system and either hack it or control it. The cost for this is currently estimated at about $2 billion, something not outside the scope of a Bill Gates, Larry Fink, or George Soros, or any large nation with predatory – or perhaps, suicidal – instincts.
Related to this, a 51% Attack could compromise the global network of cryptocurrency blockchains. Since the system depends on internal auditing and auditors (known as miners) to confirm transactions and security, a conspiratorial group of miners – if they got together – could bring down the entire system. A 51% attack is essentially an auditing corruption that leads to double spending and/or negative control by a select, corrupt group. According to Mahit Mamoria, blockchains are “built on the assumption that the majority of a crowd is always honest.” A 51% attack is one of the few scenarios that can cause cryptocurrency protocol to fail.
Security is an internal cryptocurrency risk (the online cryptocurrency transactions and the exchanges) and an individual investor risk (from your computer – use the Google Authentication App). According to a recent Coindesk article, “People have this perception that Bitcoin and Ethereum are completely anonymous when that is not the case.” According to, another source, identity can be traced through “transaction history, service providers, IP addresses, and similar means.” As an individual, if you are investing via a digital wallet and you don’t use a high level of encryption to protect your account you could be digitally hacked and your digital money stolen. As such, the currencies and the exchanges’ various security issues must be solved to make systems more secure.
As with all investing, governments’ reaction and the level of regulation they seek to place on this financial innovation will be key to its future growth and desirability. Russia just made its first arrests for illegal Bitcoin trading. Japan was the first to regulate exchanges. According to Jim Rickards of Strategic Intelligence, government elites are seeking to control cryptocurrencies for their own ends. China is not only the largest investor at present, but also has the largest number of Bitcoin miners. Any negative regulatory changes in China could cause a price collapse. (Just after this was written, reports came in that China was closing all of its exchanges). Rickards continues, “Blockchain depends on critical infrastructure including servers, telecommunications networks, the banking system, and the power grid, all of which are subject to government control.”
According to the IMF, which functions as the world bank for governments in trouble and issues its own SDR (Special Drawing Rights) currency, “These open schemes (that underlie Bitcoin, for instance) could be very disruptive if successfully implemented. By contrast, in permissioned DLTs, the validation process is controlled by a pre-selected group of participants (“consortium”) or managed by one organization.”
Translation? According to Rickards, “This paper should be viewed as the first step in the IMF’s plan to migrate its existing form of world money, the special drawing right or SDR, onto a DLT platform controlled by the IMF. In time, all other forms of money would be banned.” In other words, “In Cryptography We Trust.” Welcome to 666.
The latest word is that it is inevitable that central banks will one day issue their own digital currency linked to fiat currency. As Goldman Sachs said, “At its heart, a blockchain is a record of transactions, like a traditional ledger. These transactions can be any movement of money, goods, or secure data—a purchase at a supermarket… or the assignment of a government ID number.” Contrarily, The World Economic Forum recently put out a four point warning on the “hype” surrounding blockchains and DLT, as if to say, “This is much ado about nothing.” The fact that Russia, China, Japan, India, the Philippines and other nations are involved in the new technology, or regulating it, belies their apathetic tome.
There are many fraudsters and cons who are attracted to emerging industries. This was true during the dot.com era as well. Most of these cons are bottom-dwellers who operate small start-ups out of the limelight that attempt to defraud naive investors.
One area that is a potential for fraud is the exchanges. According to Rickards, “Any activity that
involves one party trusting his money to another party promptly becomes a magnet for fraud.” According to him, the exchanges are not regulated or licensed like TD Ameritrade and other stock brokers. Rickards continues, “Heavy regulation in other corners of financial services is likely to send the ever-present fraudsters to the unregulated regions [cryptocurrencies].”
Contrarily, two of the largest and well-known exchanges appear to have wide global acceptance and trust. Coinbase and Coinigy, an all-in-one digital platform for traders, have both been written up by various publications, including Forbes, The Wall Street Journal, and Bloomberg. Coinbase’s legal page seems upfront, though they are not licensed in California, which likely means that California residents have less chance than residents of other states in any legal action. However, Coinbase is insured by Lloyds of London.
Governments are still in the process of debating and developing the regulatory framework for exchanges, cryptocurrency, and DLT operations. Until then, exchanges might be as secure as Fort Knox, but should still endure some level of mistrust.
The potential for fraud appears to be greatest in the area of ICOs. According to the SEC Investor Bulletin, fraudsters use innovations and new technologies to perpetrate their schemes. They entice investors by touting an ICO “opportunity” as a way into the “cutting-edge” space. Investors should be suspicious of jargon-laden pitches, hard sells, and promises of high returns. Someone can easily create an ICO that looks impressive, but is really a Ponzi scheme.
Investors would be wise to consult a known website, conduct due diligence for information on ICOs or exchanges, and beware of regurgitated language in the descriptions that may say “scam.” Beware of smaller cryptocurrencies and the smaller, lesser known exchanges. It is also best to stay invested within the top 20 cryptocurrency names.
Some believe there may be danger that cryptocurrencies are in a bubble. According to Rickards in mid-August 2017, Bitcoin is in a bubble and will probably be close to $200 within two years. He foresees “bubble behavior, lack of performance through an entire business cycle, possible fraud in the trading infrastructure, and government intervention in ways that are adverse to liquidity and confidence.” Peter Schiff believes in the value of blockchain, but also believes Bitcoin is in a bubble. Ray Dalio, founder of the world’s largest (and arguably the best) hedge fund, believes Bitcoin is not money - contrary to the ‘How Money Got Free’ crowd - and is in a bubble. Rickards' conclusion is, “I don’t own any… and I don’t recommend them to investors.”
According to Ronnie Moas, more risk equals higher return. Bitcoin [and all cryptocurrency] comes with extreme risk and return, which makes integrating it into traditional portfolios difficult. There are three previous times when Bitcoin has soared like it did in July to August – each boom was followed by a dramatic collapse. Even though he acknowledges and warns of the risk, according to a recent article in Coindesk, Moas says that there is no Bitcoin bubble.
If true, the major corrections seen in the past – of up to 71% – might be over, and the recent correction was just another opportunity to buy in. None of the numerous articles that declare cryptocurrencies are a bubble (see here, or here, or here) seem to have any understanding of why or what constitutes a bubble. For example, comparing cryptocurrencies to the tulip mania? There was no technological innovation behind tulips, they were just… tulips.
Extreme price rises, and speculation, are a necessary but not a sufficient cause of bubbles. According to Wikipedia, “A stock market bubble is a type of economic bubble taking place in stock markets when market participants drive stock prices above their value in relation to some system of stock valuation.” However, it is hard to determine value in a technology so new and still developing, and no astute system would give analogous value to bitcoins and tulips. Amazon (2010) and Apple (around 2012) both looked high at prices of $100 and $80 and were accused of being in bubbles – but at prices of 970+ and 150+ today one would question the past evaluation.
Contrary to Rickards, it appears that many cryptocurrencies, in addition to acting like money, also have value due to blockchains and DLT. Therefore, they are more than just money: they are an investment. It is debatable whether they are in a bubble, yet there is still risk.
Lastly, cryptocurrencies will work right up to the point that the power goes out. Literally. A power grid knock-out of all electricity would effectively neutralize cryptocurrency holders. Then, gold, silver, guns, and trade-barter will prevail; anything digital will be useless.
In addition to the above risks, the Goldman Sachs review lists several obstacles to blockchain and DLT acceptance. These are: business adaptability and acceptance, speed of blockchain technology transactions, standardization and regulation, and security concerns (no technology is 100% secure). There are also numerous, specific technical concerns. For example, according to Damodaran, the weakness of the cap on supply is that “as the cap becomes a binding constraint, the rewards from miners have to come from transactions costs and serious thought has to go into currency design to keep these costs low.” Other examples are Ethereum’s upcoming Metropolis upgrade or Yanofsky’s ‘untangling’ project. The technological improvement of each currency and its efficiency and ability to solve problems and security concerns is a continual challenge.
In summary, as Damodaran noted, the “long term success of any cryptocurrency has to answer a different question… whether it is a “good” currency.” As a recent analyst noted, continuing to upgrade bitcoin [cryptocurrencies] is a “monumental task fraught with many risks and unknowns.” Contrary to another writer, cryptocurrencies’ major challenge is not “to overcome prospective users’ suspicion and become known as a legitimate medium of exchange for legal purposes.” Cryptocurrencies’ major challenge is to overcome all of the above risks and uncertainties so that they can gain prospective users’ trust and become known as a legitimate, secure technology. So far, they are not there, but there is great promise.
On the current state of the market
On September 13, Jamie Dimon, CEO of JP Morgan, called Bitcoin a “fraud," in the same category as ‘tulips,’ depressing crypto markets. However, his bank invested in Ethereum and this is the same guy who did not know what his mortgage derivative department was doing during the Great Financial Crisis. Maybe he does not understand the crypto space yet either. According to Ronnie Moas, “Bitcoin is no more of a scam than much of the financial services industry, including banks and insurers.…As for [Dimon’s] comments that this is a bubble -- he said that when bitcoin was at $400 a couple of years ago and now we are [close to] $4,000.”
According to the Financial Times (FT), more than $1.8 billion has been raised by ICOs so far this year. According to Coindesk, that outpaces venture capital. In July, Tezos, a new cryptocurrency, raised a historic $230 million for its ICO. Filecoin just exceeded that amount.
China recently made ICOs illegal and the price of cryptocurrencies plunged. Then a report came that China was closing all of its cryptocurrency exchanges which caused a total correction of 36% for Bitcoin, 48% for Ethereum, and 65% for Litecoin. As of September 14 Bitcoin was below $3500, down over 10% for the month – but up 500%+ for the year. Overall, prices on the top cryptocurrencies corrected 18-30% (according to Forbes, 40%) from highs.
What is going on in China? According to the one recent report, all exchanges will be closed by the end of October. It is tempting to say that this is temporary since China has global trade and financial relationships and is on a campaign to present itself as a viable reserve currency replacement. It even lobbied for, then recently became, part of the IMF’s SDR basket. For this campaign to remain successful, China must continue to moderate towards a more open financial system. Overly strict cryptocurrency regulation is contrary to this goal. In addition, the Chinese government and central bank are involved in a wide range of blockchain and DLT projects. There is still a possibility the Chinese government and central bank have been using this self-created market scare to buy up cryptocurrency. Perhaps within 6 months, their exchanges will reopen, albeit with new regulations, and the markets will rise more, inflating Chinese purchases.
However, if a draconian crackdown, like the one reported by the Wall Street Journal (WSJ), is in progress, it is congruent with Xi’s vision of becoming the next Mao Tse-tung and eliminating competitors to the yuan. It is also congruent with past restrictions of Google and Facebook on the mainland. Perhaps Xi reconciles these actions with moving towards ‘openness’ because he believes other governmental elites - reflected by Jamie Dimon’s most recent comments - will understand his concerns. Earlier reporting by Investopedia, CoinTelegraph, and Coindesk interpreted China’s crackdown on exchanges as a concern, but one that is overblown. At present, if current trends continue, the future of non-permissioned cryptocurrency – not blockchains or DLT – in China seems questionable.
According to Coindesk’s latest State of Blockchain report, the SEC is entertaining a proposal for an ETF of Ether (Ethereum). It has entertained similar proposals in the past and they have either been rejected or put on hold. But according to the report, “Regulators increasingly acknowledge the reality (that Blockchain technology has grown too big to ignore).” Emerging crypto hedge funds, like Polychain Capital, may be a way to skirt regulatory issues associated with ICOs. The IRS recently approved a qualified individual retirement account (IRA) for investors. The SEC is currently reviewing a Bitcoin ETF. Once any ETF is approved, it is likely to cause a surge upward in markets.
Additionally, central banks continue to evaluate the new technology – including the U.S. Federal Reserve. According to a recent study conducted by the European Central Bank and the Bank of Japan, DLT is promising but still too immature for immediate use in their systems. Israel’s central bank and its largest commercial bank are working with Microsoft to adapt DLT technology. The National Bank Of Abu Dhabi has just adapted the Ripple cryptocurrency protocol. According to The Financial Times, six of the world’s largest banks, including UBS, Barclays, Credit Suisse, HSBC, and State Street are attempting to make financial markets more efficient with a new form of digital cash, the “utility settlement coin.”
On Ethereum, Indorse is gunning to become a rival for social media (with a total sale of over $9 million, tokens were transferable after September 14) with its decentralized beneficiary version of a professional networking platform. It was also recently rumored that Satoshi Nakamoto, the original creator of the Bitcoin blockchain, has initiated a new blockchain. Some of the top Registered Investment Advisors (RIA’s) are starting to investigate implementation of the technology and how to invest for aspirational clients. According to a recent Coindesk report, a surge of institutional investors has the potential to keep driving the markets up.
According to Ronnie Moas, “Most of the cryptocurrency trading takes place in China, Japan and South Korea, so [headlines from those countries can rattle the market…normal corrections in the space are between 20% and 40%].” Previously, Bitcoin has always experienced a crash after a major rise, such as the recent one. If cryptocurrencies can avoid extreme corrections in the future, it might be a sign of stability and decreased volatility.
Have we entered a new paradigm for the cryptocurrencies? It is too early for that conclusion, but it is clear that more investors are understanding the potential of the technology behind the currencies and are willing to risk some of their wealth on the next move.
As the Stanford paper mentioned in part one notes, “Bitcoin exchange rates can (in a very stylized model) be fully determined by two market fundamentals: the steady state transaction volume of Bitcoin when used for payments, and the evolution of beliefs about the likelihood that the technology survives.” Although the paper cautions about the true value and utility of Bitcoin, corrections seem to be opportunities to buy in to the belief that blockchains and DLT are essential technologies and here to stay.
On how to invest
Retail investors can buy cryptocurrency through exchanges, some of which are similar to Forex. If you are going to trade, buying in and out, learn from experienced and successful traders. One good resource is Ten Rules for Trading Bitcoin, Ethereum, and Other Crypto. Investors, see The Top Six Cryptocurrencies, and Four Top Performing Alternatives to Bitcoin. To combat price volatility, cost-average your purchases.
The easiest way for retail investors to invest in cryptocurrencies is by investing through a stock brokerage account in an Exchange Traded Fund (ETF) with the symbol ARKK or by buying the over-the-counter (OTC) trust, BTC, which is how ARKK invests in Bitcoin. However, ARKK is an innovative stock and cryptocurrency ETF that appears to invest a maximum of about 10% in cryptocurrencies and is therefore more tied to how the stock market acts. BTC is currently a trust, not an ETF, and meant for accredited investors. Shares are not directly tied to the value of Bitcoin and are more susceptible to bubbles – and crashes.
The safest way to invest in blockchains and DLT may be to invest in existing companies entering the space such as IBM. IBM is investing in new DLT technologies like the Hyperledger. However, IBM is a traditional company attempting a transition into the future, so diversify among other companies (Nvidia, for example) that capitalize on DLT in other ways.
The most direct retail method for buying cryptocurrencies is through exchanges that operate online. There are presently over 130 crypto exchanges, some catering primarily to local and small currency markets. In the US there are about ten major exchanges for buying crypto-currency – stick with these because the potential for fraud in this arena is high. For a guide through ICO investing, see here.
Globally, two of the most popular exchanges for buying and selling the top crypto-currencies are Coinbase and Bitfinex (Bitfinex was hacked in August 2016 and as of August 2017 no longer accepts US customers). San Francisco based Kraken is both an exchange and a currency trading site similar to Forex in foreign currency. The Kraken exchange handles more currencies and is more advanced, but the FAQ’s page guides you through the process.
On Coinbase, you can only purchase three of the top cryptocurrencies: Bitcoin, Ethereum, and Litecoin. It takes about 15 minutes to set up an account. Any company account may be more involved and take much longer. It took me over a week and two emails to get a response from Coinbase. Kraken responded within two days. To buy any of these three coins on the Coinbase website follow this procedure:
- Sign up using your email and create a password.
- Set up a link with a bank account for purchases and liquidations
- Remember, hacking is an ever present possibility, so link a dedicated bank account that has limited funds in it (use the Google Authentication App, see here for its importance, and here for how to set it up on Coinbase - you will need the Google Authenticator App downloaded on your phone first)
- You may need to set up a separate cash account at your bank for this purpose
- Create a digital wallet (a digital storage for your funds) by following the prompts to verify your identity
- Most exchanges and wallets will store amounts of digital and/or fiat currency for you, much like a regular bank account (for more, see here).
- Remember that exchanges and wallets don’t provide the same level of protection as a bank
- Begin trading by following the prompts to purchase currencies
To sell your digital currency you will need a bank account, so save yourself some time and trouble and choose this option over the credit card. Company accounts will be more complex and take longer for set-up. Other exchanges may have a different procedure.
According to Ronnie Moas of Standpoint Research, an analyst, investor, and cryptocurrency researcher:
There are risks involved here: hacking, regulation, bankrupt or crashing exchanges, scandal, conflict between miners and users, etcetera. An event that would cause the confidence in these currencies and in these markets to collapse would drag down the coin prices dramatically. That being said, when someone presents me with a situation where I can possibly make a 1000% to 2000% return over a period of 5-10 years, I am going to take that… my gut is telling me today… I think we are still in the first quarter of a four quarter game and that even though I missed out on significant gains (2014-2016), it is not too late to get in.
According to economist and mathematician Michael Edesess, writing in What Advisors Need To Know About Cryptocurrencies, “(As to investment in Cryptocurrencies) I would not call it foolhardy. There is reason to bet they will increase in value, so it is not like betting in a casino or buying a lottery ticket, where you can only expect to lose. And there is no apparent reason to believe their price movements are correlated with the stock market or other assets, so they may add to diversification.”
Still, Aswath Damodaran, the NYU professor of finance, offers a warning that it may be a new emerging cryptocurrency that finds the secret to wide acceptance and that “the most enduring part of this phase in markets may be the block chain and not the currencies themselves.”
The writer of the Wired article quoted in the opening offers this investing advice: “Own less than 1 percent of your net worth, don’t buy and sell bitcoin, and don’t do anything with it for at least five years, at which point it will either be worth a lot more or absolutely nothing.”
There is a lot about this “new thing” that is yet to be understood and developed. There are still many problems that need to be solved. The biggest risk is the unknown of government intervention and regulation and how that will affect the development and risk/return. According to a report by the Bank of International Settlements (BIS), “It also seems clear that changes and related efficiency gains are more likely to be incremental than revolutionary.”
Blockchain technology and crypto-currencies might be the most revolutionary development since the advent of the Internet in the mid-1990s. On the other hand, they might be a Pandora’s box that governmental elites will co-opt and use to control the masses, or a poorly designed Network Marketing Plan-like venture that rewards first-in/first-outs at the top of the pyramid, then collapses when the technology does not pan out as predicted. Only time will tell.
There are two contradictory things that are true about cryptocurrency investing. If you get in and out at the wrong times, then you could lose everything that you invest. On the other hand, if you get in and out at the right time, or all of the risks line up correctly in your favor, this could be the best investment you make in your lifetime. Like the California Gold Rush, some prospectors walked away with nothing; others filed claims on mines that made them fortunes.
Caveat Emptor. Miners beware.
Seaborn Hall, AIF, has a degree in management from Georgia Tech, a Master’s degree and has studied at the doctoral level. Formerly he was a Regional Director at a national top-50 RIA; he currently manages a family investment company, writes, and publishes the Common Sense Interpretation Websites. He holds positions in ARKK, some companies in ARKK’s portfolio, plus IBM and Nvidia. He has Coinbase and Kraken accounts and positions in Bitcoin, Ethereum, and Litecoin. This report should not be viewed as investment advice or a recommendation, but is for informational purposes only.