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What is it with Cryptocurrency?
By Song Zhen Goh
What do Ethereum, Litecoin, Ripple and Bitcoin have in common? The last one gives the game away as Bitcoin is the best known of the cryptocurrencies gaining popularity around the world.
What’s incredible is that as at 30 September, these alternative “currencies” have appreciated in value by 3296%, 1013%, 2691% and 292% respectively since the start of 2017. Comparatively, all of them have comfortably beaten the ASX All Ords (3.95%) and the S&P 500 (5.42%) over that time.
So what is cryptocurrency and should you be investing in it? I am no expert in the field, but the following must be contemplated.
What drives the valuation of cryptocurrencies?
Arguably the most important of a number of factors at this point is the same mechanism that drives the valuation of any asset – demand for the asset. What is clear is that there’s a good portion of demand for cryptocurrencies being driven by the pure hype that continues to surround the sector, and people not wanting to miss out on the rise of the next Bitcoin. Extreme price swings in very short periods of time have also accompanied the hype.
Cryptocurrencies have also proved popular with those working in the world of the ‘dark web‘ – terrorists, arms dealers, drug traffickers and the like, so wherever they can hide their activities from authorities, there will be demand.
Regulation is mixed at present.
Like so much in the technology world, it is very hard for regulators to keep up. The US Securities and Exchange Commission (SEC) has ruled that some ‘coins’ are actually securities and therefore subject to SEC regulation, while at home ASIC has attempted to provide guidance of its own. Elsewhere, Chinese and South Korean regulators have banned Initial Coin Offerings. A lack of standards in the issue of cryptocurrencies means that investors face significant risks with no protections.
When new coins or ‘tokens’ are issued to interested parties in exchange for money, the offer is known as an Initial Coin Offering or “ICO”. This is very similar in concept to an Initial Public Offering or “IPO” where a private company issues new shares to public investors. The growing interest in ICO’s combined with the lack of regulatory oversight has seen a multi-fold increase in the number of new offerings. A consequence of this has been a growing number of ‘pump and dump’ schemes, where issuers sell off significant holdings at hyped up prices, leaving new investors with large losses.
What’s next for this opaque area of finance?
The stratospheric rise of cryptocurrency prices have drawn parallels with the Dot-com bubble of the late 1990s and the Dutch Tulip Mania of the 1600s. One of cryptocurrency’s most successful and highest profile investors has been on record agreeing with the bubble theory, however, emphasising that he was planning to profit from it. Other high profile finance professionals have spoken out, including the founder of the world’s largest hedge fund Ray Dalio who called the Bitcoin craze a ‘speculative bubble’, and Jamie Dimon, the CEO of JPMorgan Chase, has also publicly denounced Bitcoin as “a fraud”.
Despite the hype, there appears to be real merit in the technology that sits behind cryptocurrencies, known as blockchain technology. But, at this stage at least, it is just potential. To that end, any investment in cryptocurrencies is speculative at best, and does not fit into the evidence-based investment portfolios we build for clients.
The only guarantee in all of this is that many, not just finance professionals, will be keenly observing as this fascinating technology continues to develop.
Song is an Investment Analyst with Capital Partners Private Wealth Advisers. To contact Capital Partners please call 6163 6100, or send us an email.
5,945 total views, 3 views today
5,946 total views, 4 views today