Bitcoin has become the world’s most talked-about investment. Bernard Hickey looks at whether there’s a future in cryptocurrencies, and why many Kiwis are still holding off buying them.
Buying Bitcoin is like buying a Lotto ticket as an investment strategy – you should be prepared to lose all your money.
Many preconceptions about Bitcoin and other cryptocurrency investment vehicles need challenging. For a start, this is an asset class based on an as-yet-unrealised dream.
Investors hope that these decentralised and unregulated digital currencies will have real value and could one day be used both as money and a store of value across the world.
The dream is that bitcoin and the ‘blockchain’ technique beneath digital currencies will replace national currencies backed by central banks and governments.
It could be a way to work around the payment systems dominated by banks and credit-card companies. If this happens, cryptocurrencies would be the biggest change in the way commerce and the global economy has operated in centuries.
People have been asking me recently about Bitcoin, and whether these initial coin offerings or ICOs are a ‘real thing’. My initial thought is to tell people buying Bitcoin is like buying a Lotto ticket as an investment strategy – you should be prepared to lose all your money.
Mad moments in December
It seemed that the promise might be realised when Japan revised its banking laws in March 2017 to formally recognise Bitcoin and similar currencies as legal tender. In September, Japan’s Financial Services Agency licensed 11 Bitcoin exchanges to operate in Japan – and investors there, and in Korea and China, piled in.
They hoped Japan would be the first of many countries to make legal what had been a wild, unregulated sector, dogged by fraud, hacking, criminal behaviour, and volatile prices.
Bitcoin and other digital currencies, such as Ethereum and Ripple, hit the mainstream late last year, as their prices surged through August, September and October, before exploding through late November and early December.
Bitcoin hit a peak of NZ$27,912 on December 17, having been just NZ$1,121 a year earlier. A series of ICOs rippled through the market.
Then came the crash.
Bitcoin’s value fell by almost two thirds from its mid-December highs to NZ$9,500 by February 6, as reports emerged that Korea planned to ban Bitcoin and other virtual currency exchanges, and as China cracked down on the mining and use of Bitcoin. Traders also panicked after a hacker stole US$500 million worth of a crypto-currency called Xem from a regulated Japanese exchange in late January, and a 4.6 percent fall in US stocks on 5 February 2018 also hammered crypto-currency prices lower.
However, the values of Bitcoin and Ethereum are still more than 10 times what they were a year ago, and start-ups are still hunting for the holy grails of seamless and cheap transactions. They see value in creating transactional systems that are not run by any one government, and can disrupt the networks run by banks and credit-card companies. The prize is huge and the risk-takers are unrelenting.
How can these currencies succeed?
I believe virtual currencies will not truly cross over into the mainstream until they’re legal and stable. That’s why the legal recognition by Japan was so important, and why the banning of Bitcoin exchanges in Korea and China was so damaging.
People want to know they have some large or official organisation standing behind a transaction or store of wealth, to guarantee or protect them. They want retailers and banks to use the currency, and they want to know it is not too volatile.
Central banks and governments stand behind existing currencies based on legal and constitutional structures built up over hundreds of years. People trust that government bonds will be repaid, and big banks won’t be allowed to collapse. These assumptions underpin stable currencies.
Bitcoin and others will struggle to win that legitimacy unless major countries adopt them, or the existing currencies collapse. Neither seems likely any time soon.
New Zealand banks still don’t accept Bitcoin and regularly shut down accounts used to buy and sell Bitcoin on exchanges both here and overseas.
Very few retailers accept Bitcoin in New Zealand, and slow processing times mean it can take up to 12 hours for a Bitcoin transaction to be confirmed, which rules it out for small, over-the-counter and online transactions.
But there is plenty still going on around virtual currencies and the use of the blockchain and ICOs here in New Zealand.
What do our officials think?
The Financial Markets Authority told investors in October 2017 that cryptocurrency services needed to register with a dispute resolution scheme, become a registered financial services provider, and comply with the Financial Markets Conduct Act.
It also warned it was concerned about the accuracy of statements made by a 19-year-old Aucklander, Ashutosh Sharma, in November about his plan to raise NZ$220 million through an ICO for a Trade Me-style e-commerce site called Sell My Good. Sharma cancelled the ICO a week after the FMA warning.
The Reserve Bank is looking at crypto-currencies and how the central bank and others might use blockchain-type systems for transactions independent of the private banking system. It’s even considering issuing its own digital currency.
It said it didn’t want to regulate other currencies and didn’t see them as a threat to the stability of New Zealand’s banks.
Reserve Bank Governor Grant Spencer was openly sceptical about the boom in cryptocurrency values in December.
“It looks remarkably like a bubble forming to me . . . Over the centuries, we’ve seen bubbles, and this appears to be a bit of a classic case,” he told a television interviewer.
There is a future in blockchain
Many banks agree that the future for digital currencies is around using the blockchain system to make payment systems more efficient and reliable.
But these systems are more likely to be successful if they’re backed by central banks, regulators, and large institutions. The current wild west of unregulated currencies won’t cut it with the average Kiwi.
Global banks are already co-operating to create their own blockchain systems. New Zealand and other more cashless societies, such as Sweden and Norway, could create new virtual currencies to cut money laundering and tax evasion.
Meanwhile blockchain start-ups are forging ahead with capital-raising and development plans. Centrality, an Auckland-based venture with 75 staff across Auckland, London and Melbourne, raised $15 million in cryptocurrency in an ICO in October.
It then raised a further $100 million in under six minutes on January 17, through what it called a Token Generating Event, in which new virtual tokens were exchanged for cryptocurrency. These tokens can be used on Centrality’s platform to buy software and other blockchain-type services.
“The completion of our token main sale will enable us to accelerate platform development and scale our venture model into new international markets,” said CEO Aaron McDonald.
In the end, Bitcoin and its rivals will struggle to replace actual currencies, but the era of digital currencies backed by large organisations and central banks is not far away.
Bitcoin: A virtual currency invented by a group of anonymous software developers led by the fictional ‘Satoshi Nakamoto’ in 2009. They agreed rules and a system of computer-powered cryptography that meant transactions were recorded identically on ‘ledgers’ on a network of computers.
Blockchain: How computers create the digital ledger needed to record the encrypted transactions using Bitcoin and other virtual currencies. It’s a system of ‘blocks’ of computer code that identify transactions and their owners.
Bitcoin mining: ‘Miners’ earn Bitcoin by running the servers needed to do the complicated calculations for Bitcoin transactions on the blockchain. Bitcoin’s creators designed the system to halve the number of Bitcoins that could be mined every four years, which limits the number of Bitcoin to just under 21 million.
ICO: An Initial Coin Offering or ICO is a lot like an Initial Public Offering (IPO), but instead of shares in the new business being offered for cash, new ‘coins’ or ‘tokens’ in a new type of currency are issued in exchange for cash or other forms of virtual currency.
By Bernard Hickey
First Published 21 February 2018
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