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Jun 30, 2021

Crypto-A-Go-Go

by Rita Silvan
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Rita SilvanOn a balmy evening in 1964, the Whiskey-a-Go-Go nightclub opened its doors on Sunset Boulevard in Los Angeles. Whiskey was a hit with hipsters and launched bands like The Stooges, Alice Cooper, The Doors, among others. Whiskey was where new action was happening. Which brings us to crypto. Investors wonder: Is crypto where the party’s at?

Ask value investment legends like Charlie Munger and Warren Buffett about cryptocurrency and you’ll get an earful:

 

 

“…disgusting and contrary to the interests of civilization”

“rat poison”

“a delusion”

artificial gold”

“like trading turds”

On the other hand, crypto bros, like Elon Musk, along with a growing number of analysts, hedge fund managers, institutional investors, and consultancies like Deloitte in their recent rah-rah white paper (masking as reportage), are crypto cheerleaders.1 Crypto is where the value is, they say, and if you’re too chicken to get in, we’ll eat your dust—what your fiat money will become thanks to central bank manipulation.

So, what’s an investor to do? First, study up. The crypto world is a noisy and confusing place rife with extreme volatility, binary risk, bubbles, trillions of dollars, charlatans, innovation, disruption and revolution, twittering, and let’s admit it, an excess of testosterone.

Out of the 6,000 different cyber currencies, like Dogecoin, PancakeSwap, Tether, and BakeryToken, only a few flagship cryptos warrant serious investor attention. Think of each of these cryptocurrencies like a software company—Facebook, Google, Apple, Microsoft, Oracle—that specializes in doing different things for different markets.

Bitcoin was the first cryptocurrency and blockchain which now has a market cap of $1 trillion making it the largest of the bunch. The software behind it is very simple. Like a basic calculator, it can send and receive funds and do other simple transactions which makes it quite secure. Bitcoin proponents compare it to digital gold because supply is purportedly limited to 21 million coins, 99 per cent of which will be mined or “hashed” by 2030 in China, Russia, and Iran.

Next up is Ether on the Ethereum blockchain with a market cap of $500 billion. (Larger than that of JP Morgan and Visa, in case you were wondering.) The Ether software is very versatile and can be programmed for a variety of transactions, such as investing, borrowing, lending, raising funds, etc. This makes it the one to watch in the burgeoning area of decentralized finance (DeFi).

DeFi emerged in the summer of 2020. It shifts banking and insurance services away from traditional financial institutions to a decentralized network where transactions are available to anyone with an internet connection. Presumably this will lead to cheaper services, greater equality of access, and more reliability due to the elimination of human error. Uniswap, the largest DeFi protocol generates $70 billion in trading monthly so it’s already a thing.2

Market watchers predict we are in the very early innings of crypto, much like the beginning of the internet. Innovation is moving at warp speed making it difficult to identify the winners (Google) from the losers (Pets.com). Eye-popping returns have made investors overly excited, indiscriminately bidding up everything crypto and using lots of leverage in the process. Whether digital currencies like Bitcoin will fulfil the hype of being a “store of value”, “digital gold” and a “non-correlated asset” and “a mainstream choice for a diversified investment portfolio”, remains to be seen. In the meantime, here are some pros and cons for investing in crypto.

Crypto Boosters Say…

A Mainstream Asset Class

Bitcoin trades in 180 countries at miniscule spreads with good liquidity and enjoys network effects. Demand for crypto continues apace with trading in the trillions. The market cap for all cryptos exceeded $2 trillion in April 2021, more than doubling since January. What began as a fringy thing beloved by anarchists, criminals, and nerds, is now considered a viable non-correlated asset and is on the balance sheets of institutional investors, insurers, S&P 500 companies like Goldman Sachs, Morgan Stanley, and Blackrock, and the world’s largest hedge funds.2

A growing number of mutual funds and ETFs, like those from CI, Purpose, and Evolve, make owning crypto assets easier and more cost-effective.

Regulation To The Rescue

While ensuring privacy remains one of the pillars of crypto, the ability to move money rapidly and cheaply and to be able to program it to perform a variety of functions is increasingly attractive. Government regulation intended to tamp down the criminal elements within the cryptocurrency world, has made it more palatable for institutional investors to pile in, without whom crypto cannot really thrive.3

The Bitcoin database is also self-regulating because everyone agrees it is accurate and no one party controls it. There are tens of thousands of miners who work hard to secure the world’s largest supercomputing network because they make good money doing so.

Network Effects

As more companies do transactions with Bitcoin, Ether and others, the crypto ecosystem will evolve. Today, Coinbase, the world’s largest crypto exchange serves 56 million customers, more than Schwab, TD-Ameritrade, and E-trade combined. Companies like Tesla and Square have purchased bitcoin and PayPal, Visa and Mastercard allow their users to transact with it. Everything has a digital analogue today—movies, newspapers, books. Why not money? Finance is one of the last industries to be disrupted by technological innovation but disrupted it will be.

Crypto Bashers Say…

Volatility

It’s impossible to use a digital coin whose value wildly fluctuates. Bitcoin’s volatility has exceeded that of a basket of developed world currencies by a factor of more than 10,000. One day your bitcoin buys a luxury car, the next day a pain au chocolat. In May, a group of institutional fund managers issued a warning on the adoption of Bitcoin as an asset class due to its extreme volatility— where it can drop 50 per cent in one month– and therefore its unsuitability for their clients as a hedge against equity volatility and inflation. The growing power of retail traders to affect the price of crypto only adds to its unreliability as a store of value.

Bad People Doing Bad Things

It’s no secret that Bitcoin and other digital coins are the favoured currency among the criminal class. Money laundering, kidnapping, extortion, drug running, prostitution, child abuse—as unregulated currencies, cryptos enable fraudulent transactions which are estimated to be over 40 per cent. No one tracks how many crypto wallets are hacked or ransacked, or how many crypto founders vanish with billions of dollars’ worth of coins. Almost all Bitcoins are mined in China, Iran, and Russia, not exactly global do-gooders.

Binary Risk

Could the value of Bitcoin go to zero? Some scenarios to ponder:

Rules Are Made To Be Broken

The value of Bitcoin is derived from its purported scarcity, but it’s conceivable that some Bitcoin owners could re-write the rules and mint new coins. Given that 50 per cent of Bitcoin is mined in China, the government could destroy the coin by hacking the blockchain, scrambling transactions or spending the coins to deplete accounts.4

Govcoins

In addition to increasing regulations on digital coins, many countries including the United States and China are issuing their own e-currencies in order to protect their financial ecosystems and shift power back to the state. Institutional investors in cryptocurrencies are facing increased scrutiny from regulators. Would you rather transact with a soverign currency or one with No Fixed Address?5

Who You Gonna Call

Forgot your password? Lost your crypto wallet? Suspect your account was hacked? Dommage. Since 2012, investors have lost more than US$16 billion in crypto scams. When looking for redress, many novice investors are surprised to discover some of the exchanges are bogus and founders have absconded with their digital wallets.

Did Somebody Say Ponzi Scheme

Only two per cent of holders control 95 per cent of all Bitcoins. Any large transactions will destabilize the price. Hence, crypto bros need to constantly solicit large institutions to put Bitcoin and other crypto currencies on their balance sheets and encourage investors to think of them as just another asset class. Jamie Dimon of JP Morgan is a recent convert as are several billionaire hedge fund managers. A recent UK study found that Gen Z and millennials are the greatest crypto enthusiasts, but they tend use leverage to boost returns and may lack the experience to size investments.6

Ecological Doom

Mining bitcoin and constantly updating the blockchain ledgers are environmentally costly. (Hence one of the reasons it is mostly done in developing nations.) They are heavy users of electricity and a major greenhouse gas emitter.2 By 2024, Chinese miners alone are expected to use as much energy as Italy.7 Even, Elon Musk, one of the biggest crypto boosters, has tweeted he will suspend Tesla using the cryptocurrency citing its extensive use of fossil fuels. Recently, New York introduced a bill to stop all digital coin mining for three years pending an environmental impact study.

Bottom Line:

If you are tempted by the potential for eye-watering returns or just simply want to be part of a happening scene, experts advise to cap crypto holdings to two to five per cent of your total portfolio.

 

Rita Silvan, CIM is a finance journalist specializing in women and investing. She is the former editor-in-chief of ELLE Canada and Golden Girl Finance. Rita produces content for leading financial institutions and wealth advisors and has appeared on BNN Bloomberg, CBC Newsworld, and other media outlets. She can be reached at rita@ellesworth.ca.

1      https://www.ft.com/content/8d35a908-9d49-4992-9980-54f314bf5193

2      https://www.advisorperspectives.com/commentaries/2021/05/13/note-to-elon-crypto-miners-are-part-of-the-solution-to-curbing-greenhouse-gas-emissions?utm_source=boomtrain&utm_medium=email&utm_campaign=Research-Perspectives&bt_

3      https://www.ft.com/content/98f6caf9-f8f9-47de-9cf9-4c2f1aa981aa

4      https://www.advisorperspectives.com/commentaries/2021/04/29/bitcoin-is-an-ecological-and-monetary-disaster-and-it-happens-to-be-worth-zero

5      https://www.economist.com/leaders/2021/05/08/the-digital-currencies-that-matter

6      https://www.ft.com/content/be796d33-a5e7-4753-98a8-b586f1680d58

7   https://www.economist.com/espresso