Cryptocurrencies – where next as an investment? Oblivion or a healthy correction leading to the next peak?

Posted on: 5 Jul 2022

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The total market for cryptocurrencies still stands at a sizeable USD1trillion, albeit down from a peak of about USD3tr. By comparison the market capitalisation of the London Stock Exchange is near USD5tr, and the total of all stock markets around USD100tr, with the US markets representing about 50% of this. Bitcoin, created by the presumed pseudonymous Satoshi Nakamoto in 2009, remains the world’s most actively traded cryptocurrency. While another handful might trigger general recognition (Ethereum, Tether, Solana, Cardano), over 10,000 are tracked by the big exchanges and price trackers (Coinbase, CoinMarketCap, CoinGecko).

Central bank and government action to address surging inflation has in recent months brought to an end the prolonged period of ultra-low interest rates, putting significant pressure on prices. At its current price of around USD20,000, Bitcoin has fallen by about 70% from its all time high in late 2021. Other major currencies are similarly down, and in the last month the collapse of the so-called stable-coin Terra and its sister token Luna, and pressure on hedge fund margin calls, has further contributed to the credit crunch in the digital asset industry. Sceptics see this as highlighting the fundamental lack of value in these private cryptocurrencies (Bill Gates restated his belief in June 2022 that cryptocurrencies are “100% based on greater fool theory”). Supporters see another natural cycle of volatility, with Bitcoin having bounced back from 50% falls in both of the past two years. They also point out that traditional investments are not immune from significant price falls, with for instance Zoom, Rivian or Netflix, all down over 70% from their peak. Nayib Bukele, who as President of El Salvador made Bitcoin legal tender in 2021, told investors on 19th June to “stop looking at the graph and enjoy life”.

Cryptocurrency ownership in the UK has increased significantly over recent years. While there is not complete alignment in recent research (e.g. Finder, Fladgate, Pew Research centre) the general picture is that over 5% of UK adults currently own cryptocurrency, and nearly a fifth have at some stage.  Compared with other countries cited in recent survey including the US and India, active ownership in the UK is estimated to be significantly lower. Approximately a fifth of younger adults (18-24) say that they intend to buy crypto for the first time in the future. Bitcoin has over a 50% market share of historic and existing cryptocurrency investments.

So, engagement in the cryptocurrency market is relatively widespread and has shown signs of continued growth, at least until recently, but is it really an area to dip one’s toe into? As with any other potential investment (or indeed bet), a suitable level of due diligence is key, to ensure as informed a decision as possible, fitting with one’s appetite for riskiness and other environmental and social drivers. Key aspects and risks to consider will include the following:

  • Volatility: Wild gyrations in price have been a core feature of cryptocurrencies, and this extreme volatility is expected to continue. In one week in May 2022 Bitcoin lost 20%, Etereum 26%, Solana 41% Cardano 35%. In same week Nasdaq tech index fell 7.6%, and FTSE 100 3.6%.
  • Security, Fraud and Financial Crime: The anonymity (or rather pseudonymity) of cryptocurrencies has made them attractive for criminals. Hacks and thefts of exchanges, which constitute a core part of the “plumbing”, have been seen, such as Mount Gox in 2014, at which time it was the largest Bitcoin exchange. Cryptocurrencies have also proved attractive for use in ransomware attacks and in online dark markets.
  • Environmental impact through excessive energy consumption: in July 2019 Bitcoin’s electricity consumption was estimated to be approximately 7 gigawatts, equivalent to 0.2% of the global total, or Switzerland’s national consumption (Cambridge Bitcoin Electricity Consumption Index). Crypto emissions are said to be greater than those created by gold mining, globally (Digiconomist). Elon Musk’s cancellation of the acceptance of Bitcoin to pay for Tesla cars, citing environmental concerns, led to a 50% drop in its price.
  • Fraud and Insider trading: Being a predominantly unregulated industry, safeguards for retail investors are lacking, which leaves the market prone to “pump & dump” tactics. A 2019 report by Bitwise Asset Management alleged that 95% of all trading volume reported by CoinMarketCap had been artificially generated in wash trades:
  • Outsize influence in the hands of a small number of players: National Bureau of Economic Research (US research organisation) reported in October 2021 that 0.01% of Bitcoin miners control 50% of capacity. Flipside Crypto (also US) highlighted that less than 2% of anonymous accounts control 95% of all available Bitcoin supply
  • Regulatory Risk: As usage of cryptocurrencies has increased, Financial Services Regulators have begun to consider what level of regulatory protection is appropriate, or indeed whether the currencies are even suitable products. In September 2021 China declared all cryptocurrency transactions illegal, effectively rendering investments held there inaccessible. The Monetary Authority of Singapore, previously characterised as relatively warmly disposed to crypto has this month released a statement indicating that they planned to be “unremittingly hard” on crypto, and expected private digital money to be displaced by central bank tokens.

The debate on the future direction of cryptocurrencies is unlikely to be settled decisively any time soon. Academic criticism is not hard to come by, with an impressive roster of Nobel Economic prize winners characterising investing in cryptocurrencies as a speculative bubble, like many before. On the other hand, in addition to deep pocketed heavyweights in the industry, the cryptocurrency industry can still count on advocates in a number of governments and regulatory bodies (including the SEC in the US).

Advocates refer to the relative infancy of distributed ledger technology (Web3), draw parallels with the dot-com bubble and crash, out of which global titans like Amazon emerged, and characterise this period as one of creative destruction. The technology will not be uninvented, but the journey forward from the early “wild west” era of crypto will continue to face a multitude of risks. A wild ride lies ahead – Buyer beware!

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