Bitcoin just hit $6000 dollars and $100 billion in market cap. I’ve been seeing a lot of people around me in India dabble in cryptocurrencies and this is my view.
Cryptocurrencies are nothing new, it’s just that they are in vogue now. The earliest virtual currency can be traced to the 1980s when a David Chaum, an American cryptographer came up with something called as e-cash which failed. But the current crop of tokens are on a whole new level and scale. There isn’t a day that goes by without articles with dramatic and often incredulous titles such as these.
Barbarians at the Monetary Gate - Project Syndicate
Bitcoin Is Not the ‘New Gold,’ Goldman Sachs Tells Clients - BI
Bitcoin is a fraud that will blow up, says JP Morgan boss - The Guardian
Is bitcoin a bubble or the future of everything? - BI
And whenever something is in vogue it very important to look at the bigger picture and the following is my exploration of it.
For the uninitiated here is the definition of a cryptocurrency
A cryptocurrency is an encrypted decentralized peer to peer digital medium of exchange.
Traditional fiat currencies are controlled by governments and central banks but cryptocurrencies like Bitcoin are decentralized and nobody controls them. They are also encrypted meaning the transactions and identities are truly anonymous. The technology that underpins these currencies is called as Blockchain, which in itself is touted to be a revolution and is a topic of another post.
I’m not going talk more about the basics, there are very good resources that you can find with a cursory google search.
I’ve been an investor in the market for a better part of over 17.5 years now. My investing style has always been simple - invest where you see value. Although the display of nostalgia and emotions are frowned upon by investors, one of my favorite and successful investments was in Hero Motors. I had bought a few hundred shares at around Rs 350 sometime in 2002 and I still hold them. The rationale was that a growing economy would enable Hero to grow as a business and create value for shareholders and they definitely did.
By this yardstick, it is very hard to take a call on investing in cryptocurrencies. Looking at the moves that have made in the past few years it is very hard to see the fundamental reasons. Investing in cryptocurrencies is a whole new ball game. When you invest in stocks or bonds there are fair and transparent markets, regulations and participants. Cryptoassets, on the other hand, are decentralized and globally the regulations are patchy at best.
When you invest in a stock of a company there is a paper trail and your shares are securely held in your demat account. Crypto tokens, on the other hand, are stored in wallets which aren’t overseen by any central regulatory authority. Meaning you alone are responsible for the safety of it.
If your wallet, platform or an exchange is hacked there is no recourse to seek recompense. There are no investors protection funds, unlike capital markets and, hacks are common. In 2014 MtGox then the world largest Bitcoin exchange was hacked and 750,000+ Bitcoins worth over $460 million dollars were stolen. The now infamous DAO hack on the Ethereum network led to Ethereum tokens worth over $50 million dollars being siphoned off. Uncoin the Bangalore based exchange was also subject to a hack in August of this year.
You might say that this is changing with countries like Japan recognizing allowing Bitcoin as a medium of payments, but that is not nearly enough is it? The dynamics you should consider when it comes to investing in this asset class are innumerable. China which is host to the biggest bitcoin miners recently made ICO’s illegal and ordered Bitcoin exchanges to shutdown.
ICO or Initial Coin Offering is a way of raising money by offering tokens in return similar to an IPO. The advantage is that there is no regulation on ICOs or at least up until now
Contending with regulatory changes is one of the biggest risks when it comes to investing in cryptocurrencies.
The changing regulatory environment is not only limited to China, but a host of other countries such as the US, South Korea, Russia, Venezuela have put in new regulations or are in the process of formulating them. Here are some major regulatory changes recently.
- The US Securities Exchange Commission had announced earlier during the year that token sold through ICOs many be considered as securities.
- The U.S. Commodity Futures Trading Commission’s (CFTC) put our primer which said that ICO tokens may be classified as commodities which would make them subject to CFTC regulations.
- Soth Korean financial regulators in September had discussed strengthening regulation of Bitcoin and other virtual currencies.
- Vladimir Putin earlier this month called for regulating cryptocurrencies. The Russian financial regulators are expected to announce regulations governing cryptocurrencies.
But in spite of all this Bitcoin has continued its upward march. Is this based on fundamentals? Well, that’s the million dollar question.
In a recent column on Project Syndicate Nobel winning economist Ken Rogoff made a prescient argument.
the long history of currency tells us that what the private sector innovates, the state eventually regulates and appropriates – and there is no reason to expect virtual currency to avoid a similar fate.
Looking at the charts of these cryptocurrencies one cannot help but think of a bubble.
For example here is a chart of Bitcoin and Ethereum the two biggest cryptocurrencies
This year to date chart is much scarier with very deep troughs and peaks.
Such mind-numbing moves are commonplace. There are over 1000+ cryptocurrencies which are trading today and most of them have seen similar moves. Here is another comparing the performance of the top 3 altcoins or alternative coins. These are some mind numbing-moves.
Cryptocurrencies are extremely volatile and are not for the faint hearted.
These charts show the volatility of Bitcoin, Ethereum and Litecoin over 60 day periods along with that of USD/EUR which is the world most traded currency pair. Bitcoin still has a long way to go before it becomes as stable as fiat currencies. These moves reek of speculation and unaware investors who are lured by the promise of high returns can get caught flatfooted.
But it is not all doom for Bitcoins. Cryptocurrencies contain the potential to revolutionize modern finance but the questions will remain over the future of the current crop.
Of coins and conmen
Where are people chasing returns, there are scamsters to take advantage. The-Ken on October 17th came out with article on crypto scams with a shocking description
Around 500,000 people have put their money in crypto Ponzi schemes, and these fraudsters have siphoned off more than Rs 4,000 crore by fooling gullible people
In May this year, there was the One Coin scam in which over Rs 18 crores was seized by the Mumbai Police. This story has played time and again throughout history. But It is hard not to sympathize with these people.
Should you trade or invest?
The RBI had put out a circular in Feb 2017 which said
The Reserve Bank of India advises that it has not given any licence / authorisation to any entity / company to operate such schemes or deal with Bitcoin or any virtual currency. As such, any user, holder, investor, trader, etc. dealing with Virtual Currencies will be doing so at their own risk.
Assuming you are okay with the security risks, the global regulatory risks, currency fluctuations, scams etc you can probably allocate a small portion of your portfolio in the range of say 5-10% to dabble in these digital currencies. There are platforms like Zebpay, Uncoin etc in India through. Traders hoping to trade these cryptocurrencies will have wait longer because the spreads are huge on Indian exchanges.
At the time of writing, these were the spreads on Zebpay and Uncoin which display them on their homepages.