Wednesday, 01 December 2021 08:11

The case against crypto as an investment

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The mania surrounding crypto assets makes the dotcom boom of just over 20 years ago look totally credible, many professional investors say.

It is clear that blockchain, the distributed ledger technology behind crypto, is real and will serve many benefits to society in years to come similar to the development of the internet.  The concern for many professional investors revolves around the specific crypto currencies themselves.

The RBA recently published a paper outlining three types of digital assets:

  1. Cryptocurrencies – these have their own currency unit and are not denominated in the currency of or backed by any sovereign issuer.  Bitcoin is the most prominent with a market cap of US $1.1 trillion.  Another example is Dogecoin which was started as a joke in 2013 now has a market cap of around US $30bn
  2. Stablecoins – are designed to have a relatively stable price, typically  through being pegged to a commodity or currency.
  3. Central bank digital currency (CBDC) – is a potential new form of digital money that would be a liability of the central bank.  It could be like a digital version of cash possibly accessible via wallets on phones.

Good investors consider not only the positive aspects of an investment case, but where they could be wrong.  Many crypto investors seem almost evangelical in their approach and scoff at alternate views to their beliefs.  There are indeed many similarities to 1999/2000 in the unwavering belief that new tech companies back then (coins today) would take over the world and never face anything but sunny futures without competition or regulatory change.

Michael Collins an investment specialist at Magellan Financial Group says that one of the flaws of crypto currency is that the system is based on mutual trust which is unstable because trust is fragile and sub-networks can emerge if members disagree on procedures.  Bitcoin in 2018 splintered after members adopted new protocols incompatible with prevailing ones.  

Another problem is that distributed ledgers appear just as vulnerable to cyberfraud as any other technology, which could suddenly ruin their value, even if bitcoins blockchain has proved secure so far.

Then there is the regulatory risk according to an anonymous institutional investor who said the most common transactional use is money laundering.  Investors can not pay tax with crypto, which implies it is difficult to argue it as a true currency.

Collins says that the other regulatory risk relates to financial stability.  If enough bitcoin circulated in an economy, monetary policy would lose its potence as a macro tool to control inflation and economic activity because it would have no influence over ‘parallel’ cryptos.  There are problems too with calls for central banks to issue their own digital money (CBDC) to the public to gain total control of the money supply and improve the payments system.  The biggest risk is that it would eradicate the four-centuries-old fractional reserve banking system because banks would no longer receive the same level of deposits on which they base their lending.   If bank deposits fell enough, the question then would be which institutions would conduct the lending that is the lifeblood of capitalism.

John Addis founder of Intelligent Investor believes crypto is a digital ‘wild west’.  He nominates another big problem with crypto is that it is ‘non-custodial’, which means investors maintain control of their own keys and assets.  If the keys are lost, the value is gone and if the system is hacked, or there is a scam, there is no recourse.  The Canadian crypto exchange, Quadriga, which collapsed in 2019, owed US$190m to 115,000 customers.

While ASIC recently approved a crypto based ETF, product approval by a regulator is in no way an endorsement or guarantee of investment success.  ASIC chairman recently urged investors to be careful investing in crypto, and highlighted the regulator is virtually powerless to intervene which means consumers are ‘on their own’.

Bill Gates sums crypto up beautifully with the words “my general thought would be that if you have less money than Elon Musk, you should probably watch out”.

When it comes to its true worth, bitcoins ultimate vulnerability is that it has no intrinsic value.  Gold has other purposes and besides is a means of payment.  Government backed currencies can be used to pay taxes and for services.  Bitcoin is  worth what the next person will pay for it which may become only a fraction of today’s price.

 

 

This article appeared in the Australian Financial Review on 1st December 2021

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