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Bitcoin: hype or hip?

Much though I wish it was due to my sparkling writing, I know many of you are reading this because it contains the words ‘bitcoin’ and ‘blockchain’.

Hopefully many of you will continue anyway even though I won’t be sharing the secrets of instant wealth (although I will be sharing some examples of how fickle instant wealth creation can be).

That these words have become the investment equivalent of funny cat videos demonstrates how our online, interconnected world amplifies everything, including investment bubbles.

“Businesses experimenting with blockchain should avoid a speculative link that smacks of desperation.”

Blockchain and bitcoin don’t just bait clicks they bait big dollars. Kodak - which was once the dominant producer of film stock in the world before it became the case study for total disruption when digital cameras all but wiped it out - had a massive spike in value when it announced a bitcoin-like cryptocurrency at the annual Consumer Electronics extravaganza in Las Vegas.

Ignore the obvious irony of launching such coin in a haven for gambling and at least Kodak had a cogent argument for its KODAKCoin and associated blockchain-based image management system KODAKOne.

The two new products are designed to help the creators of photographic images maintain control of and be properly compensated for the use of those images. This is an increasingly large and complex challenge in the online era when images can just be grabbed and used willy-nilly without the creator’s knowledge or profit.

But a more than doubling of market value in one day of a company which hasn’t even launched the products?

Farce

Still, that story was dwarfed by the Long Island Iced Tea company whose value tripled when it changed its name to Long Blockchain. As the Financial Times’ Lex noted, this ruse, reminiscent of tin pot mining companies becoming internet start-ups during the dotcom bubble nearly two decades ago, had real world implications.

“The farce boosted the company’s market capitalisation by $US43 million, enough to stave off possible ejection from the Nasdaq (Index),” the piece said.

Both Kodak and Long Blockchain have since shed most of the spike but when it comes to farce, nothing tops Dogecoin.

Perhaps most fantastically – although fantasy is a relative concept in cyber world – Dogecoin is a cybercurrency actually created as a parody which at one point topped $US2 billion in market value. Seriously. It’s called Dogecoin after the risible internet meme around a dog breed.

Even the guy who started the joke has apologised. Who would bid the value of a joke currency to a thousand rocks? Well history tells us there is rarely a shortage of woodducks, chancers and the simply greedy when markets run, particularly when there is excess cash in search of any kind of yield sloshing around.

For a truly eye-opening account of the kinds of people involved in the bubble, The New York Times has this rather disturbing feature. When billions of dollars suddenly emerge, as Hunter S. Thompson would’ve said (and wouldn’t he have been the perfect chronicler of this time) “when the going gets weird, the weird turn pro”. He of course wrote that in Fear and Loathing in Las Vegas which actually wasn’t a feature about the Consumer Electronics Show.

So actually what is this phenomena? It’s important to distinguish between the hype in markets and actual worth of cryptocurrencies and blockchain developments.

Critically cryptocurrencies have no intrinsic worth – while even gold has some as it has industrial uses and desirability for jewellery. They are not then a store of wealth – particularly given how volatile they are.

Investment on the basis of intrinsic value is pure speculation on whether more buyers will continue to appear than sellers.

Middlemen

Many buyers believe cryptocurrencies will replace traditional ones because they are cheaper, more efficient and anonymous. It’s true removing middlemen like banks from transactions can remove costs but the system is not free.

Cryptocurrencies rely on blockchains or distributed ledgers – essentially massive swarms of computers which maintain the integrity of the value chain by distributing encrypted data, simultaneously recording and validating transactions. (bluenotes has a detailed explanation of blockchain here.)

The system is not free because computers need energy to run. The owners who run the system – or ‘mine’ – are paid in the currency they mine. The energy needed is astronomical.

The mines then have typically been located where energy is very cheap, such as near Chinese hydro energy schemes with excess capacity.

Mining makes sense when energy is cheap and the currency they are being paid in is rising precipitously in value. That, however, is unlikely to continue – indeed China has already banned some mines (and indeed is cracking down more widely on cryptocurrencies because they are being used to export capital against the government’s wishes).

What of the economics? Bank of America Merrill Lynch did a nice analysis noting the reward for mining – say bitcoins - halves roughly in value every four years.

“By around 2041, it is estimated the limit in the number of bitcoins – nominally 21 million - will be reached and the reward for mining will be zero,” BAML said.

“The last number we saw was 12.5 bitcoins per block. Based on this and the value of the bitcoin, you can work out profitability metrics for mining, driven by the cost of the kit you need, electricity etc, and the expected number of coins you will mine.”

Then there is the cost of energy.

Others have speculated about whether the blockchain supporting bitcoin can actually cope with massive amounts of new currency and transactions – each transaction requires mining to authorise and the system is already encountering traffic jams.

Blockchain is something else. It is a process not a currency and most observers believe the process of distributed ledgers has vast potential beyond supporting cryptocurrencies. Many pilots are in place.

Cryptocurrencies were invented in the first place to streamline transactions and cut out costs – particularly cross border.

They’ve been shown to have potential for this but being the coin for a transaction doesn’t install value in the coin itself: physical and fiat currency can be used for transactions but it can also be used as a store of wealth.

The catch is there are still very few places which accept bitcoins today and, put off by the volatility or threat of regulation, more sectors are actively refusing to.

Hodl

For every new development – say the invention of new jargon like HODL (crypto believer talk for keeping the faith, assumed to be a fat finger creation when someone meant to type HOLD) or inspiring a new Japanese girl band – there is a more substantive push back such as South Korea moving to crack down or industry sectors backing away.

In the United Kingdom mortgage lenders and brokers who fear breaching anti money-laundering regulations are refusing to accept cryptocurrencies.

Cryptocurrency providers are grappling with a similar conundrum – to the point that exchanges such as Bitcoin Suisse had trouble finding a bank for its own cash needs, as finews.asia reported in November.

The problem cryptocurrencies face in entering the official sector is created by exactly the feature which has attracted many believers: the encryption and anonymity.

At a time when the international agencies are putting the onus on institutions to track financial flows, a flow which is by definition impossible to track is going to be an issue.

Regulators are being pretty clear: Ravi Menon, managing director of the Monetary Authority of Singapore, has said he believes in the underlying technology – blockchain – but not cryptocurrencies per se.

 He has especially warned against ‘initial coin offerings’, the latest phase in the market, where speculators are asked to hand over money up front for new cryptocurrencies.

“I do hope that when that fever has gone away, when the crash has happened, it will not undermine the much deeper and more meaningful technologies associated with digital currencies and blockchains,” he said at a recent UBS conference.

Steve Mnuchin, the US’ highest-ranking finance official says digital tokens may have the same whiff of notoriety as offshore Swiss bank accounts used to hide illicit money.

The US wants G-20 nations to regulate digital wallets so they are not associated with ill-gotten or ill-destined funds.

This is the real challenge for the crypto bubble: it is already of a scale the global financial sector is quarantining it – and, existentially, for the very reason it is attractive to many believers: that it can be used to circumvent the official system.

Andrew Cornell is manging editor at bluenotes

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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